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Shaping the Hong Kong Retirement Landscape of the Future AsianInvestor Competition

Shaping the Hong Kong Retirement Landscape of the Future AsianInvestor Competition. 2 December 2006. Jennifer Chee, Doris Ho. Background The Mercer Approach. Building on MPF success. Retirement savings introduced to significant proportion of population Almost full compliance

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Shaping the Hong Kong Retirement Landscape of the Future AsianInvestor Competition

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  1. Shaping the Hong Kong Retirement Landscape of the FutureAsianInvestor Competition 2 December 2006 Jennifer Chee, Doris Ho

  2. BackgroundThe Mercer Approach Building on MPF success Retirement savings introduced to significant proportion of population Almost full compliance Efficient mechanism for collection and investment of contributions Our focus is on: Basic design issues (contribution levels / retirement age) Income in retirement vs. lump sum Encouraging additional voluntary contributions Changes to Employment Ordinance Investment choice Fee levels and disclosure CSSA Benefit Assume benefit level and indexing mechanism are appropriate Try to ensure that less people rely on it

  3. Midpoint investment return scenario 35%* Low investment return scenario 21%* Basic Design IssuesExisting level of benefits • World Bank studies • Subsistence levels of retirement income = 40% of pre-retirement income • Other studies indicate 45%-50% • Still significant drop in living standards • Existing expected levels of benefit are not enough • Cannot rely on individuals/employers to save/provide more • Implication is that contribution levels and retirement ages need to increase High investment return scenario 59%* * The ratios assume that the MPF earnings cap is indexed in line with wage inflation. They further assume 2.5%/3% p.a. price/salary inflation for all scenarios and 2.5%/4%/5.5% p.a. net investment return for low/midpoint/high investment return scenarios respectively

  4. Basic Design IssuesIncreased employer contributions / indexing Need not necessarily add to overall employment costs Restructure compensation packages Cash converted to MPF contribution Mandatory indexing of salary caps, minimums etc. Suggest index linked to general wage inflation

  5. Basic Design IssuesIncreased retirement age / indexing 70 65 65 60 Normal Retirement Age Normal Retirement Age Early Retirement Age Early Retirement Age 20 Years

  6. Basic Design IssuesEffect of proposed changes High Investment Return Scenario Midpoint Investment Return Scenario Low Investment Return Scenario No change 59% 35% 21% Increase in employer contribution to 8%, phased in over 6 years 74% 44% 27% Raise Normal Retirement Age to 70 83% 48% 28% Combined effect of both changes 104% 60% 36% Note that under the “low investment return” scenario, the replacement ratio remains too low.

  7. Income in RetirementThe drawdown concept • Lump sum does not provide security in retirement • Pressure on CSSA system may increase if income stream is not mandated • Traditional lifetime annuity products unpopular • Propose drawdown of accumulated mandatory contributions within maximum and minimum rates • Mandatory • Transparent • Age specific • Accumulated voluntary contributions may be taken as a lump sum or drawn down as required • Individual retains investment choice over accumulated fund after retirement

  8. Income in RetirementSample drawdown rates Age Minimum Factor Maximum Factor 65 5.8% 10.1% 70 6.6% 11.9% 75 7.8% 16.1% 80 9.5% 32.3% 85 12.0% — 90 14.5% — 95 18.9% —

  9. Income in RetirementExample of drawdown concept

  10. Income in RetirementAdvantages / disadvantages of drawdown concept ADVANTAGES DISADVANTAGES Administration of choice (investment / income level) Administration of income payment Not complete protection against longevity risk Flexibility of income level Continued investment choice Capital not given up on early death MPF assets increased – lower fees?

  11. Additional Voluntary ContributionsProvidingindividuals with incentive to save more • MPF fee competitive when compared to other forms of personal savings • Payment of regular and one-off contributions should be encouraged • We suggest: • Increased tax deduction for employee contributions, to say 10% or 15% of MPF earnings • In return, such contributions would be subject to preservation • Matching contribution by government for lower paid • For example, $0.5 by government for every $1 paid by individual • “Lower” paid could mean those earning less than average salary or some % of it • Government pays more now, less later • All plans required to offer flexible mechanisms for additional contributions e.g. • Quarterly one-off payments • Additional deductions from payroll

  12. Employment Ordinance Removing the defined benefit underpin • Propose removal of statutory Long Service and Severance Payments • Given proposed increase to contribution rates, statutory Long Service and Severance Payments should no longer be relevant • 8% salaries = 0.96 multiple (vs. 0.67) with zero investment return • Protect existing entitlements • Simplifies administration for employers • Discourages unnecessary risk taking

  13. InvestmentBasic principles • MPF will be the only or a significant part of retirement savings for many • Investment decisions underwritten by Government via CSSA • Or employer via Long Service / Severance Payments • Government should have a greater degree of control over types of fund choices available

  14. InvestmentCore funds • Each MPF provider offer mandatory core funds with pre-determined risk levels. The purpose of the core funds: • Offer good prospects of exceeding inflation in the long term (the “Growth” funds) • Reduce market risk during retirement (the “Defensive” fund) • Protect the drawdown income stream against volatile market values (the “Cash” fund)

  15. All equity Aggressive Balanced 70% Equity 30% Bonds Cash All Bond Medium Risk Balanced 50% Equity 50% Bonds Lower Risk Balanced 30% Equity 70% Bonds InvestmentCore funds • Each MPF provider required to offer a minimum 6 “core funds” meeting pre-determined risk/expected return criteria Growth FundsDefensive FundCash Fund

  16. InvestmentCore funds • Consistent platform for communicating concept of risk to employees • Annual statement to communicate expected retirement income • Expected investment returns • Favourable investment returns • Poor investment returns • Provides foundations for adding non-core funds to meet public demand

  17. Aggressive balanced fund Medium risk balanced fund Low risk balanced fund Fixed income fund 70 75 80 InvestmentDefault strategy • Default strategy should: • Minimise the risk of individuals making inappropriate investment choices • Invest in growth assets while individual is in a position to tolerate risk • Provide some certainty in period leading up to and during drawdown • Propose: • Switch anticipated income into cash 2 years in advance • Actual % will depend on actual drawdown rates

  18. Fees • Industry-wide methodology • Transparency to members and plan sponsors • Administration fees from asset based to per member fee • Consideration of a maximum fee for very low earners and during final years of drawdown.

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