Summary of Case Study on Employee Provident Fund of Malaysia

Introduction

The Employee Provident Fund, EPF was set up by the Federal Labour Department in 1949, 8 years before Malaysia gained independence from the British. In 1951, this entity became a statutory body, set up under the Employees Provident Fund Ordinance in 1951.

On 22nd July 1982, the EPF Ordinance 1951 became the EPF Act 1951 (which was later replaced by the Employees Provident Fund Act, 1991) with the mandate of ‘managing a defined contribution retirement scheme which is compulsory for private sector and non-pensionable public-sector employees‘.

It also covers the self-employed, informal sector and foreign workers, but on a voluntary basis. The contribution is tax deductible up to RM6,000 annually, and the dividends earned from the fund are tax free.

Obligated by law

Every employee and their employer are required to make prescribed monthly contributions to the EPF. The current contribution rate is as below:

24.00% (11.00% by employees and 13.00% by employers) for employees who earn less than RM5,000 per month
23.00% (11.00% by employees, 12.00% by employers) for employees earning more than RM5,000 per month
For employees aged above 60, the contribution is set at half the regular rate

Case to case basis

During economic crises, in order to boost private consumption or spending, the EPF would allow a reduction in the employees’ mandatory contribution rate to the fund.

This was the case in 2001, after the Asian financial crisis in 1997 and 1998. When the contribution rate was reduced from 11% to 9% [1], as well as during the 2008 and 2009 global economic and financial crises. When it was reduced from 11% to 8%.

In 2016, the EPF adopted the same strategy. Albeit with minor modifications. The employees have no option to reduce their contribution rate. The statutory rate was 8.00% for the period of March 2016 until December 2017.

But if the employee elects to pay monthly contributions more than 8.00%, the election can be made to EPF. Nearly 60% of the members took up the option to revert to the earlier 11% statutory rate.

Malaysia is pacing with Japan

Demographic changes as Malaysia is ageing more rapidly than other countries and even now a sizeable number of workers do not have the recommended minimum savings level needed for retirement. A revamp of the current model is needed to ensure that members will be financially independent post retirement.

Among the largest fund in the world

The EPF is one of the largest public defined-contribution retirement funds in the world. 5th in Asia and 12th in the world [2]. For a developing nation, this is certainly a good feat for Malaysia.

Eomployee Provident Fund: Sovereign pension funds

Malaysia is ranked 66th in terms of nominal GDP per capita, and 36th and 11th in the world and in Asia respectively in terms of working population size. Although the EPF is managing pension funds for a relatively small workforce compared to developed countries, the EPF has investments in all major markets.

Investment by asset class

More than 50% of the investment is in fixed income assets. Malaysia Government Securities (MGS) and loans and corporate bonds. As governed by the EPF Act 1991. While investment in equity makes up about 36% of the portfolio.

This ‘rule’ partly explains the booming domestic capital market in Malaysia. At the same time ensures no sizeable outflow of capital overseas. Many of the infrastructure projects in Malaysia is funded locally, as the EPF plays a major role in some of these critical catalytic investments.

Investments in MGS and corporate bonds are governed by the EPF’s mandate of capital preservation. Allowing the fund to meet its 2.50% guaranteed returns to the members.

Employee Provident Fund asset classes allocation

Amendment in EPF Act 1991

The amendments in 1991 had two bigger purposes. Firstly is to expand the scope and type of investment. Secondly is to enable the EPF to play a more effective role as an institutional investor to create more depth in the capital market.

New provision sets a minimum limit for the EPF’s total investment fund to be invested or reinvested during any one year in securities issued by the Government of Malaysia to 50% only as compared to the previous limit of 70%
As an effort to diversify its investment, power has been given to the EPF to invest in land matters
To give power to the EPF to invest in specific types of investments. Such as privatisation projects, joint venture projects, securities or bonds issuance, new financial market instruments and other investments. That will provide a positive and reasonable return. These amendments directly contributed to the development of capital market in Malaysia. Therefore allowing big (infrastructure) projects to be undertaken and to be financed domestically.

Investment in overseas market

Why did the EPF decide to invest in overseas markets, especially when investing in domestic markets has been producing returns above the mandated targets for the past half a century?

Pension funds that are large relative to their domestic capital market face a challenge to find sufficient investments for their capital
Stewart and Price, 2018

The Malaysian market is simply too small. In fact, the size of the fund is about 62% of Malaysia’s GDP. We ran out of places to invest here. Investment in overseas markets initially began in 1996 with a very small investment in private equity funds. Overseas fund started to grow at a faster pace than the growth of the economy.

The guiding principles for overseas investment is it must be approved by the EPF Investment Panel. Subject to the EPF Act 1991 and based on the stability of the economy as well as depth of the markets.

Future challenges

Malaysia as a nation is getting older. The country is forecasted to reach ageing nation status by 2035. When persons older than 60 years will account for 15% of the population. 2 factors are driving the ageing population: a longer life expectancy and the falling fertility rate
The low retirement age and high life expectancy leads to a life expectancy pension gap
Majority of the EPF members earn low salary. The median salary for workers in Malaysia in 2016 is RM1,700. Which is about 1.7 times higher than minimum wage.
50% of members exhaust their savings within 5 years
On average, EPF members only have RM 232,738 saving for their retirement days