Mandatory Savings and Retirement Adequacy: A Portfolio Simulation of EPF in Sri Lanka Wasana Karunarathne The University of Melbourne

July 2005Wasana Karunarathne2 Agenda The Employees Provident Fund (EPF) The Employees Provident Fund (EPF) EPF’s Investment Performances EPF’s Investment Performances Empirical Findings Empirical Findings Does EPF Provide Sufficient Member Balances? Does EPF Provide Sufficient Member Balances? Member Balances under Different Portfolio Investments Member Balances under Different Portfolio Investments Parametric Reform Options Parametric Reform Options Policy Recomendations Policy Recomendations

July 2005Wasana Karunarathne3 The EPF Scheme EPF is implemented in 1958 Major vehicle for private sector employees Covers around 30% of the labour force (80% of the private sector employees) Fully funded, defined contributory (DC) type Centrally managed by the Central Bank of Sri Lanka on behalf of the government

July 2005Wasana Karunarathne4 Contribution Rate: 20% of gross salary Contribution Rate: 20% of gross salary Mandatory for both employers (12%) and employees (8%) Benefits: lump sum Payment Benefits: lump sum Payment Retirement age: 55 years Retirement age: 55 years Pre-retirement withdrawals: allowed for housing purposes Pre-retirement withdrawals: allowed for housing purposes EPF Scheme cont.

July 2005Wasana Karunarathne5 EPF Scheme cont. Figure 1: EPF Contributions and Savings,

July 2005Wasana Karunarathne6 Investment Performance EPF investments are highly regulated and restricted to invest in government securities EPF investments are highly regulated and restricted to invest in government securities in brief

July 2005Wasana Karunarathne7 Inv. Performance cont. Figure 2: EPF, Investment Allocation, 2002

July 2005Wasana Karunarathne8 Figure 2: EPF, Real and Nominal rates Return, Inv. Performance cont.

July 2005Wasana Karunarathne9 Empirical Findings: Does EPF provide adequate balances? The paper calculates The Capital Accumulation Ratio (CAR) Replacement Rate (RR) Next slide provides the results under the baseline scenario

July 2005Wasana Karunarathne10 Note: Replacement rates have been calculated using nominal discount rates Coefficient of variation is SD/ Mean and generally expressed as a percentage Table1: Base Line Case: Capital Accumulation Ratio and Replacement Rate Average RR in real term: 30%

July 2005Wasana Karunarathne11 Could the situation be changed, if EPF used diversified portfolios? Empirical Findings cont.

July 2005Wasana Karunarathne12 Table2: CAR under Diversified portfolio Investments

July 2005Wasana Karunarathne13 Empirical Findings cont. Parametric Reform Options Parametric Reform Options Available Options Available Options Reform the investment function Reform the investment function Increase retirement age Increase retirement age Increase contribution rate Increase contribution rate

July 2005Wasana Karunarathne14 Table2: CAR under Diversified portfolio Investments

July 2005Wasana Karunarathne15 Recommendations Pension reforms should not be carried out in isolation. it should be an integrated part of overall economic reforms. Issues relative to accumulation phase as well as decumulation phase should be addressed. Issues relative to accumulation phase as well as decumulation phase should be addressed. Political commitment and greater literacy required. Unnecessary government intervention on EPF activities should be minimized. Political commitment and greater literacy required. Unnecessary government intervention on EPF activities should be minimized.

July 2005Wasana Karunarathne16 Recommendations Enhance the professionalism of the management. Enhance the professionalism of the management. Improve the investment function. Diversify portfolios. Gradually de-link provident funds from budgetary financing Improve the investment function. Diversify portfolios. Gradually de-link provident funds from budgetary financing Limit pre-retirement withdrawals Limit pre-retirement withdrawals

July 2005Wasana Karunarathne17 Thank you! Contacts: Wasana Karunarathne Department of Economics University of Melbourne, Economics and Commerce Building Economics and Commerce Building Victoria, 3010, Australia Phone: I would like thank National University of Singapore for financial support provided for my PhD research.