Hong Kong’s Mandatory Provident Fund Schemes (Amendment) Bill 2009 was passed on 8 July, giving employees more control over their Mandatory Provident Fund (MPF) contributions. The changes will give employees the option to transfer the accumulated balance of their own mandatory contributions to an MPF product chosen by them. The effective date of these changes has yet to be announced, but it is expected to take place within 12 to 18 months. This is a significant change since MPF was introduced on 1 December 2000.

This article investigates the opportunities that this legislative change will create for the Hong Kong pension system and the likely impact on the different stakeholders – the government, providers, employers and employees.

Background

Like many countries around the world, Hong Kong has an aging population, compounded by increased longevity due to advancements in health care.¹ Prior to the introduction of the MPF system, Hong Kong had relatively low coverage of employees under voluntary retirement schemes. Responding to these trends – an aging population with increased life expectancy and a need for a fully funded retirement savings system – the Hong Kong government introduced in December 2000, the MPF system, designed to increase savings for retirement. The MPF is a mandatory, privately managed, fully funded defined contribution scheme.

The MPF has now increased the overall retirement scheme coverage from only one-third of the employed population to more than 85 percent of the employed population.² There is no doubt that the MPF has dramatically improved the participation rates of Hong Kong employees in a retirement plan, but are members engaged and informed about their retirement planning? Many would answer “no” to this question, and this is due, in part, to the way the mandatory system works.

Although both the employer and employee are each mandated to contribute 5 percent of monthly earnings, capped at HKD20,000 per month (equivalent to approximately USD2,500), to the MPF, under the current arrangement, it is the employer, not the individual, who chooses the MPF product to which these contributions are paid. However, all fees are borne by the individual, not the employer. Fees are on average 2 percent of scheme assets but can range from 1 percent to 4 percent² of scheme assets, depending on the MPF product, the investment fund and negotiations by the employer.

Introduction of employee choice

The changes to be introduced by the Mandatory Provident Fund Schemes (Amendment) Bill 2009 are designed to give employees greater control over their MPF savings and promote greater market competition among the providers.

Once every calendar year³, the employee can instruct the trustee of the employer’s chosen MPF product to transfer the accumulated employee mandatory balance to a personal account under an MPF product selected by the employee. The employer’s 5 percent contribution will remain in the employer’s chosen MPF product.

In addition, employees will be allowed at any time to move benefits from their previous employment that they had initially transferred into their current employer’s fund. This move will encourage employees to consolidate their balances into a single provider of their choice.

Other key changes introduced by the legislation to enhance employee choice include:

• Only necessary transaction costs incurred in selling or purchasing investments in order to effect the transfer can be charged to employees.
• Certain restrictions on the transfer of accrued benefits are removed so that even though there may be outstanding contributions or contribution surcharges in the employee’s account, the transfer can take place.
• Industry funds may be accessed by workers in other industries to open a personal account to hold accrued benefits.
• The regulator, Mandatory Provident Fund Schemes Authority (MPFA), will establish a register of personal accounts established by members with various MPF providers.

What are the implications for the various stakeholders?

The government perspective

By introducing the employee choice rules, the government is hoping to increase competition among the providers, with the expectation that providers will need to differentiate their products from the next provider’s and offer incentives, such as reduced fees and enhanced services, to attract and retain members. In addition, giving workers more control over their retirement savings should cause them to be more engaged and make decisions about the provider, product and investment strategies of their retirement savings portfolio.

However, are employees ready to become more engaged in their financial planning for retirement? Do they have the necessary financial skills to compare and check product features to ensure that these match their appetite for risk?

In Mercer’s 2009 global DC survey, 33.3 percent of participating Hong Kong employers cited insufficient member communications and education as risks to their DC plans. The government will have a key role in working with employers and providers to build up the members’ financial literacy.

When employees become more comfortable choosing retirement investments, they may ask for more choices. This will create a greater burden on employers. To get employers’ buy- in, the government and providers may need to investigate options to ensure that additional choices can be offered in an efficient and cost-effective manner - a centralized contribution clearing house may be a good solution.

Informed decision making will be a crucial element in ensuring that members make the most of the choices available to them.

The provider perspective

There will be some challenges and opportunities for MPF providers arising from increased portability and choice.

Currently, there are more than 30 providers in the MPF market with a total asset value of approximately HKD260 billion as of June 30 2009 (equivalent to approximately USD33 billion)² – a large number for a relatively small market. In addition, the top five providers dominate the market, with more than 70 percent of the assets.⁴ Even with the estimated growth of the MPF market to potentially HKD1.5 trillion by 2020 (approximately USD190 billion)⁵, the increase in scale may not be sufficient to support the current number of providers – at least not when using the same operational model.

In response to the upcoming changes, providers may need to make infrastructure upgrades to cater to employee demands for additional flexibility and reporting requirements. Some providers may simply be too small to make these changes cost-effectively. Others may need to merge with competitors to survive.

We expect to see more “open architecture” for investment fund design as employees demand more choice. By offering a good range of investment choices, providers will increase the likelihood of retaining members.

Some providers have niche relationships with employers; however, with the introduction of employee choice, there will be a significant shift from institutional marketing to retail marketing. All providers will need to build a relationship now, not just with the employer, but also with individuals. Some providers may face a challenge in doing this with their existing sales force. Member communications will be a vital tool in building that relationship with individuals.

Some providers may seek to differentiate their services by targeting groups of individuals with similar needs. This may lead to more diverse product offerings than are currently seen in the MPF market. Some of the more technologically advanced providers may be able to introduce even greater individual choice flexibility as a differentiator, such as offering an account aggregator facility - which will consolidate an employee’s account balance information from several MPF products under one view.

The employer perspective

As there is minimal operational impact on employers due to the MPF choice, it could be argued that employers need to do nothing. For those employers that may have selected their existing MPF products for convenience or due to an existing relationship with the provider, this may be their preferred approach.

However, we believe that for employers that see their retirement plan as a core component of their remuneration strategy, there is still much to do in terms of ensuring that employees are engaged in their retirement planning. Employers can play a key role in assisting employees with this. Member education and financial literacy will be vital for employees to make informed decisions about their retirement savings choices.

In some cases, as part of the benefits offering, employers may have negotiated favorable fees or additional services on behalf of their employees. Communications will be important, so that employees can recognize these advantages. Otherwise, employees may not be aware of these differences if they move to an alternative scheme/product. Also, employers need to consider to what extent they should protect employees from mis-selling and ending up in inappropriate arrangements – although the desire to assist in employees’ understanding must be balanced carefully, to prevent the impression of providing advice.

As the aging workforce trend continues, employers will also need to grapple with the needs of this group of employees. Older employees will be looking to their employers to help them plan and prepare for retirement.

The employee perspective

Will these changes be enough to engage workers in their individual retirement planning, or will they view their retirement contributions merely as a tax saving?

Experiences in other markets with pension choice, such as Australia, show that member apathy rules. The Australian experience found that nine months after super fund choice was introduced in 2006, only 10 percent of fund members were considering switching from one fund to another.⁶ Therefore, it may take more than simply providing regulations to allow a once-yearly switch to engage members in actively participating in their retirement planning for the future.

Although there are cultural differences between Australia and Hong Kong, we expect that when choice first comes in, the vast majority of employees (particularly those who have always looked to their employer for guidance) are unlikely to move their balances away from their employers’ chosen MPF products.

Even for those employees who are not satisfied with their employers’ chosen MPF products, in the absence of clear knowledge of differences among the available MPF products and which one best meets their requirements, employees may hedge their bets and spread their monies across a number of products. At the end of the day, having too many choices may make it harder for these individuals to have a clear understanding of their retirement savings. It may also dilute their negotiation power on fees and services with providers.

Even with more choice, it may be inevitable that retirement plans in Hong Kong will be viewed as only one part of an individual’s personal savings. This is certainly the model that is becoming more prominent around the world, with the US 401(k) market being a classic example. Even in Asia, where there has been much recent activity around pension systems, the individual retirement account concept has received support, an example of which is the recent rollout in India of the New Pension System on a voluntary basis to all citizens.

When employees get more engaged and feel they have more control over their MPF savings, we are likely to see increased voluntary savings in the MPF system. As a result of choice, we may also see an increased need for financial planning advisory services, as more and more people express a desire to make an informed choice for a preferred MPF product.

What will success look like?

The Hong Kong government hopes that the Hong Kong pension market will be invigorated when employee choice comes into effect. One scenario is that fewer providers will offer competitive, compelling and differentiated products to Hong Kong citizens, who are engaged and knowledgeable about their retirement planning. To accomplish this, employers will need to play an active role in helping their employees recognize the need and value of effective retirement planning. This is an objective that employers should pursue, regardless of the outcome of these impending changes.