Risk pooling: The "secret" to CPF life's lifelong payout feature

Rising life expectancy in Singapore is a welcome trend, but with it comes serious challenges. The number of seniors outliving their retirement savings by depleting their CPF and cash savings will be increasingly common, with serious implications for themselves and society.

Statistically, about half of Singaporeans will live beyond the age of 85, and one third of Singaporeans will live beyond the age of 90.

What can be done to give future cohorts of Singaporeans a financially secure retirement, regardless of how long they live?

Singapore's answer to this challenge is the CPF Lifelong Income For the Elderly (LIFE). Introduced in 2009, CPF LIFE replaced the Retirement Sum Scheme as the default CPF payout scheme for Singaporeans during retirement.

A key feature of CPF LIFE is the guarantee of lifelong CPF monthly payouts, which provides Singaporeans assurance in retirement.

That sounds great, but as we are keenly aware, in resource-scarce Singapore, nothing is truly free.

Whether it is massively discounted Uber or Grab rides, GST cash vouchers, or a brand new luggage bag from a travel insurance claim - someone, somewhere is paying for it. This could be a company willingly making short-term losses to increase market share, the taxpayer, or premiums paid by fellow customers in an insurance pool.

So, how is CPF LIFE going to afford to pay Singaporeans who live well beyond the CPF savings they accumulated during the course of their lives?

Raising taxes is one way, which other countries are doing. However, raising taxes across the board to provide handouts to seniors would make Singapore less competitive globally, ultimately reducing the resources we have as a country. It would also burden those who are working today, making it even tougher for them to save and invest for their own retirements.

The second method, which is employed by CPF LIFE, is utilising the concept of risk pooling.

A 5-MINUTE EXPLANATION OF RISK POOLING

Risk pooling is the fundamental concept on which insurance is based on. The insured pay premiums, which goes into a shared pool, and they receive a payout if the event they wish to be insured against (whether it is an accident, critical illness, or death) occurs.

The value we receive from paying our insurance premiums is the peace of mind knowing that if something untoward were to happen, we would be financially taken care of. Obviously, all insurance companies would be investing the money in their various insurance pools and earning interest, while keeping healthy operating cashflow to handle payouts.

HOW CPF LIFE EMPLOYS RISK POOLING FOR THE BENEFIT OF ALL MEMBERS

In the case of CPF LIFE, the premiums we pay (in the form of a one-time transfer from our CPF Retirement Account) for our CPF LIFE annuity policy is pooled and used to fund our monthly payouts.

[Note: Members on the CPF LIFE Basic Plan continue to withdraw their funds from their CPF Retirement Account, while paying a smaller premium to CPF LIFE that allows them to continue to receive monthly payouts from CPF LIFE should they live beyond what their Retirement Account can distribute.]

In the old Retirement Sum Scheme, monies in our CPF Retirement Account continue to earn interest. However, as each members' CPF savings gets depleted over the years, the interest earned is lesser over time, and some Singaporeans will eventually have no money left in their CPF.

CPF LIFE is designed to protect us from this "risk" of outliving our retirement savings. Pooling everyone's premiums into the Lifelong Income Fund (plus combined interest) allows all members to enjoy monthly payouts for as long as they live - some of whom would happen to live longer than others.

DOES IT MEAN THOSE WHO PASS ON EARLY "LOSE OUT"?

At the very least, you and your beneficiaries will receive at least what you pay into CPF LIFE, through a combination of monthly payouts and bequest.

From an individual point of view, CPF LIFE covers all Singaporeans against the "risk" of living longer than our financial resources can handle. Even if we do not end up receiving more money than we put into CPF LIFE, we're already enjoyed the benefits of this "insurance" by being part in the CPF LIFE pool and knowing we have a measure of financial security in our golden years.

Furthermore, the pooled interest has also been factored into our monthly payouts, so we are enjoying some of the fruits of the interest generated by our CPF LIFE premiums.

TOGETHER, WE CAN GO FURTHER

Rather than letting individual Singaporeans struggle to stretch their retirement savings, CPF LIFE ensures that no CPF LIFE member will run out of income in their old age.

This is only possible with the shared resources of all members, and the clever application of risk pooling, which has been applied to protect Singaporeans from "longevity risk".

This article was first published in Dollars and Sense.