Now that defined contribution (DC) plans will become the sole source of retirement funds for most people around the globe, it’s a good time to ask some probing questions about their effectiveness. Are DC plans an efficient vehicle for the accumulation of adequate retirement benefits? Even when comparing cost-equivalent DB and DC plans, are there structural inefficiencies in DC plans that result in lower retirement benefits?

To learn from the experience of others, we looked at countries in the Asia Pacific region that have some of the more mature mandatory first or second pillar DC systems. This article examines the mandatory systems in three of these countries – Australia, Singapore and Malaysia – to see how successful these DC systems have been in providing retirement benefits for their citizens.

A little background

First, let’s look briefly at the key details of the three DC systems under review. The criterion for inclusion was that all needed to be relatively mature systems, and the Singaporean Central Provident Fund (CPF) certainly makes the grade, having commenced in 1955. Malaysia’s Employees Provident Fund (EPF) is also mature, having commenced in 1958. The Australian system commenced development in 1987, with the inclusion of mandatory superannuation contributions added to industrial awards, but commenced fully in 1992 with the introduction of the Superannuation Guarantee Charge. While a little younger than its two cousins, the Australian system is regarded by many as one of the most advanced in the world.

The Australian model is considered second pillar, in that it is distinctly separate from the government and from the first pillar age pension system. Both the Singapore CPF and the Malaysia EPF are first pillar systems – they are centrally run, and there is no basic state pension in either country. Some key features of the three systems are as follows:

From the table above, it appears that a large difference in retirement income would result based on the contribution rates alone, with Malaysia and Singapore requiring much higher contribution rates than Australia would. However, we will see later that you can’t necessarily judge a book by its cover.

Performance review

In order to consider the success of these mature DC systems, what can be learned from their experiences, and where improvements can still be made, we have conducted a performance review based on several key factors, set out below.

Let’s have a look at how the DC systems of Australia, Malaysia and Singapore have performed in these areas:

Legend:

	.	Australia	.	Malaysia	.	Singapore
Benefit adequacy
Contributions		9 percent contributions are insufficient, and employee contributions are low		16.1 percent allocated to retirement Reasonable prevalence of employer voluntary		High contributions, which may be used for retirement
Benefits		High prevalence of lump sum   Draw-down gaining in popularity		High prevalence of lump sum   Draw-down gaining in popularity		High prevalence of lump sum   CPF LIFE from 2009, although needs expansion
System leakage
Taxes		Taxed-Taxed-Exempt (TTE) - low or no tax at each point		Exempt-Exempt-Enjoy (EEE)		Exempt-Exempt-Tax (EET)
Nonretirement benefits		Minimal ability to withdraw before retirement		Only 30 percent of contributions for non-retirement purposes. Remaining contribution is adequate		As little as 5 percent of salary specifically allocated for retirement
Value for money
Fees		Average around 1percent of balance, all inclusive   Competitive provider market keeps fees low		Management fees of approx. 0.2 percent Lack of transparency regarding what other costs are implied		Lack of transparency regarding what costs are really paid by members
Investment returns		Wide array of choice of portfolio Default option will typically involve moderate risk for long term		Conservative investments, typically yielding 4  - 5 percent pa Alternative investments available for those with high balances Minimum return of 2.5 percent pa, appropriate for conservative investment with no choice		Interest rates (for retirement savings) based on 10-year government securities + 1 percent Minimum return of 4 percent pa on retirement savings; has been continuously applied since 1999 Minimum return to be removed in 2010 - potential drop in returns based on historical results Alternative investments available for those with high balances
Governance/security
		World-class risk-based monitoring by regulator   Providers must be licensed, requiring strict governance processes Limited government protection in case of fraudulent loss		Implied government support		Implied government support
Employee engagement
Education		Improved education by providers, but still 53 percent of working-age population with poor numeracy skills		No education program		Significant efforts being made by government, CPF and others, but long way to go
Effective decision making		Low levels of active investment decisions and voluntary contributions		Poor management of lump sum benefits		Poor management of lump sum benefits, low allocation to retirement

As can be seen from this summary, by no means are these three systems consistent in all aspects of their successes and failures. However, there are still several areas in which each system is facing the same problems.

Key successes

Being mandatory systems, each has been successful in delivering retirement benefits to the man on the street. Even in mature voluntary pension systems such as the UK’s, there still remain wide discrepancies in employer pension support between employees of large and small companies (a discrepancy that will be addressed in the UK through Personal Accounts, beginning in 2012).

In both Singapore and Malaysia, contribution levels should be sufficient to secure an adequate retirement benefit, although we address below the main shortcomings that limit the impact of this success. In 2007, the Malaysian government improved the allocation of contributions for retirement purposes, from 60 percent of total contributions to 70 percent. Further, around 26 percent of employers make additional contributions (typically 3 - 4 percent) to the EPF – something both Australia and Singapore have failed to achieve to any great extent.

All systems are operated in a manner that provides a level of security to the assets held (investment risk aside), and all offer benefits in a tax-effective manner. In Australia, the tax treatment has improved with time, with all taxes on retirement benefits removed in 2006.

Australia has been particularly successful in developing a private delivery system (in contrast to the centrally run CPF and EPF), and provider competition has promoted low fees, wide choice for employees and value-added features, such as access to low-cost banking products, education, and effective online and telephone support. Competition within the market was, in fact, strengthened in 2006, with the introduction of the “Choice of Fund” – referring to choice of provider, not of investment fund (which was already commonplace). While only about 5 percent of the workforce has utilized this choice, allowing employees to nominate the provider to which their employers must make contributions has encouraged providers to keep fees low and features high.

Areas for improvement

Despite their successes in increasing retirement benefit coverage for the broad population, all these systems still have some significant areas for improvement. Those areas might be unique to a particular country, but some of the key issues are faced by two or all three systems.

• Who should fund this increase – employers or employees?
• It will restrict the flexibility of employees to choose the vehicle they use (superannuation, property, direct investments, etc.) for their retirement savings.
• It will restrict the flexibility to vary contributions with time, particularly for young employees struggling to meet mortgage payments and raise families.

A 2009 Mercer poll of Australian employees found that 69 percent supported an increase in minimum contributions from 9 percent to 15 percent. Of these, 49 percent suggested that this increase should be jointly funded by employers and employees.

In Singapore, retirement benefits may be significantly limited through “leakages” from retirement savings. While total contributions are significant, at 34.5 percent of salary for employees under the age of 55, only 5 percent of salary is specifically allocated to the Special Account for retirement purposes. The remaining contributions are allocated to an account for medical expenses and to an account that may be used for housing purposes. While these are certainly important commitments throughout an individual’s lifetime, we believe that insufficient focus is being placed on retirement savings.

All three countries face significant problems regarding the use of the ultimate retirement savings, as all allow benefits to be taken as a lump sum. With lack of employee knowledge concerning how to manage a potentially significant lump sum benefit, often these benefits are exhausted far too quickly. In Malaysia, it is estimated that around 70 percent of benefits (which may be taken from age 55) are exhausted within 10 years, typically on expenses such as children’s education or wedding celebrations.

In Singapore, all benefits may be taken as a lump sum from age 55, with the exception of the Minimum Sum of S$106,000. This Minimum Sum is paid in installments over a 20-year period, beginning from age 62, although it may also be used to purchase a life annuity from an insurer. However, with average annual incomes of around S$50,000, such an annuity or installment plan represents only a fraction of preretirement-income.

Australia historically has also had a lump sum mentality, and this has not been discouraged by the minimal tax advantages of taking income-style benefits.

Actions being taken

All three countries have made, and are continuing to make, efforts to improve the effectiveness of DC delivery:

• In 2007, the Malaysian EPF introduced “Flexible Age 55 Withdrawal,” allowing members to take their benefits in installments rather than as a lump sum. While voluntary, take-up is increasing, with 21 percent of age 55 withdrawal applications in Q1 2009 being in installment form, compared with 15 percent in Q1 2008. The Malaysian government is also considering the merits and structure of a lifetime income scheme to be offered through the EPF.
• The take-up of drawdown products in Australia is increasing, mainly through improved education, accessibility, and slight tax advantages (investment returns remain tax free for assets left in the superannuation system).
• From 2009, the Singapore CPF is introducing CPF LIFE, which pays an amount of income for life. CPF LIFE is a pooled longevity risk vehicle whereby the upfront premium paid and ongoing income received may be adjusted based on the investment and mortality experience of the pool. Four choices are available, with a small trade-off between monthly income and capital sum paid to dependents upon death.

It is also clear that improvements are required in the area of education. Many individuals simply do not understand what is considered an adequate retirement benefit, what level of contributions are required to accrue this benefit, how to manage investments in the accrual phase, and then how to manage assets in the drawdown phase. This is a significant challenge that each of the countries is attempting to address in its own way. The conflicting human desire for “a bird in the hand” versus a steady income amount is a significant obstacle to overcome. The traditional Asian practice of being supported in old age by one’s children is certainly a valuable cultural trait. However, as this is unlikely to be dependable, individuals will need to develop a mindset of greater preparation for their own retirement.

Refocusing to boost the retirement pot

The DC systems of Australia, Singapore and Malaysia are all unique in terms of their structural approach to saving, investment and plan management, and all have been successful in producing retirement benefits for the broad population. There are a number of characteristics against which pension systems elsewhere might be tested:

• Mandatory and broad-based coverage for all
• Encouragement of broader thinking financially (Singapore and Malaysia), in regard to saving for retirement, education, housing and medical expenses
• Efficient, centrally run plans or competitive and strictly governed private plans
• Effective use of tax incentives to save
• Tight restrictions on system leakages (Australia)
• Flexible and world-class investment structures (in Australia), allowing measured choice for employees

However, there are two common areas needing improvement:

1. All countries must encourage greater accrual of retirement income – through higher contributions (Australia), reduced leakages (Singapore, Malaysia) and reduced access to lump sums (all). A key challenge for authorities is the development of a system of affordable lifetime annuities. Conservative pricing, due primarily to longevity risk concerns and a lack of suitable investment vehicles, means that existing annuity products tend to be expensive.

2. All must continue to explore methods of increasing financial literacy among employees. We now live in a world of self-reliance, but many employees are currently ill-equipped to take on this challenge in relation to retirement benefits, particularly when at least the lower-income groups will have seen little money throughout their lifetimes.