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A Community-wide Retirement Protection Scheme

SUBMISSION ON THE GOVERNMENT'S CONSULTATION PAPER OF OCTOBER 1992
"A COMMUNITY-WIDE RETIREMENT PROTECTION SCHEME"

1 INTRODUCTION

Since its establishment, the Foundation has supported the enhancement of benefits for the elderly, in particular, an old age pension. We took the opportunity to make a submission to the interdepartmental Working Group on Retirement Protection and met with the working Group on 27 February 1992.

Our overall reaction to the Consultation Paper is one of disappointment. Even given the limited terms of reference given to the Working Group - such limitations being discussed further below - the Paper does not put forward a scheme that could be implemented in legislation without a great deal of further work. There a major areas of difficulty, such as how existing schemes are to be brought within the proposed rules, that are ignored or dealt with superficially. The drawbacks of the scheme proposed in the Consultation Paper are discussed in more detail in section 2 below.

Moreover, the Foundation believes that the process by which the Consultation Paper was produced is flawed. Firstly, the body deliberating the issues, the interdepartmental Working Group, was not appropriately composed. Experts on retirement benefits from outside the Government should have been included in the reviewing body from the start. There appears to have been belated recognitions of this, and we understand that representatives of the accountancy, actuarial, trustee and insurance sectors were brought into the Working Group mid-way through its deliberations.

However in addition to their expertise these parties have a vested interest. The Working Group should have included representatives of employees, of employers and of the elderly themselves. These last-mentioned groups have the greatest stake in the outcome of the Consultation Paper, but had no representation on the Working Group.

A second major limitation is that that terms of reference of the Working Group were extremely restricted. The Working Group was told not to consider the possibility of a central provident fund. It also considered itself bound by the March 1991 White Paper "Social Welfare into the l990s and beyond", and so did not consider the wideranging issues and needs of the elderly that are not employment-related.

The Foundation believes that restrictions in the terms of reference of the Working Group are not in accordance with the principle of open government. In effect, the Working Group was told in advance the answer it was supposed to come up with.

The Foundation does not support the introduction of a central provident fund, for example, but many within our community do. An issue such as this should be openly discussed on its merits. More importantly, the Foundation believes that that the basic question of how to provide for Hong Kong s ageing population has never been adequately addressed and that a fundamental review is needed in which no options are excluded. Such a review should take in not only the needs of employees saving for retirement, but also those of individuals who are already old, or who are not in regular employment. The review should consider not only monetary provision for retirement, but also medical, accommodation and other needs of the elderly.

These needs in turn raise the issue of other social benefits such as health insurance, unemployment and sickness coverage and life insurance which have been provided for many years in the developed countries. As Hong Kong itself becomes a wealthy and developers territory, it needs to conduct a fundamental review of whether and in what form, such social benefits are appropriate to its people’s needs.

In summary, the Foundation believes,

(1) The Consultation Paper is too limited in scope and too flawed in its conclusions to be useful as a basis for a retirement scheme for the territory.

(2) The Government should take immediate steps to introduce a universal old age pension of around HK$2,000 per month for all Hong Kong people over the age of 65.

(3) A fresh review of the needs of the elderly should be undertaken. The body conducting the review should for greater credibility include and be led by non-Governmental members, including representatives of the elderly, the employers and the employees, as well as technical experts. The review should consider how private sector pension schemes can be encouraged and also the non-monetary needs of the elderly.

(4) A fundamental review of the provision of social benefits generally should be conducted, leading to the publication of a Green Paper.

2 DRAWBACKS OF SCHEME PROPOSED IN CONSULTATIVE PAPER

The Foundation sees the following drawbacks to the scheme proposed.

The scheme is expected in most cases to provide the retiree only with a lump sum on retirement. While the paper expresses support for wider use of defined benefit schemes, including those that offer pension payments, no concrete measures are given to encourage the development of such schemes and it is likely that if implemented most workers would receive their benefits in a lump sum as is the case at present.

The problem with a provident fund that pays out a lump sum is that there is nothing to stop the retiree from spending it within a year and becoming destitute. Even prudent individuals would find it hard to invest and manage a lump sum so as to provide themselves with a steady stream of income throughout their retirement. There are diseconomies of scale that make it impractical for all except perhaps the highest paid employees to manage their portfolios on an individual basis.

The Foundation believes that that for most elderly people the need is for a regular monthly income throughout the person's remaining life; in short, a pension. A pension can be provided by the Government, by private sector provident funds, or as in many developed countries, by a combination of both. A scheme such as the Consultative Paper proposes, that provides the individual with a lump sum at 65 and then leaves him to his own devices, cannot be said to offer proper "retirement protection". It is merely a mandatory savings scheme.

The second problem with the provident fund type of scheme is that it does not begin to take meaningful effect for many years. The payout from a provident fund does not become large until the individual has many contributing years behind him. Even if the scheme proposed in the Paper were implemented at once it would not really have much impact until well into the next century. Those employees retiring in the next few years will be little better off.

The scheme is employment-related and therefore does nothing for those who have already retired, or who are not in regular full-time employment. Housewives, the unemployed, those working part-time or on piece work rates, the self-employed; none of these groups are covered by the scheme. This is another major failing of the Paper.

A further weakness is that the Paper gives a misleading impression of the amounts of money that are needed to provide an adequate standard of living for the retiree. The paper identifies 40% of pre-retirement earnings as a reasonable target figure for retirement income. However a considerably higher figure, perhaps 60 or 70%, is probably more realistic.

Even if the 40% figure is accepted, it is unlikely that this target can be met by saving only 10% of income as the Paper recommends. For most employees earnings rise through their working lives; therefore most of the contribution paid into their fund will be based on a salary figure lower, probably considerably lower, than their final earnings. To meet a targetted total contributions of l0% of final earnings for every year of employment it will by necessary to make substantial "topping up" contributions in the later years. This is not brought out in the paper.

Even the above analysis ignores inflation. While retirement schemes in all countries face inflation, there are particular difficulties Hong Kong because of the high level of inflation and the nature of the money market. Inflation over the last few years in Hong Kong has hovered around the l0% mark. However, there are no "risk free" investments in Hong Kong that will pay this anything near this rate of interest; bank deposits, for example, at present pay around 1.5%. Retirement fund managers can only seek to match Hong Kong's inflation rate by taking substantial risks, which would tend to lead to a high rate of fund failure. The only alternative is for the individual to save even more to compensate for inflationary losses. These factors must be taken into account in any full study of retirement benefit provision.

There are also major difficulties integrating existing retirement schemes with the regime proposed in the Paper. The Paper has almost nothing to say on this subject except that participants in existing schemes, if the schemes are approved (presumably under the Occupational Retirement Schemes Ordinance), will be regarded as covered under the Paper's proposed regime. However the Paper notes that it may be necessary to amend such existing schemes to meet requirements of the proposed regime that are not present, such as the preservation of benefits until 65.

There are at present more than 11,000 retirement schemes approved by the Inland Revenue Department, covering thousands of firms and nearly one million employees. It will be a very large task even to review these schemes to see whether they meet the requirements of the new regime. If they do not meet the requirements, and it is likely that very few will provide for benefits to be preserved if the employee leaves the company, then what can the Government do?

For those schemes administered under Hong Kong law, the Government can force amendments by legislation. However, the Foundation believes that any attempt by the Government to prevent those leaving a company from drawing down their provident fund balance as they leave will be massively unpopular. Notwithstanding that it is done with good intentions, it the Government seeks to impose this provision it raises grave legal questions concerning the property and other rights of the employees and firms participating in those schemes. It would be an attempt to "nationalism" these existing schemes, which would set a highly undesirable precedent.

It is probable that the many of the existing retirement schemes are administered under foreign law, such as that of Bermuda. In such case the Government would have no legal right to interfere with their terms and management. If the Government sought to interfere this would be a political act with the gravest consequences for stability and confidence in Hong Kong.

In practice, the Foundation believes that the Government will not be able to touch existing foreign schemes and will not be able to persuade or force many existing Hong Kong schemes to restrict payouts to employees who leave the firm before retirement. It will then have a choice between doing nothing, and accepting that a third of the workforce remains covered by schemes that do not meet its rules, or imposing the new regime as an additional requirement, in other words forcing employers and employees to set up a second scheme that does meet the rules. The Foundation believes that both courses are highly undesirable.

The regime proposed in the Paper will also cause difficulties for many of the firms that at present do not have approved retirement schemes. Many of these firms are very small, and see very high staff turnover. It is in many cases impractical for such firms to set up retirement schemes. If schemes are set up for such firms the administrative costs will be large and fund managers and trustees will be reluctant to take on the business. The imposition of the regime proposed in the Paper would be likely in practice to act as a deterrent to the establishment of small businesses, or to their employment of further staff once established. The effect on the vital small business sector of the economy should be studied further before the scheme proposed in the Paper is implemented.

The Foundation also believes that a mandatory nature of scheme proposed in the paper tends to restrict freedom of choice and the ability of employers and employees to negotiate terms of employment to their mutual satisfaction. Different firms and individuals have different objectives and abilities to provide for retirement. While all approved schemes should meet regulatory standards the Foundation believes that it is wrong for the Government to require all schemes to have common terms to the extent proposed in the Paper.

The Foundation has a further objection to the mandatory nature of the scheme proposed. It is that it would be morally wrong of the Government to impose a mandatory scheme without taking responsibility for failure of that scheme. The Foundation believes that if under the proposed regime a scheme were to fail or providing reduced benefits because of poor investment decisions the Government should not bail the scheme out. However if the scheme were to fail through fraud the Government's moral obligation to compensate participants would be difficult to avoid. Having forced firms and individuals to contribute to the scheme in the first place, the Government would have an obligation to monitor schemes adequately and compensate the public for regulatory failure resulting in fraud.

The Paper does not propose any transitional period for the implementation of the new regime. The Foundation believes that in view of the very large number of firms and employees involved, that a transition period of some years would be needed.

The Foundation also doubts that sufficient investment managers, actuaries, trustees and other related professionals are available at present to service the large amount of new business that would result from implementation of the scheme. The strain of expanding capacity to meet demand would be likely to result in a higher incidence of error and fraud and high administrative costs, particularly if there is no transition period

The Paper also fails to discuss the regulatory machinery that would be needed to supervise the proposed vastly expanded retirement sector. The Foundation has reservations as to the adequacy of the regulatory regime embodied in the Occupational Retirement Schemes Ordinance. It appears that the Registrar appointed under the Ordinance has inadequate resources to monitor the more than 11,000 schemes that have already been approved by the Inland Revenue Department, together with the large number of non-approved schemed that are understood to exist. The Foundation is not convinced that the burden of supervision can be shifted to the schemes' accountants and lawyers, as proposed by the Ordinance. However the Registrar would certainly be swamped by the very large numbers of new schemes that would be required under the proposals.

Finally, the Foundation believes that in many cases it will be totally impractical to ensure transferability of benefits between different schemes, or to freeze such benefits until retirement. Even setting aside the legal and human rights issues discussed above, there are immense administrative difficulties in keeping track of the contributions of an employee who frequently changes jobs. If it is desired to establish a provident fund style of retirement provision and to retrict payouts before retirement then is no alternative, given Hong Kong’s highly mobile workforce, to a provident fund administered by the Government, in other words a CPF.

Ironically, having rejected the idea of a CPF at the outset, the Paper concludes by proposing a scheme that is very like a CPF. The proposed scheme is mandatory, imposing common terms on the whole working population, and involves employer and employee contributing to a fund balance that is to be preserved for the employee through changes of fob until retirement, whereupon it is likely to be paid out in a lump sum. The only difference between this and a CPF is that the scheme proposed in the Paper is to be managed by the private sector rather than by the Government.

The scheme proposed therefore has all the disadvantages of a CPF. Many of these are outlined above. Further arguments against a CPF for Hong Kong are set out in the Foundation's paper on retirement benefits dated November 1991. However the proposed scheme suffers from the further disadvantage that it is simply impractical to administer a CPF within the private sector. If we are to have a CPF-style scheme, as proposed in the Paper, then there is no alternative to its being administered centrally, ie by the Government.

The Foundation believes, however, that the CPF model, whether run by the private sector or the Government, is totally unsuited to the Hong Kong environment. The CPF model, introduced some 30 years ago in Singapore when it was in a very undeveloped state, is not an appropriate model to carry Hong Kong into the twenty-first century. Rather than to the Singapore of the 1960s Hong Kong should be looking to the developed countries, none of which have a CPF-style scheme.

The Foundation's own proposals towards an effective system of retirement provision for Hong Kong are set out briefly in section 3 below.

3 TOWARDS A PROPER SYSTEM OF PROVISION FOR THE ELDERLY

As outlined in section 1 above, the Foundation believes that the Consultative Paper is cannot be developed into a meaningful system of provision for the elderly. The Paper should be dropped, and a fresh start made. A fundamental review of the issues is needed by parties independent of the Government, including representatives of the elderly, the employees and the employers.

The Foundation sets out below its brief recommendations to such proposed new review body.

(1) The first priority should be to help those who are now old and in poverty. There are increasing numbers of such people in Hong Kong, many of them too proud to claim means-tested public assistance, or the old age and higher old age allowances; such allowances being in any case too meagre to sustain a reasonable standard of living.

(2) Any adequate scheme must also take into account the needs of those sectors of society who, while now young and provided for, are at most risk of becoming destitute in old age. These include the unemployed and those who are not in regular full time employment, widows who have been housewives during their adult lives, those who suffer accident or disability preventing them from working, the disabled and other disadvantaged groups.

(3) The Foundation believes that the needs of the above groups are best met by an old age pension provided by the Government. This must be of adequate amount to sustain a minimum standard of living, perhaps HK$2,000 per month at present, and should beg available to those who need it without stigma. It should be provided on a universal basis to all elderly people. This is the system in many developed countries. Such an old age pension could be largely financed by a levy of 2% on wages up to a limit of HK$20, 000 per month on both employer and employee, together with the savings from the existing old age allowance and public assistance. For further details, see the Foundation's November 1991 paper.

(4) Measures should be taken to encourage private sector schemes to provide a pension rather than a lump sum on retirement. The provident fund model is dominant in Hong Kong because of the short-term philosophy prevalent here. However a lump sum is not appropriate for most people. Most of the developed countries have private sector pension schemes, run either on a pooled basis or for individual companies. Hong Kong must move towards the concept of the pension, whether provided by the Government or by the private sector, if it is to provided adequately for its elderly.

The present tax system discriminates against pensions in favour of lump sum provident fund payouts. The former are taxed while the latter are tax-free. This anomaly must be removed from the tax system.

(5) The Foundation believes that if a proper Government-run system of provision for the elderly such as an old age pension is in place, there is no need to impose a mandatory scheme upon employers and employees. It should be left to market forces to determine which firms provide what sort of scheme. The Foundation notes that market forces are working rapidly in this direction already as the number of schemes submitted to the Inland Revenue for approval, and the number of workers participating in the schemes, has increased greatly in recent years.