Investment of CPF monies by GIC

Mr Gerald Giam Yean Song asked the Deputy Prime Minister and Minister for Finance (a) how many years, if any, in the last 20 years is GIC unable to pay the interest on the Special Singapore Government Securities (SSGS) owed to the CPF Board from its normal investment returns; (b) what are the returns from GIC’s investment portfolio after accounting for the interest payable on the SSGS in each of the past 20 years; and (c) what extraordinary measures, if any, are taken in the last 20 years when normal GIC returns are insufficient to pay the SSGS interest rate.

This is the question I asked the DPM and Finance Minister on 8 July 2014 in Parliament, regarding GIC’s investment of CPF monies. His reply is below.


11. Er Dr Lee Bee Wah asked the Deputy Prime Minister and Minister for Finance a) how CPF monies are invested; b) what are the returns from the CPF Board’s investments; c) how does the CPF Board determine the interest to be paid to CPF account holders and whether it will review the current interest rate to pay a higher rate; and d) whether CPF account holders can be given a risk-free option to invest their funds directly in Temasek Holdings to earn better returns.

12. Mr Gan Thiam Poh asked the Deputy Prime Minister and Minister for Finance (a) where and how has the Government invested the proceeds from the Special Singapore Government Securities, which the CPF Board invests in with the CPF monies; (b) whether it is possible to invest these proceeds such that they yield high returns with no risk even though high-risk investments typically yield high returns and vice versa; (c) what steps are put in place to ensure that these investments are sound, prudent and viable; and (d) whether independent internal and external audits are conducted regularly to ensure and safeguard the CPF investments and funds.

13. Mr Lim Biow Chuan asked the Deputy Prime Minister and Minister for Finance (a) what are the rates of interest paid by the CPF Board on CPF funds for the past 10 years; and (b) whether the CPF Board will consider paying a higher interest rate or pegging the interest rate paid on CPF funds to the rate paid on 10-year Singapore Government bonds.

14. Mr Gerald Giam Yean Song asked the Deputy Prime Minister and Minister for Finance (a) how many years, if any, in the last 20 years is GIC unable to pay the interest on the Special Singapore Government Securities (SSGS) owed to the CPF Board from its normal investment returns; (b) what are the returns from GIC’s investment portfolio after accounting for the interest payable on the SSGS in each of the past 20 years; and (c) what extraordinary measures, if any, are taken in the last 20 years when normal GIC returns are insufficient to pay the SSGS interest rate.

The Deputy Prime Minister and Minister for Finance (Mr Tharman Shanmugaratnam): Mdm Speaker, may I take Question Nos 11 to 14 together?

Mdm Speaker: Yes, please.

Mr Tharman Shanmugaratnam: Thank you, Mdm Speaker. Minister Tan Chuan Jin has explained the basic features of the CPF system, the reasons for the Minimum Sum scheme, and the areas which can be improved. Dr Lee Bee Wah, Mr Gan Thiam Poh, Mr Lim Biow Chuan, Ms Tin Pei Ling and Mr Gerald Giam have asked further questions on whether higher returns can be paid without changing the risk-free nature of CPF accounts, and how CPF funds are invested and safeguarded. They have also asked about the GIC’s investment returns.

Before I get into the details on these questions, it will be useful to provide some perspective on the challenges faced by retirement savings schemes around the world. There is a looming pensions crisis in most of the advanced countries, and the challenges remain largely unresolved.

The first challenge is financial sustainability. In many advanced countries, the “pay-as-you-go” social security system has become unsustainable. As more of their citizens are retiring, the pensions they have been promised are becoming unaffordable to those who have to pay for the system, in other words, the younger citizens who are working and contributing through social security taxes.

Some of these countries have responded with politically difficult but necessary reforms, such as postponing the retirement age or cutting retirement benefits for younger workers. Most recently, the Australian government has proposed major reforms to its Age Pension scheme, which is the primary source of income for the majority of Australian pensioners today. These reforms include raising the age at which pensions can be withdrawn from 65 to 70 years old.

But in many cases, the severity of the problem has not been acknowledged and reforms have been postponed. In the US for example, most public pension funds still over-estimate their future investment returns, and understate their liabilities. With more realistic assumptions, it is estimated that about 85% of US public pensions will go bankrupt within the next 30 years. So this is the first challenge – financial sustainability.

The second challenge is to give individuals a fair return on their retirement savings but avoid exposing them to more risk than they can bear.

As both governments and employers face increasing difficulty in funding “pay-as-you-go” pension schemes, more risk is being shifted to the individual in many countries. The shift is to pension plans where the worker’s savings go into his own account, and he eventually draws on his own account in retirement. The 401(K) schemes in the US are an example. These schemes which are called “defined contribution schemes”, are like the CPF in that the eventual payouts are funded by the contributions by the worker and employer into his account, not payouts funded by future workers. But in many such schemes, unlike the CPF, the worker has to choose his own investment plan, and bears the risk on his investments.

In theory, individuals can expect to earn higher returns over the long term by taking more risk on investments, such as investing more in equities or equity-heavy funds. In practice, there are three problems. First, the evidence from the advanced economies shows that most individuals underperform the market, even when they invest in funds rather than do their own stock-picking. Some individuals do well, but most face daunting and unfamiliar investment choices, and are swayed by sentiment. They tend to buy into the funds after gains have been made, and sell after losses. As a result, in the US, for example, individual investors in equity funds earned only one-third of what the market index earned over the last 30 years; one-third of what the S&P Index earned over the last 30 years. Fees charged by private pension funds eat into the returns earned by individuals. In Europe this is another reason why returns on private pension funds have been low in the last decade.

A second risk is that you may retire when the financial markets are down. A recent article in the TheEconomist magazine described the typical retirement scheme as a lottery, because the individuals’ pot of money at the time they retire will depend on the state of the markets at the time. For example, an individual who retired just before the Global Financial Crisis will have much more income in retirement compared to an individual who retired during the crisis. One year can make a big difference.

A third risk is that you retire when interest rates are low. The current prolonged low-interest rate environment is in fact a major challenge in many countries, because the pot of money that you have upon retiring now gives you a smaller stream of annuity income for the rest of your years. This is the consequence of low interest rates, either the annuity becomes more expensive to buy or for the same pot of money you get a smaller stream of income for the rest of your years.

Many retirement schemes require or encourage members to convert their capital into an annuity or monthly payout. However, interest rates matter greatly when buying an annuity, and unlike CPF LIFE, these schemes do not provide a floor on interest rates. So when market interest rates go down, the member experiences has to buy an annuity that is either more expensive or he gets a smaller stream of income in retirement for the same pot of money that he has.
Even if individuals are relieved of the requirement to buy an annuity that pays out for life, which some governments have been tempted to do, it does not solve the problem. Low market interest rates mean that retirees will receive less income even if they invest on their own in suitable retirement portfolios.

I have provided this background, Mdm Speaker, to explain why our CPF system has worked well and provides a strong foundation for the future. It has protected members from risk. The scheme is aimed at meeting basic retirement needs. As many members have had relatively small balances, it has been right to shield them from risk. The CPF has also avoided imposing risk on taxpayers, unlike many countries where ordinary citizens face a much larger tax burden in future, on account of under-funded social security schemes.

The CPF is not a perfect retirement savings scheme, but it is amongst the better regarded internationally. As the Prime Minister has stated, we want to improve the CPF to provide greater security in retirement, especially for those with lower wages and to help retirees cope with inflation. We also want to give those who are “asset-rich and cash-poor” more convenient options to get cash from their homes.

But as we seek to improve the CPF or to add any flexibility, we must retain its basic strengths and avoid the huge problems seen elsewhere:

First, our CPF system is sustainable. There are no unfunded or sudden liabilities that will burden our children’s generation.

Second, the CPF offers some flexibility for members to withdraw savings, indeed more so than many other social security systems. In particular, by tapping on their Ordinary Account (OA) savings, the vast majority of Singaporeans have been able to own their homes and service their mortgages with little or no out-of-pocket cash, which Minister Tan has just emphasised.

Third, while the CPF scheme does not provide the highest returns, it gives fair returns and certainly one of the safest in the world. Whilst the CPF does not provide the highest returns, it provides one of the safest in the world. These are fair returns. Few systems offer the guaranteed floors on interest rates – 3.5% of the OA and currently 5% on the SMRA (Special, Medisave and Retirement Accounts) for those with smaller balances, who comprise the majority of members. And for those with larger balances, it is 1% less. The interest rates are guaranteed by one of the few remaining triple-A rated governments in the world.

The CPF also offers the option to members who wish to place more money in their Special Account (SA) account, so that they can earn a higher interest rate than on their OA Account, and it allows them the option of taking higher risks through the CPF Investment Scheme (CPFIS) in the hope of higher returns. So that is the third strength – fair returns and safe returns.

Fourth, on top of the guaranteed interest rates, the Government subsidises CPF members through the Budget in a targeted and sustainable manner. We provide significant help to lower income members to build up retirement assets, by giving them housing grants in their OA and CPF contributions through the Workfare Income Supplement (WIS). Members of the Pioneer Generation also now get top-ups for life in their Medisave accounts.

Taken as a whole, our CPF system prepares Singaporeans well for the future. Based on current policies, a new entrant into the workforce today can expect to draw a retirement income of about two thirds of his last-drawn pay if he is a median income earner. This is around the OECD average. He gets a much higher ratio of his previous pay if he is a lower income earner, chiefly because of Government subsidies. As Minister Tan has said, our key concern is to help the current generation of older Singaporeans who have lower balances, often very low balances, due to their much lower wages in the past and the more liberal withdrawal rules then.

Let me now address the specific questions on how CPF interest rates are determined. The current CPF interest rate structure was implemented in 2008. It was an enhancement, especially for members with smaller balances. We debated the changes in Parliament in 2007, as part of the broader package of reforms to strengthen retirement security.
The fundamental principle is to peg CPF interest rates to returns on investments of comparable risk and duration in the market. We also structured the interest rates to provide greater benefit to members with small and medium-sized balances, by paying Extra Interest (EI) on the first $60,000 of balances.

Let me start with the OA rate. In determining the interest rates, we have to recognise the fundamental difference in the purpose of the OA compared to the longer term SA, MA and RA (or SMRA). OA savings can be withdrawn at any time for home purchases, servicing mortgage loans, or education. It is a liquid account. The interest rate on OA has therefore been pegged to the 12-month fixed deposit and month-end savings rates of the major local banks. However, unlike market interest rates, it pays a guaranteed floor rate of 2.5%, or 3.5% for OA balances of up to $20,000. More than half of all members enjoy the full 3.5% on their OA.

Tu Members also have options to earn more than these OA interest rates. They can transfer OA savings to the SA so that these become long-term savings, earning higher returns. That is an option that members have. It is a useful option for those who have paid up their housing loans. Those who want to take on market risks in the hope of earning better returns can also invest part of their OA balances through the CPFIS.

Furthermore, the CPF interest rates are not the only help that members get to build up their savings. As I had just mentioned, the Government also provides subsidies through the Budget to CPF members, targeted especially at lower and middle-income members. These subsidies in effect amount to a significant boost to what a typical lower income member earns on his balances.

If we look at his OA, in particular, on top of the 3.5% interest rate on his OA, he gets Workfare payments and housing grants. When he sells his home to upgrade or downgrade later, the housing grant is returned to his OA as part of his savings for retirement. Based on current policies, these grants (amortised over his working life) will in effect grow his savings by at least 2.5% per year over a 30-40 years of working life. So, in effect, his savings ‘earn’ 6% per annum through the combination of CPF interest rates and Government subsidies.

This does not include the OA savings used to purchase the housing asset, which benefits separately from appreciation in housing value. As Minister Tan explained, his home is an important retirement asset, and based on its value, he can withdraw monies from his CPF balances at age 55.

The OECD highlighted this critical role of homeownership in its recent analysis of pension systems in the advanced countries. Homeownership “can make a big difference for many pensioners, both reducing the need for cash and providing a way to generate income later in life.”

Mr Lim Biow Chuan asked if CPF interest rates could be pegged to those on 10-year Singapore Government Securities (10Y SGS). The OA interest rate, pegged to market deposits that can be withdrawn at any time, is fair. However, for several years now, the OA has earned the floor rate of 2.5% to 3.5%, well above the market rates. It also means that the OA has in fact been earning more than what 10Y SGS earns. The average yield on 10Y SGS over the past 10 years has been 2.4% and it is currently about 2.3%. So the floor rate of the OA at 2.5% to 3.5%, depending on the size of your balances, has in fact been higher than even the 10Y SGS.

The SMRA, on the other hand, is pegged at 1% above the 10Y SGS, which I will now explain. The Special Account and Retirement Account are as we all know held for retirement. It is long-term savings. As Medisave (MA) balances are also mainly used as Singaporeans get older, we have treated them like the SA for purpose of determining interest rates.

The returns on the SMRA have been enhanced over the years. When we set the new basis for SMRA rates in 2007, our aim was to peg it to the rates for similar long-term, risk-free investment. This was what the Economic Review Committee (ERC) had recommended in 2002.

The best peg would have been a 30-year government bond, because 30 years is the typical duration for which SMRA monies are held. However, as we had not started issuing 30-year SGS in 2007, SMRA rates were pegged to the yield on 10Y SGS plus 1%, to approximate the 30-year rate. 10Y SGS plus 1% was an approximation of what a 30-year government bond would have paid.

As I told the House then, when we debated the changes to the CPF, the 1% spread on top of the 10-year government bonds was in fact a little generous, as it was higher than what had been observed for 30-year bonds in international markets. However, it was fair and reasonable, giving allowance for future economic and market uncertainties, such as if inflation picks up sharply over the long term.

Going by the formula for SMRA rates, we would be paying about 3.4% today on SMRA. This is higher than the actual yield of 3% on the 30Y SGS, which we now have but is not widely traded. So 3.4% is what the formula would dictate for SMRA. However, we have maintained a floor of 4% on SMRA, or 5% on balances of up to $60,000. We have renewed this floor each year since 2008. Two-thirds of CPF members in fact earn the full 5% on SMRA.

This is a fair system of returns for the SMRA. The CPF in essence pegs SMRA returns to long-term SGS, but it has also been paying a floor of 4% to 5% that is well above market rates in the current environment. As I explained earlier, we have shielded members from the risk of low market interest rates.

I will next explain how CPF monies are invested, as asked by Er Dr Lee Bee Wah and Mr Gan Thiam Poh. The CPF Board invests CPF members’ monies in Special Singapore Government Securities (SSGS). These are issued specially by the Government to CPF Board. They are not traded instruments. The payout from the SSGS is pegged to the interest rates that the CPF Board is committed to pay its members.

The Government guarantees these SSGS bonds, so that CPF Board faces no risk of being unable to meet its obligations to its members. This is a solid guarantee, from a triple-A credit-rated government. The triple-A credit rating reflects Singapore’s very strong financial position, with the Government’s assets comfortably exceeding its liabilities. Both Standard and Poor’s and Moody’s recently reaffirmed our triple-A credit rating, noting that our strong net asset position provides ample cushion against shocks.

What does the Government do with the proceeds from SSGS issuance? It pools them with the rest of the Government’s funds, such as the proceeds from the tradable Singapore Government Securities (SGS), any government surpluses as well as the proceeds from land sales which under our Constitutional rules have to be accounted for as past reserves. So, the Government pools the SSGS proceeds with the rest of the Government’s funds.

The comingled funds are first deposited with MAS as Government deposits. MAS converts these funds into foreign assets through the foreign exchange market. A major portion of these assets are however of a longer term nature, and are hence transferred over to be managed by the GIC.

The SSGS proceeds are not passed to Temasek for management. Temasek manages its own assets, and does not manage any CPF monies.

What these investment arrangements mean is that CPF members bear no investment risk at all in their CPF balances. Their monies are safe, and the returns they have been promised are guaranteed. Neither does the CPF Board bear any risk, regardless of whether the GIC’s investments earn or lose money in any particular year. The risk is wholly borne by the Government, on its own balance sheet.

The Government pools the proceeds from SSGS with its other assets, and invests long-term funds through the GIC. The GIC does not, in fact, manage SSGS monies on their own, separate from the Government’s other assets. This is an important distinction, which I will come to later. GIC is fund manager for the Government, not owner of the assets and liabilities. It seeks to achieve the Government’s mandate of achieving good long-term returns, without regard to the sources of the funds that the Government places with it – for example, whether they are proceeds from SGS, SSGS or government surpluses.

Over the long term, our investments in GIC have earned a creditable return. For example, over the last 20 years, GIC earned 6.5% per annum in US dollar terms, which translates to 5.0% per annum when expressed in Singapore dollar terms.

But that is not the whole story. The average long-term return masks wide fluctuations in returns from year to year. You can have good average, long-term returns but what it disguises is variations which can be very significant from year to year. To answer Mr Gerald Giam’s question, over the last 20 years, there were eight years where GIC’s investment returns were below what the Government pays on SSGS.

A good example was the Global Financial Crisis. As I stated in Parliament at the time, GIC’s portfolio value in US dollar terms declined by about 25% during the 14 months from October 2007. October 2007 was a peak and from then to December 2008, GIC’s portfolio value declined by 25%. GIC’s performance was similar to that of other funds with a similar mix of asset classes, but it illustrated the market volatilities faced by every long-term investor.
Even over the five years following the crisis, ending 31 March 2013, GIC earned an annualised return of just 2.6% in US dollar terms, which translates into a mere 0.5% in Singapore dollar terms. GIC’s Annual Report explains the reasons for this weak recovery from the crisis, especially in illiquid asset classes that it was holding, like real estate. Its five-year annualised returns are expected to improve significantly going forward.

Hence, while the Government expects to earn returns through the GIC over the long term that exceed what it pays on SSGS, and has done so in the past, there is no assurance of GIC’s returns exceeding SSGS interest rates over shorter periods, much less every year. This is also because of the guaranteed floor on CPF interest rates, which do not follow declines in market interest rates.

How then is the Government able to meet its SSGS obligations in the years when the markets are weak and GIC’s returns fall below what the Government has to pay SSGS? The reason is that the Government has a substantial buffer of net assets – net assets meaning assets in excess of liabilities – which ensures that it can meet its obligations. In years when investment returns are poor, the net assets have helped to absorb any losses and ensure that the Government can meet its obligations on the SSGS as well as its market-traded SGS. Correspondingly, when investment returns are strong, the net assets grow.

To address Mr Gerald Giam’s further question, therefore, no extraordinary measures have been necessary to enable the Government to meet its SSGS obligations in the years when GIC’s returns fall short.

It is this role of the Government, with its significant net assets, that ultimately allows the CPF Board and CPF members to be shielded from risk. The Government, through GIC, expects to earn good returns over the long term, but the volatility can be substantial from year to year. The Government has been absorbing that volatility, and protecting CPF members.

This is also the reason why no market player, other than the Government, is able to take on the CPF obligations. The guarantor is not merely playing the role of a long-term investor. It also must have significant capital that provides a buffer when the markets are down.

Our CPF system is hence sustainable, so long as the Government continues to run prudent budgets, and invest the reserves wisely. Then the Government’s balance sheet will remain strong and investment returns over the long term can continue to meet our debt costs.

However, the GIC’s good long-term returns also reflect the fact that it is managing the Government’s assets as a pool, which includes the Government’s unencumbered assets – in other words, assets that are not matched by liabilities. This is a critical feature of our system. The GIC is managing Government assets as a pool, and the pool comprises not just assets that are backing the SGS and SSGS but also the Government’s unencumbered assets – past Government surpluses, proceeds from land sales, which under our Constitutional rules have to be accounted for in, past reserves, these are unencumbered assets – and the GIC manages the whole pool of assets as one pool. This allows the GIC to invest for the long term, including investing in riskier assets such as equities, real estate and private equity.

It would be quite different if the GIC, instead of managing the Government’s pooled assets, were to manage a separate, standalone fund to provide backing for CPF liabilities. A standalone fund would have to be managed much more conservatively, to avoid the risk of failing to meet CPF obligations. It would not be aimed at accepting risks that enable good long-term returns, but at avoiding any short-term shortfalls. Consequently, the returns it would earn over time will be lower than what the GIC can achieve in its current role.

Finally, I should emphasise that the investment returns in excess of the SSGS rates that the GIC expects to make as a long-term investor are not simply hoarded away in the reserves. Fifty per cent of the returns from our reserves flow back to our annual Budget through the Net Investment Returns Contribution (NIRC). This currently adds about $8 billion to our Budget annually. The NIRC has provided the Government valuable resources that have allowed us to embark on new priorities for Singapore, including enhancing our social safety nets.

Mr Gan Thiam Poh asked about independent audits and other measures to safeguard CPF investments and funds. As I have explained, CPF monies are invested in SSGS that are guaranteed by the Singapore Government. The Singapore Government’s guarantee is a key safeguard.

CPF Board, besides its own internal auditors, is externally audited by professional audit firms approved by the Auditor-General.

As for the Government’s investments, I can assure Members that GIC is audited on a regular basis. GIC’s financial statements are independently audited by the Auditor-General every year. Its audited financial statements are submitted to the President and the Council of Presidential advisors annually. The President also has full information about the size of the reserves and the performance of GIC’s investments. GIC’s investment performance over 5, 10 and 20 years is also made public through its Annual Reports.

To conclude briefly, let me just reiterate that our CPF system is sound, and provides a solid foundation for Singapore’s future. It is not a static system. Over the years, we have adjusted the system, such as to reduce the scope for housing withdrawals and focus increasingly on retirement and medical needs in old age.

As the Prime Minister has said, we intend to make important future improvements to the CPF to strengthen retirement security. Minister Tan has assured Members that we are open to different views and suggestions.

Whatever we do to improve the system, we must provide fair returns to the ordinary member who is unable to take on much risk, and ensure that the CPF remains sustainable over the long term. The Government should continue to subsidise CPF members, especially those with lower incomes, but these subsidies should be provided through the Budget, so as to ensure the CPF is sustainable.


Source: Singapore Parliament Reports (Hansard)

Author: Gerald Giam

Gerald Giam is the Member of Parliament for Aljunied GRC. He is a member of the Workers' Party of Singapore. The opinions expressed on this page are his alone.