Thursday, November 17, 2011

Flexible Pensions

The state pension systems adopted in many advanced countries are now in deficit, due to ballooning cost and under-funding. This does not mean that the pension system is inferior to the provident fund system (such as the Central Provident Fund operated in Singapore). The provident fund system also has its pitfalls.

The key weakness of the pension system is its rigidity. It aims to pay the pension in predetermined amounts when asset values and economic conditions can fluctuate significantly. A better solution, which has not been tried, is to have flexible pensions, i.e. the amounts will be changed according to the underlying value of the assets. This type of flexible values are already embodied in mutual fund investments and can be applied to make pension payments flexible and keep the system solvent over the long term.

There are two key advantages in the pension system. First, it provides for pooling of investments over the long term, by professional fund managers. This is much better than allowing the retirees to take out their provident fund savings to invest on their own - as most lay people cannot manage their own investments.

The second benefit is the pooling of longevity risks. Those who die younger draw out less, and allows the pension fund to pay the pensions to those who live longer.

The fear about insolvent pension schemes can be addressed by building in the flexibility to the pension payments.  In good economic times, the pensions can be bigger. In bad times, they can be smaller. The pensioner can cope with fluctuating pension amounts (provided that the adjustments are modest and made every six months). When they receive a smaller payment during an economic downturn, the cost of living will probably be lower - so the smaller pension payments may still be adequate.

It is time for Singapore to convert CPF Life into a flexible pension scheme and to make it attractive for retirees to invest their savings (other than the CPF minimum sum) in a sound pension scheme.


Unknown said...

I agree, changes need to be made. Apart from flexibility, I think we need to incorporate the same kind of transparency that other pensions schemes have.

When I did interviews about the CPF, most of the comments were quite negative.

Tan Kin Lian said...

It is difficult to explain the current CPF, as it has evolved into a complicated scheme to serve for many purposes. In the process, it has neglected its core purpose of being scheme to save for retirement.

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