National Lifelong Income Scheme (CPF Life) 2nd Update – My Critique

March 4, 2008 by admin
Filed under: CPF, Current Affairs 

The Crux of my critique

The key recommendations of the National Lifelong Income Scheme (NLIS) have been put forth in the report submitted by the National Longevity Insurance Committee chaired by Prof Lim Pin, and accepted by the government. While some details of the scheme might still be subject to minor amendments, the structure of the scheme and how it will provide a lifelong income to CPF members have more or less been finalized. It is therefore time to critique and take a stand on the scheme.

My take is that while the CPF Life scheme is a vast improvement over the previously announced Longevity Insurance scheme, the CPF Life scheme is still deficient in that the payouts are not indexed to inflation, the government has not expressed any desire to co-fund the scheme, the payout amount is subject to drastic change in the event that interest rates fall or life expectancies improve significantly, and the government is limiting itself to helping the poor with one-off handouts rather than a continuous and sustainable welfare programme.

The compulsory nature of the CPF Life scheme, or more generally, the compulsory nature of the Minimum Sum scheme itself transfers both control and responsibility of a person for his assets to the government. Citizens who are savvy in managing their own wealth and planning for their own retirement may feel that this loss of control is unjustified and is an insult to their intelligence. However, the broader public may not be so savvy, and insurance and annuity schemes that are operated at the national level need to be compulsory in order for them to be actuarially feasible. If the CPF Life scheme is well managed, the interests of the broader community will be served if everyone is compelled to participate. In this case, the needs of the many outweigh the needs of the few.

The key point is that the compulsory nature of these schemes places a great moral burden on the government to manage them competently, on par with or even better than the best that the private sector can provide.

In particular, if both the Minimum Sum and CPF Life schemes are to be compulsory, the onus must be on the government to play its part in ensuring that payouts remain relatively stable no matter how interest rates or mortality rates may change. This has not been done, and this deficiency form the crux of my critique of the scheme as it is currently presented.

On self-reliance, sustainability, government co-funding, and greater transparency

On page 7 of the Committee’s report, it was stated that: “The CPF system is fully funded because it is based on the cardinal principles of self-reliance and self-provision — a member can only spend what he has saved. This principle must be maintained for the LI scheme, so as not to weaken the CPF”.

The Committee’s report also states that the scheme should be operated on a sound financial basis, be sustainable over the long term, and in particular, avoid the pitfalls of under-funded national pension schemes in other developed countries.

While the above reasoning appears logical on the surface, there are deep flaws which really speak of the cold, calculating attitude of the government towards the people.

During a citizen’s productive years, he or she works hard and contributes to our economic growth. The entrepreneural drive and industry of Singaporeans is what makes our nation wealthy. The taxes paid by citizens are used by the government to build infrastructure, develop new technologies, keep our streets and borders safe, and create a conducive environment that attracts investments and creates jobs.

When people grow old and retire, it must be the responsibility of the government to take care of them using the wealth built up by the nation, as it was these people who made that wealth possible in the first place. This is a basic tenet of democratic socialism.

To suggest that people rely solely on each others’ pocketbooks for their retirement needs is mean spirited and heartless, and reduces each person to an economic digit. A country that is being run as a mere corporation loses its soul and its identity, and becomes a hotel rather than a home, a mere stepping stone for those who are able to come and go.

Rather than leaving Singaporeans to fend for each other alone, the government should co-fund the scheme by injecting suplus funds from the budget and directing more of the Net Investment Income (NII) into the scheme in order to enhance payouts. The NII is the investment income of our reserves, which are in turn derived from the blood, sweat and toil of generations past. The government should use this rich source of funds to help Singaporeans retire with dignity.

On page 7 of the Committee’s report, it is stated that the mortality experience in the LI scheme will be reviewed periodically. With regard to financial sustainability, the Committe’s report states on page 32 that “The operator must ensure at all times that assets can meet present and future liabilities. Premiums and payouts must be adjusted periodically to reflect actual mortality experience and investment returns.” Will changing mortality experience and interest rates be used as excuses to squeeze Singaporeans even more in the future? I would like to see this process being made more transparent, with full details of mortality calculations, investment returns, and derivation of monthly payouts published and made available free of charge to the public.

The government is correct to say that the scheme must be financially sound and sustainable over the long run. The Committee’s report has also made clear that premiums and payouts will change when necessary. In the present situation without government co-funding, CPF members’ payouts may have to be drastically reduced should interest rates fall or if life expectancy increases unexpectedly, in order to maintain the financial viability of the scheme. For example, on page 31 of the report, it is stated that if the rate of return from investments is 1 percentage point lower than expected, it could lead to monthly payments being reduced by 20%. This will certainly affect members’ quality of life and may cause hardship. Hence, government co-funding is necessary to protect members from fluctuations in interest rates and life expectancy which are outside their control, and enable them to retire with peace of mind, knowing they can always provide for their next meal.

On inflation protection

For the month of January 2008, the inflation rate hit 6.6%, on the heels of a rising trend of inflation since last year. CPF members and retirees have had their purchasing power reduced as CPF interest rates and Minimum Sum payouts have not kept up with inflation.

The CPF Life scheme does not index its payouts to inflation, putting participants at risk of not having sufficient income to meet their basic living expenses in their later years. For example, assuming that the inflation rate is a steady 3% per annum, which is considered moderate given our recent experience, a monthly payout of $600 begun at age 65 will only have the purchasing power equivalent to $385.12 at age 80, and $332.21 at age 85 — not very much different from the original amount promised by the government under the defunct Longevity Insurance proposal with non-refundable premiums!

In the brochure “A Quick Guide to CPF Life” published by the Ministry of Manpower (MOM), it is explained that the scheme offers some limited protection against inflation as payouts are pegged to prevailing interest rates, which are supposed to rise with inflation.

However, recent experience has shown that this need not be the case. For example, the three-month Singapore interbank offered rate (Sibor) dropped to 1.76 per cent last month, its lowest level since February 2005, despite escalating inflation. The 10-year SGS bond yield is currently around 2.5 per cent, not significantly different from the average yields recorded last year.

Given the apparent disconnect between prevailing interest rates and the rate of inflation, I am concerned that CPF Life payouts will not be adequate for retirees’ needs should inflation continue to trend higher over the long run. It is imperative that a greater degree of inflation protection be afforded to CPF members.

On page 21 of the Committee’s report, it is stated that: “The Committee noted that while monthly payouts indexed for inflation would be ideal, such plans would be the most expensive and require higher premiums. Monthly payouts would also have to be much less in earlier years, so that more could be paid later. Moreover, many members of the public feared that they would not live long enough to receive later and higher payouts. For these reasons, the Committe proposed not to have step-up payouts. Instead a steady income for life would be recommended for the basic scheme.”

Unfortunately, a fixed income would reduce a members’ purchasing power by close to 50% in 20 years, assuming a 3% annual rate of inflation, undoubtedly causing much financial hardship. Since allowing prevailing interest rates to rise too much may not be feasible, the government should provide periodic top-ups to the members’ account in earlier years and allow it to accumulate interest, so that in later years, payouts can rise in tandem with inflation.

Lack of universal coverage of the scheme

An estimated 25% of active CPF members who turn 55 in 2013, the first cohort who will participate in the CPF Life scheme, will have less than $40,000 cash balance in their Minimum Sum and will be excluded from the scheme although they can opt in.

On page 22 of the Committee’s report, it is stated that: “Some members of the public had also requested that the government help fund the LI scheme for CPF members who have insufficient funds. The Committee considered this issue and concluded that such assistance should not be a permanent feature of the LI scheme structure as the CPF system was fair and based on members saving for their own needs. Nevertheless, the Committee agreed that one-off measures could be considered by the government to help this group.”

Yet, if the government merely resorts to one-off meaures to help the poor or give one-off incentives to encourage people who would not otherwise qualify to opt into the scheme, that may not be of much assistance in the long run with the rapidly rising cost of living. These groups of people will still be left without a strong safety net, given that even if they manage to join the scheme, their monthly payouts will likely be extremely small.

A longer term approach has to be devised to help the poor and those without the minimum of $40,000 cash balance in their Minimum Sum.

CPF Board to administer the scheme

I agree with the Committee’s recommendation that CPF Board administer the scheme. I would rather the scheme be administered by a central govenment body than by private insurance companies, many of which have a habit of giving poor returns to policy holders when financial markets do not perform well. I do not have a very favourable impression of the way private insurance companies price their products nor the kind of payouts or bonuses received by holders of “for-profit” policies in recent years, especially the recession years of 2001-2003.

Monthly payouts not exactly proportional to Minimum Sum balance

The Committe’s report states that monthly payouts will be proportional the the Minimum Sum balance, but I found that it is not exactly or directly proportional. For example, according to the CPF Life calculator at the CPF web site, a male with $67,000 cash balance in his Minimum Sum would get a monthly payout of approximately $604 under the Refund-80 option. However, a male choosing the same option with $134,000 cash balance in his Minimum Sum would get a monthly payout of only $1,132, which is less than twice the previous one.

I have written an email query to the CPF Board on this, and their response was that this is due to the tiered interest rate structure where only the first $60,000 of CPF monies earns the extra interest (of 1%). In other words, due to the first $60,000 attracting a higher interest rate, the government can afford to pay slightly more on that portion of the Minimum Sum cash balance. This point should be made clear to the public.

Are Singaporeans really for the LI scheme?

On page 6 of the Committee’s report, it was stated that: “The Committee concluded from its consultations that Singaporeans wanted the LI scheme.”

However, an informal Channel NewsAsia poll taken in October 2007 showed that when readers were asked if they wanted the option of having higher premiums and a payout age of 80 instead of 85, 15% out of a total of 743 readers voted “I don’t mind this option as I think the spare funds will be of better use when I am 80″, whereas 85% voted “I disagree with the whole idea of compulsory annuities in the first place“.

Discussions on internet forums such as the popular Sammyboy Alfresco Coffeeshop forum hosted on the Delphi Forums platform during that period showed very similar sentiment.

Although, as I have acknowledged, the CPF Life scheme is a vast improvement over the old proposal, the Committee did not release any updated polls, surverys, statistics or any other empirical evidence demonstrating that Singaporeans had embraced the new CPF Life scheme.

Some back-of-the-envelope calculations

I have made some back-of-the-envelope CPF Life calculations (this is a slight update from the previous version I made).

This example is for a male participant who has $67,000 cash in his CPF Minimum Sum (assuming a total Minimum Sum of $134,000, of which half is property pledge, and half is cash savings).

These are my assumptions:

(1) The government makes a consistent rate of return of 5% on ALL of its funds under management. That is, the government is able to invest both the Retirement Account (RA) and Refundable Premium (RP) at an ROI of 5%. The return on the RP is NOT accrued to the CPF member’s account but instead held in government coffers. Only the return on the RA is accrued to the CPF member’s account and distributed to beneficiaries in the event of early demise. Any investment return earned on the RP fund is kept by the government.

(2) Monthly income of $610 begins at age 65.

(3) The member chooses an LI payout age of 80.

The following table shows the balance amount in the member’s RA and RP account at each age from 55 to 90, the amount that the beneficiaries would get in the event of demise, as well as the net profit that the government earns from the scheme, which is the interest earned from the RP pool minus off the cumulative payouts made so far from the pooled premiums to the CPF member.

From the age of 65 to 80, the RP pool is not touched — only the RA funds inclusive of interested earned are drawn down to provide the monthly payments.

I am assuming that after the age of 80, the government starts paying off the member using the pooled RP fund including any residual amount left in the RA, while continuing to invest the pooled fund at an ROI of 5%. However from this point onwards, none of the interest earned is accured to the member’s account as the RA portion has become nonexistent. (After age 80, the table below simply reflects a single account that the member holds, which accures no interest whatsoever.)

The member gets $7,320 per year, based on a monthly income of $610. As can be seen from the table, the RA fund has insufficient balance to pay the member by age 80. After age 80, there is no more RA fund, just one account from which the monthly income is drawn, which accures no interest.

By the age of 80, the government is estimated to have as much as $38,372.59 net profit. That is a HUGE profit for the government! In fact, the net profit for the government increases to a high of $45,722.79 by the time the member reaches age 83! Clearly if the CPF member passes away around the ages of 80-85, the government stands to earn a LOT OF MONEY from the scheme! This is because the interest earned on RP fund is NOT given to the beneficiary but kept in the common pool upon the member’s death.

As can also be seen from the table, the amount of money that left outstanding in the member’s account rapidly diminishes after 80, so that by age 84, the beneficiary would get NOTHING in the event of demise of the member. However, the government coffers still have a lot of cash. There is enough cash in the government coffers to pay the member $610 per month for several more years while still maintaining profitability from the scheme. It is only AFTER the age of 90 (not shown on the table) that the government starts losing money on the scheme.

This back-of-the-envelope calculation shows that even assuming the government is right about half of CPF Life participants surviving to 85 years of age, the government will clearly make a net profit from most members, given that comparatively fewer members will make it past 90 years of age.

It is therefore very fair to assume that the government could perpetually generate large surpluses from the scheme, especially when we take into account the fact that premiums and monthly payouts will be altered in accordance with morality experience and the return of investments, thereby ensuring that the government seldom goes into deficit in any particular year.

(EDITOR’S NOTE: There was a correction to the calculations in this section. – 05 Mar 2008)

In conclusion

The CPF Life scheme is an attempt to repair a national pension system that has become inadequate in sustaining members through old age. The reason why the CPF system has become deficient in the first place is because of persistently low interest rates paid on CPF accounts, which has prevented members from building their wealth, as well as members having to pay a large amount of funds towards their property. As a result of these two factors, and to some extent the inadequacies of the Medisave system in taking care of members’ medical needs, the CPF Life scheme is needed to fill the gaps of this sinking ship.

My back-of-the-envelope calculation coupled with the government’s current stand that premiums and monthly payouts will be altered in accordance with morality experience and the return of investments shows that even when implementing the CPF Life scheme, the government is mercenery enough to insist that it has virtually a 100% chance of making a good profit from the scheme.

My take therefore is not that people should be made to adhere to the principles of self-reliance and self-provision at all cost, but that the government should be weened of its reliance on the people to fatten its already bulging coffers, and instead help provide for the peoples’ retirement from its massive vaults which house the blood and toil of generations past.

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Comments

4 Comments on National Lifelong Income Scheme (CPF Life) 2nd Update – My Critique

  1. Daily Sg: 5 March 2008 « The Singapore Daily on Fri, 7th Mar 2008 6:07 pm

    2. [...] CPF & Annuities – Sgpolitics.net: National Lifelong Income Scheme (CPF Life) 2nd Update – My Critique [...]

  2. Phinehas on Tue, 15th Apr 2008 11:18 pm

    3. hello, i would be interested to see a sensitivity analysis for the table with varying ROI (say 3% – 7%?). if you don’t want to publish it, would you send the excel calc to me by email? :)

  3. Jeff Lu on Sat, 2nd May 2009 10:47 pm

    4. i believe people failed to see the big picture of this issue, so here is my opinion;

    immediately after the 2006 ge sporeans took a lot of nasty news from the pap
    including this NLIS. the pap lost 30% of the popular votes to the opposition
    and they are furious, they are bent on whacking the group of people who voted
    against them. they have since unleashed their wrath on the baby boomers.
    the picture is as clear as this.

    as yourself what did the pap do when they lost 4 seats to the opposition in
    another ge when chok tong was pm?

  4. Enol Tan on Sun, 11th Apr 2010 6:24 pm

    5. Jeff Lu,
    Agreed!

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