Monday, October 15, 2007

What CPF changes mean for us?

Will I lose money from the new old-age annuity?

Mr Mohamed Said Ali, 47, grassroots leader at Changi Simei, raised this point at a dialogue session for grassroots leaders on 23 Sep.

He said: 'People are concerned most about the longevity insurance scheme... Some are worried about whether they will lose money if they die early and how much it will cost.'

First: Will you lose money if you die early?

The bad news is yes. If you die early, you can expect to lose money.

The good news: Don't worry.

That is how insurance works. The event you insured against usually never happens. It means you paid your insurance premiums for nothing.

Suppose you buy fire insurance and your home doesn't burn down. Or you buy auto insurance and you don't have a car accident.

All you got for your premiums was protection. But that is not to be sneezed at as protection is quite valuable.

The same principle applies to longevity insurance. It is an annuity that protects against the chance of out-living your money, so that you don't become destitute in old age.

It could happen that you die early, in which case, you didn't need the protection after all. Of course, there is no way of knowing that in advance, which makes longevity insurance very useful.
Click to see larger image

Two more points: The new insurance will likely give the option of paying 20 to 30 per cent more to have the balance of your annuity returned to your beneficiaries should you die early.

To me, the higher cost makes this option not worth it.

Ironically, however, it is the only option now permitted if you want to buy a private annuity after age 55 using your CPF money.

Second: No one knows how much the lifetime annuity will cost. But one person with the skills to make an estimate is qualified actuary, Mr Tan Kin Lian, former CEO of NTUC Income.

He estimates that at age 55, a person would pay from $6,000 to $8,000 for an annuity that pays about $400 a month from age 85 until death.

Is it expensive?

Mr Tan told me: 'The price is neither too high nor too low. It simply reflects the life expectancy and a payout to the annuitant of about 4 per cent per year.'

An additional 1 percentage point of CPF interest is good. But why not more?

First: Do CPF members deserve more than 4 per cent? After all, the government earns a higher return from its Temasek and GIC investments.

This point was raised at the same dialogue session for grassroot leaders. While it seems to make sense, it isn't a straight mango-to-mango comparison.

Temasek and GIC investments involve risk. It explains their higher long-run returns compared to CPF accounts, which are risk-free.

Second: CPF accounts are not the source of cheap financing that people seem to think.

To know why, you must understand that one way the Government borrows money is by selling bonds.

It pays an interest rate of about 2 per cent for the two-year government bonds. It increases to 3 per cent for 13-year bonds.

Compare this to the 3.5 to 4 per cent interest paid to CPF members. It is much more.

You can think of the difference as a government subsidy with the lower income groups feeling the most benefits - since the added 1 percentage point applies only to the first $60,000 in CPF accounts.

The total subsidy is $700 million a year. It works out to $250 a year for each of the 2.8 million CPF members.

Work long, live longer

DID a study by US aircraft maker Boeing really claim that its workers who retired at age 65 did not live as long as those who retired earlier?

At a 23 Sep dialogue session, PM Lee Hsien Loong said: 'I can tell you for sure it's not true... There's no such study... It's a hoax.

'If you go to the Boeing website, (it says) the study is not true.'

I looked and sure enough, there is no such thing. But I found other studies which investigate the effects of working after 55.

The most comprehensive was published in the British Medical Journal in 2005. It involved over 3,500 employees of the petrochemical industry who retired at 55, 60 and 65.

It found that those who stopped working at 55 had nearly double the death rate of those who continued to work until age 65. This is the exact opposite of the hoax study.

How is it that activity helps us to live longer? Medical doctor Alex Ooi told me that no one knows the exact mechanism.

He jokes that an ageing body that works may say to itself: 'Hey, there is something for me to do here. I had better stay around and do it.'

No comments: