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G:\Client-Prospective\Malaysia NEAC\Malaysia pension social security reform- 041220.ppt Jennifer Chee, Doris Ho Shaping the Hong Kong Retirement Landscape of the Future AsianInvestor Competition 2 December 2006

Shaping the Hong Kong Retirement Landscape of the Future AsianInvestor Competition

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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 - PowerPoint PPT Presentation

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Page 1: Shaping the Hong Kong Retirement Landscape of the Future AsianInvestor Competition

G:\Client-Prospective\Malaysia NEAC\Malaysia pension social security reform-041220.ppt

Jennifer Chee, Doris Ho

Shaping the Hong Kong Retirement Landscape of the FutureAsianInvestor Competition

2 December 2006

Page 2: Shaping the Hong Kong Retirement Landscape of the Future AsianInvestor Competition

Mercer Human Resource Consulting and Mercer Investment Consulting 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

Page 3: Shaping the Hong Kong Retirement Landscape of the Future AsianInvestor Competition

Mercer Human Resource Consulting and Mercer Investment Consulting 3

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

* 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

Basic Design IssuesExisting level of benefits

High investment return scenario 59%*

Midpoint investment return scenario 35%*

Low investment return scenario 21%*

Page 4: Shaping the Hong Kong Retirement Landscape of the Future AsianInvestor Competition

Mercer Human Resource Consulting and Mercer Investment Consulting 4

Basic Design IssuesIncreased employer contributions / indexing

Need not necessarily add to overall employment costs

Restructure compensation packagesCash converted to MPF contribution

Mandatory indexing of salary caps, minimums etc.

Suggest index linked to general wage inflation

Page 5: Shaping the Hong Kong Retirement Landscape of the Future AsianInvestor Competition

Mercer Human Resource Consulting and Mercer Investment Consulting 5

Basic Design IssuesIncreased retirement age / indexing

20 Years

65

No

rma

l R

eti

rem

en

t A

ge

Ea

rly

Re

tire

me

nt

Ag

e

60

65

70

No

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l R

eti

rem

en

t A

ge

Ea

rly

Re

tire

me

nt

Ag

e

Page 6: Shaping the Hong Kong Retirement Landscape of the Future AsianInvestor Competition

Mercer Human Resource Consulting and Mercer Investment Consulting 6

No change

Increase in employer contribution to 8%, phased in over 6 years

Raise Normal Retirement Age to 70

Combined effect of both changes

59% 35% 21%

74% 44% 27%

High Investment Return Scenario

MidpointInvestment Return Scenario

LowInvestment Return Scenario

83% 48% 28%

104% 60% 36%

Basic Design IssuesEffect of proposed changes

Note that under the “low investment return” scenario, the replacement ratio remains too low.

Page 7: Shaping the Hong Kong Retirement Landscape of the Future AsianInvestor Competition

Mercer Human Resource Consulting and Mercer Investment Consulting 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

Page 8: Shaping the Hong Kong Retirement Landscape of the Future AsianInvestor Competition

Mercer Human Resource Consulting and Mercer Investment Consulting 8

Age

Income in RetirementSample drawdown rates

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% —

Page 9: Shaping the Hong Kong Retirement Landscape of the Future AsianInvestor Competition

Mercer Human Resource Consulting and Mercer Investment Consulting 9

Income in RetirementExample of drawdown concept

0

50

100

150

200

250

60 62 64 66 68 70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 100

102

104

Age

Rem

ain

ing

bal

ance

0

1

2

3

4

5

6

7

8

9

10

Inco

me

dra

wn

Balance (min. income) Balance (max. income)

Min income Max income

maximum

minimum

range

Page 10: Shaping the Hong Kong Retirement Landscape of the Future AsianInvestor Competition

Mercer Human Resource Consulting and Mercer Investment Consulting 10

Income in RetirementAdvantages / disadvantages of drawdown concept

ADVANTAGES

Flexibility of income level

Continued investment choice

Capital not given up on early death

MPF assets increased – lower fees?

DISADVANTAGES

Administration of choice (investment / income level)

Administration of income payment

Not complete protection against longevity risk

Page 11: Shaping the Hong Kong Retirement Landscape of the Future AsianInvestor Competition

Mercer Human Resource Consulting and Mercer Investment Consulting 11

Additional Voluntary ContributionsProviding individuals 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

Page 12: Shaping the Hong Kong Retirement Landscape of the Future AsianInvestor Competition

Mercer Human Resource Consulting and Mercer Investment Consulting 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

Page 13: Shaping the Hong Kong Retirement Landscape of the Future AsianInvestor Competition

Mercer Human Resource Consulting and Mercer Investment Consulting 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

Page 14: Shaping the Hong Kong Retirement Landscape of the Future AsianInvestor Competition

Mercer Human Resource Consulting and Mercer Investment Consulting 14

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)

InvestmentCore funds

Page 15: Shaping the Hong Kong Retirement Landscape of the Future AsianInvestor Competition

Mercer Human Resource Consulting and Mercer Investment Consulting 15

Each MPF provider required to offer a minimum 6 “core funds” meeting pre-determined risk/expected return criteria

Growth Funds Defensive Fund Cash Fund

InvestmentCore funds

AggressiveBalanced

70% Equity30% Bonds

Lower Risk Balanced

30% Equity70% Bonds

MediumRisk Balanced

50% Equity50% Bonds

All equity

CashAll Bond

Page 16: Shaping the Hong Kong Retirement Landscape of the Future AsianInvestor Competition

Mercer Human Resource Consulting and Mercer Investment Consulting 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

Page 17: Shaping the Hong Kong Retirement Landscape of the Future AsianInvestor Competition

Mercer Human Resource Consulting and Mercer Investment Consulting 17

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

Aggressivebalanced fund

Medium riskbalanced fund

70 75 80

Low riskbalanced fund

Fixedincome fund

InvestmentDefault strategy

Page 18: Shaping the Hong Kong Retirement Landscape of the Future AsianInvestor Competition

Mercer Human Resource Consulting and Mercer Investment Consulting 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.