Case Study On The Employees Provident Fund Of Malaysia .
Public Disclosure AuthorizedPublic Disclosure AuthorizedPublic Disclosure AuthorizedPublic Disclosure AuthorizedFINANCE, COMPETITIVENESS,AND INNOVATIONJUNE 2018THE MALAYSIA DEVELOPMENT EXPERIENCE SERIESCase Study on theEmployees ProvidentFund of Malaysia
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JUNE 2018THE MALAYSIA DEVELOPMENT EXPERIENCE SERIESCase Study on theEmployees ProvidentFund of MalaysiaFINANCE, COMPETITIVENESS,AND INNOVATION
About KNOWLEDGE & RESEARCHThe World Bank Group’s current partnership with Malaysia is focused on knowledgesharing. It is centred on support for Malaysia’s vision to join the ranks of highincome economies by 2020 through inclusive and sustainable growth, and to shareits lessons with developing countries.In March 2016, the World Bank Group officially launched its Global Knowledge andResearch Hub in Malaysia. The new Hub is the first of its kind, serving both as afield presence in Malaysia and as a global knowledge and research hub. It focuseson sharing Malaysia’s people-centred development expertise and creating newinnovative policy research on local, regional and global issues.Knowledge & Research reports are flagship work emanating from the teamsbased in the Malaysia Hub.The Malaysia Development Experience Series captures key lessons fromMalaysia relevant for emerging economies in Asia, Africa and elsewhere that aretransitioning out of poverty and into shared prosperity.Cover Photo and photos courtesy of the Employees Provident Fund Malaysia.The findings, interpretations, and conclusions expressed in this report do notnecessarily reflect the views of the Executive Directors of the World Bank or thegovernments they represent. The World Bank does not guarantee the accuracy ofthe data included in this work. The boundaries, colours, denominations, and otherinformation shown on any map in this work do not imply any judgment on the partof the World Bank concerning the legal status of any territory or the endorsementor acceptance of such boundaries.Please contact Wei Zhang at wzhang@worldbank.org and Ashraf Arshad ataarshad1@worldbank.org if you have questions or comments with respect tocontent.
Table of ContentsAcknowledgements4List of Figures5List of Tables5Executive Summary6Chapter 1: Why the EPF?Background1013Obligated by law13Types of EPF accounts15Chapter 2: Practical Lessons and Best Practices18Clear governance structure19Robust decision making21Voluntary disclosure22Investment policies and strategies23Investment by asset classes24Investment in overseas markets28Risk Management Framework32Role of capital market development33Operational effectiveness34Strong Leadership & Integrity34Focus on customers36Simpanan Shariah39Chapter 3: Future Challenges40Ageing nation41Inadequate coverage42Chapter 4: Conclusion44References46Appendix48Case Study on the Employees Provident Fund of Malaysia3
AcknowledgementsThe report was prepared by a team of the Finance, Competitiveness& Innovation Global Practice of the World Bank Group consistingof William Joseph Price (task team leader), Muhammed AbdulKhalid, Jose De Luna Martinez, Wei Zhang and Ashraf Arshad.Other colleagues including Richard Record, Nadia Novik and MohamedRozani Mohamed Osman provided useful inputs. Joshua Foong andKane Chong provided excellent editorial assistance.The team received guidance and support from Ceyla Pazarbasioglu,Zoubida Allaoua, Ulrich Zachau, Mara Warwick, Irina Astrakhan, andFaris Hadad-Zervos. The team expresses its gratitude to peer reviewersin the World Bank Group i.e. Fiona Stewart, Swee Ee Ang, and AchimDaniel Schmillen for their thoughtful comments and suggestions.We are indebted to the Employees Provident Fund (EPF) for its valuablecollaboration with the World Bank Group. In particular, the team isgrateful to Tan Sri Samsudin Osman (Chairman), Datuk Shahril RidzaRidzuan (Chief Executive Officer), Dato’ Mohamad Nasir Ab. Latif,Tunku Alizakri Raja Muhammad Alias, Nurini Kassim, Badrul HishamDahalan, Samsiah Mohd Yusop Sulaiman Mohamed Ridza, and SyazrahArinah Abd Salam, who were exceptionally forthcoming and proactivein providing insights and information. The team would like to also thankthe past Chairman and Chief Executive Officer of EPF who participatedin this study and shared their inputs with us.4Case Study on the Employees Provident Fund of Malaysia
List of FiguresFigure 1EPF returns relative to Malaysia Government Government Bonds and 1-year fixed deposits12Figure 2Governance Structure20Figure 3Asset Allocation, 201624FIgure 4Share of Asset Classes, 2010-201626Figure 5Timeline: EPF’s Investment in Foreign Markets30Figure 6The EPFs Risk Management Framework32Figure 7Features of i-Akaun37Figure 8EPF’s Pledge38Figure 9Total number of workers without EPF coverage43List of TablesTable 1Summary of Employees Provident Fund contribution rates in Malaysia(percentage), 1952-201814Table 2ROI and Investment Income by Asset Class, 2010-201627Table 3Nominal return on Investment, domestic and foreign, as at Dec 201631Table 4Initiatives in enhancing quality of services36Table 5Interactions with members, 2014-201639Case Study on the Employees Provident Fund of Malaysia5
ExecutiveSummary6Case Study on the Employees Provident Fund of Malaysia
Executive SummaryThis paper documents the best practices and practical lessons learnedfrom Malaysia’s largest mandatory public provident fund, the EmployeesProvident Fund (EPF). The objective of this paper is to increase the knowledgebase of efficient pension funds for developing countries, drawing from Malaysia’sexperiences. Findings include key critical factors that contributed to the successof the EPF, from a small pension fund set up in 1949, to become one of the largestpension fund among developing countries and the 15th largest in the world.1 Thispaper summarizes the EPF’s key strategies in corporate governance, investment,and operational strategies, as well as policies deployed by the EPF in managing itsassets.The lessons from the EPF come from three main factors. Firstly, the EPF hasdeveloped a strong governance structure which discourages external politicalmeddling and encourages transparency and accountability. Secondly, the EPF’sinvestments strategy, guided by its Strategic Asset Allocation, including diversifyingto foreign markets and new asset classes, has enabled the Fund to produceenhanced returns. Thirdly, the EPF’s operational effectiveness which is driven bythe professionalism of their employees and their continuous improvement formembers’ benefit.Nonetheless, several challenges remain in the present and in the future. Thefirst challenge involves demographic changes as Malaysia is ageing more rapidlythan other countries and even now a sizable number of workers do not have therecommended minimum savings level needed for retirement. A revamp of thecurrent model is needed to ensure that members will be financially independentpost-retirement. The second challenge is lack of coverage: only half of those in thelabour force are contributing to the EPF, which leaves the other half without oldage pension coverage. A reform agenda needs to expand coverage particularlyfor the self-employed. The final challenges are maintaining public trust and stayingrelevant, especially in the age of the fourth industrial revolution and the emerginggig economy that has different needs and demands.This case study will hopefully be of benefit to both policy makers andpractitioners, particularly in the developing world. It could help play an importantpart in designing a successful provident fund to contribute to a comprehensivesocial safety net for citizens.1Willis Towers Watson. 2017. The World’s 300 Largest Pension Funds. Available from /Insights/2017/09/The-worlds-300-largest-pension- funds-year-ended-2016.pdfCase Study on the Employees Provident Fund of Malaysia7
Executive SummaryObjectiveThis paper aims to document the critical factorsthat transformed the EPF from a relativelysmall public retirement fund for both privatesector and non-pensionable public-sectoremployees to become one of the largest in theworld. It provides practical lessons and actionablepolicy measures, while providing insights foran efficient provident system for developingcountries, drawing from Malaysia’s experiences.Among others, the paper sheds light into theEPF’s key success factors, including its investmentand governance strategies, the required buildingblocks, and main challenges and constraints. Themodel presented is not the only way to providepensions in a country. But it does show the benefitsof a particular approach that should be consideredby policy makers in other countries when designingor reforming a pension system.To achieve these objectives, the study undertooka two-pronged approach:1. Desktop review, including collecting baselinebenchmark and secondary data, and2. Conducting semi-structured interviews withpast and present key senior management ofthe EPF (please see Appendix for the list ofindividuals interviewed).This paper focuses in some detail on the bestpractises of the EPF, but does not provide indepth analysis on the challenges for the EPF.Although the paper does outline future challengesfor the EPF, it does not specifically articulate policyoptions, nor does it discuss the challenges relatedto the functioning of the EPF as a social protectioninstitution or the history and lessons from thedevelopment of the Malaysian capital market.These matters will be addressed in detail in furtherpapers.8Case Study on the Employees Provident Fund of Malaysia
Case Study on the Employees Provident Fund of Malaysia9
CHAPTER 1Why the EPF?Why the EPF? What can other countrieslearn from the EPF? The EPF is one ofthe largest public defined-contributionretirement funds in the world.As of end-2016, the EPF total asset under management was RM731.1 billion(or about USD 165 billion), making it the second largest pension fund amongthe developing countries, the 5th largest in Asia, and 15th largest in the world.10Case Study on the Employees Provident Fund of Malaysia
Chapter 1: Why the EPF?To put things in perspective, the Malaysian economy and workforce arerelatively small compared to other countries; Malaysia is ranked 66th interms of nominal GDP per capita, and 36th and 11th in the world and in Asiarespectively 2 in terms of working population size. Although the EPF is managingpension funds for a relatively small workforce compared to developed countries,the EPF has investments in all major markets, in particular North America, Europeand Asia, as well as investments in various asset classes such as equities, fixedincome instruments, real estate & infrastructure and money market instruments.3So, the EPF model shows the benefit of scale that can be brought to a relativelysmall country – and which can lead to further benefits if scale can be combinedwith good governance and expertise. Many countries have adopted a similarmodel. Some have experienced good results – for example in Kosovo which is thesubject of another case study in this series. Others are yet to reap the full benefits– and this case study shows some critical steps on the journey to ensure that similarorganizations can deliver enhanced value-added for their populations.The EPF has focused on developing in-house investment expertise over theyears to make large scale investments in a global portfolio in multiple assetclasses. It engages external fund managers as well, and it has implemented astringent process to evaluate the implementation strategy that delivers best net offees returns.The EPF has consistently produced competitive returns. The average dividendduring the period 2010-2016 was 6.20% per annum in nominal terms. The Fundhas consistently outperformed its real 2.00% target for 16 years running, exceptfor the year 2008, where the real return was lower at 1.50% due to the GlobalFinancial Crisis. To put this in perspective, it is important to compare it to somecounterfactuals. Figure 1 compares investments in Malaysian GovernmentSecurities (which used to make up the bulk of the EPF portfolio in past decades)and the yield on 1-year fixed deposits (which would be one simple saving strategyfor EPF members if they were not locking their savings away in a pension). The chartshows that the EPF has consistently outperformed both Government Bonds and12-month deposits since 2002. But more importantly the chart shows that as theEPF put in place the major reforms outlined in this report – including developing itsbroader investment allocation including foreign assets from the early 2000’s, thedegree of out-performance by the EPF relative to government bonds and termdeposits increased from around 1.00% point a year on average to 2.50% - 3.00%points a year on average.23IMF (International Monetary Fund). 2017. World Economic Outlook Database: October 2017. Washington, D.C.: IMF; World Bank.n.d. Development Data Group Database. Washington, D.C.: World Bank.EPF (Employees Provident Fund). 2017. Annual Report 2016: The Financials. Kuala Lumpur: EPF, p. 145.Case Study on the Employees Provident Fund of Malaysia11
Chapter 1: Why the EPF?FIGURE 1: EPF returns relative to Malaysian Government Bonds and 1-year fixed depositsFigure 1: EPF returns relative to Malaysian Government Bonds and 1-year fixed depositsMGS - 5 YearsEPF DividendFD - 12 % 3201420152016SK2017SS2017Another insight into relative performance is to compare EPF returns to other pension fund providers.In Malaysia, the Private Retirement Schemes (PRS) were introduced in 2013 to provide for individual retirementaccounts. As such there is only a run of data from 2013 to 2018. Ideally, return comparisons would be madeover longer time periods. Over that time period the EPF average annual dividend was 6.40% and its averagereturn on investment was 7.20% in nominal terms. PRS portfolios can be cautious, moderate or growthorientated. The respective average returns between 2013 and 2018 were 3.51% for the cautious funds, 4.07%for the moderate funds and 4.87% for the growth funds.4 The EPF asset allocation is closest to the moderateor the growth funds – but the results show that its returns have been superior over a comparable time periodthan all the major PRS fund types – with the annual outperformance on average investment returns rangingfrom 3.70% for cautious funds, 3.10% for the moderate and 2.30% for the growth fund.5So, what did the EPF – a pension fund from a developing economy – do right to improve its performanceas it became one of the biggest public provident pension funds in the world? Before we explore the keysuccess factors, let us review the history and background of the EPF.4512In all cases the average figures are simple averages for the respective funds and the EPF returns.EPF members can also choose the ‘EPF-MIS’ option, or the Member Investment Scheme which allows access though the EPF to unit trusts run by private fund managers.There are between 200 – 400 options. It is difficult to get clear comparisons between the performance of the different funds and the EPF over time. The EPF-MIS planscan charge fees of up to 3.00% of assets under management a year – though many charge in the 1.00% to 2.00% range. This gives the EPF an inbuilt 0.70%-1.70% realreturn head start each year given the overall fee level in the EPF of just under 0.30% as a share of assets under management. But part of the point of the EPF-MIS choiceis as much to allow members to choose different asset allocations that might fit their needs given that the EPF runs a single investment strategy. The EPF-MIS plans alsodo not have the EPF’s 2.50% nominal return guarantee.Case Study on the Employees Provident Fund of Malaysia
Chapter 1: Why the EPF?BackgroundThe EPF was set up by the Federal Labour Department in 1949, eight yearsbefore Malaysia gained independence from the British. In 1951, this entitybecame a statutory body, set up under the Employees Provident Fund Ordinance in1951. On 22nd July 1982, the EPF Ordinance 1951 became the EPF Act 1951 (whichwas later replaced by the Employees Provident Fund Act, 1991) with the mandateof “managing a defined contribution retirement scheme which is compulsory forprivate sector and non-pensionable public-sector employees. It also covers theself-employed, informal sector and foreign workers, but on a voluntary basis6.” Thecontribution is tax deductible up to RM6,000 annually, and the dividends earnedfrom the fund are tax-free.Obligated by lawEvery employee and their employer are required to make prescribed monthlycontributions to the EPF. The current contribution rate is as below:a. 24.00% (11.00% by employees and 13.00% by employers) for employeeswho earn less than RM5,000 per monthb. 23.00% (11.00% by employees, 12.00% by employers) for employees earningmore than RM5,000 per monthc. For employees aged above 60, the contribution is set at half the regular rateAs shown in Table 1, the contribution rate started at 10.00% in 1952, splitevenly between employee and employer. The contribution rate gradually increasedto about one fourth of current wages, which is the fifth highest in the world.767EPF. 2017. Social Protection Insight 2017. Kuala Lumpur: EPF. p. 2. Available from http://ssrc.um.edu.my/wp- august-170615043428.pdf.EPF. 2016a. Annual Report 2015. Kuala Lumpur: EPF. p.66.Case Study on the Employees Provident Fund of Malaysia13
Chapter 1: Why the EPF?TABLE 1: Summary of Employees Provident Fund contribution rates inMalaysia (percentage), 1952-2018YEAREMPLOYEEEMPLOYERTOTAL1952 - June 19755510July 1975 - November 19806713December 1980 - December 199291120January 1993 - December 1995101222January 1996 - March 2001111223April 2001 - March 200291221April 2002 - May 2003111223June 2003 - May 200491221June 2004 - May 2005111223June 2005 - December 2008111223January 2009 - December 201081220January 2011 - December 2011111223January 2012 - February 2016Income RM5,000 and lessIncome more than RM5,000111113122423March 2016 - December 2017Income RM5,000 and lessIncome more than RM5,0008*8*131221*- 2420*- 23January 2018 - presentIncome RM5,000 and lessIncome more than RM5,000111113122423Source: EPF (various years).* Reduction of the contribution rate is available upon request of employee. By virtue of P.U(A) 21, the statutory rate for employee’scontribution is 8.00%. Section 43(3) and 43(4) of the EPF Act 1991 provides an option for the employer or employee to increase theircontribution rate by giving notice to EPF. If the employee elects to pay monthly contributions at a rate which exceeds 8.00%, he shallgive a notice of such election through Form KWSP 17A (Ahl) to the Board. The rate elected by the employee is applicable as a statutoryrate until, the employee, at any time, revoke his election by submitting Form KWSP 18A (Ahl) by virtue of section 43(5) and 43(6).14Case Study on the Employees Provident Fund of Malaysia
Chapter 1: Why the EPF?During economic crises, in order to boost private consumption or spending, theEPF would allow a reduction in the employees’ mandatory contribution rate to thefund. This was the case in 2001 – after the Asian financial crisis in 1997/98 – when thecontribution rate was reduced from 11.00% to 9.00%, as well as during the 2008–2009global economic and financial crises, when it was reduced from 11.00% to 8.00%. In 2016,the EPF adopted the same strategy, albeit with minor modifications. The employees haveno option to reduce their contribution rate, the statutory rate was 8.00% for the period ofMarch 2016 until December 2017, but if the employee
10 Case Study on the Employees Provident Fund of Malaysia. Case tudy on the Employees Provident Fun of alaysia 11 To put things in perspective, the Malaysian economy and workforce are relatively small compared to other countries; Malaysia is ranked 66th in
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