Hong Kong will finally put an end to a mechanism that allows companies to use their employees’ retirement savings for long-service and severance payments – a move expected to both expand the pool of pension money available to fund managers and encourage them to improve their offerings.

Carrie Lam

The territory's chief executive, Carrie Lam, made the hoped-for announcement about the contentious scheme under the Mandatory Provident Fund (MPF) system in her 2018 policy address yesterday (October 10).

Under the mechanism, employers can withdraw money from the contributions they had paid into employees' pension plans to offset the cost of long-service or severance payments. It will be removed by 2024 at the latest.

“This is of course welcome. The problem has been dragging on for a long time. A major concern is the leakage [of pension assets],” Sally Wong, chief executive of the Hong Kong Investment Funds Association, told AsianInvestor.

Low-income people see the most leakage from their retirement funds under the offset mechanism, she added, but they are also the ones who need these savings the most.

Hence this is an important move that separates pension plans from other labour-related issues, Wong noted.

The total amount of severance or long-service offsetting claims in 2017 was HK$4.3 billion, a 12% increase from the previous year. The claims accounted for 2% of the HK$198 billion growth in MPF assets over that period.

Elaine Hwang, Hong Kong-based director of retirement at consultancy Willis Towers Watson, said 2017 was a booming year in which few businesses shut down and investment returns were good, so 2% is not representative of the overall picture.

The problem would be more serious and hit vulnerable individuals the most in times of economic downturn, she noted. Moreover, offsetting claims have been rising, so the government is right to resolve the issue now, Hwang added.

The year 2017 marks one of the best years for MPF performance, as the system posted a 19.87% return. Aggregate accrued MPF benefits amounted to HK$844 billion as of December 2017.

MORE FUND FLEXIBILITY 

In addition, after the offset mechanism is scrapped, MPF savers will have more flexibility to choose investment plans that meet their own risk/return profiles.

Employees and employers each have to make a monthly contribution of 5% of the employee's relevant income (capped at HK$1,500 a month) to an MPF scheme. An employer chooses a fund house for investing the MPF contributions for all the staff in the company.

At present, employees cannot shift contributions made by their employers to other managers because that money can be used for long-service or severance payments. In future, individuals will be able to shift all their pension assets to different managers, noted Hwang.

That will help boost competition among MPF providers and ultimately improve the industry, she said. “[Fund managers will] have to think about how to attract people to join their plans; whether to [charge] lower fees and provide better services."

The aim is to secure the passage of the enabling legislation by the Legislative Council within the government's current term – that is, by 2022 – and implement the abolition of the offsetting arrangement two years after the passage of the amendments, Lam said.

BACKGROUND TO THE OFFSET

The offset mechanism was included when the MPF scheme was launched in 2000 as part of a concession made by the Hong Kong government to convince the business sector to accept the scheme.

While opposition to the offset has grown stronger over the years, businesses argued that the additional labour costs would be too heavy for small and medium-sized enterprises.

To ease their concerns about the offset being removed, Lam said the government would contribute HK$29.3 billion ($3.7 billion) to support firms’ long-service and severance payments for a transition period of 25 years. The subsidy scheme will come in two tiers, with HK$17.2 billion to be committed in the 12-year first phase.

The amount is more generous than that proposed by former chief executive Leung Chun-ying, who had mooted a subsidy of HK$7.9 billion over a 10-year period.

The government also proposes setting up designated savings accounts to help employers save up early for meeting potential severance or long-service expenses in future.

Local media reported in January that employers would contribute an additional 1% of employees’ income to a specialised account for making long-service or severance payments under a draft proposal. However, the policy address did not give details of this.