Based on the proposal to be launched by Hong Kong Mortgage Corporation (HKMC) in the middle of next year, people aged 65 and above will be allowed to invest up to HK$1 million (US$128,000) in exchange for a guaranteed monthly income until death.
“While we welcome the plan, it may not be adequate,” says Lesley-Ann Morgan, Global Head of Defined Contribution and Retirement at Schroders. She explains that there are three key risks that people face in retirement: living longer than expected, experiencing higher inflation than expected and getting lower investment returns than expected. Morgan believes that the scheme, which is capped at HK$1 million, cannot be expected to address all of these risks.
Risks after retirement
Early in retirement, investment returns and inflation are the two principal concerns, she says. However, longevity risk, which starts out relatively small, due to the high probability of survival through the early years, will grow quickly as the individual ages – reflecting the fact that longevity is self-fulfilling, i.e. the probability of reaching age 90 is much higher for an 89-year-old than for a 65-year-old.
“You need some longevity protection, but you don’t need it until later in life; maybe not until you get into your eighties,” says Morgan. This insight helps to focus the solution on the appropriate risk at each stage of retirement.
According to Schroders, a successful post-retirement strategy should meet four primary ‘needs’ criteria. It should provide stable investment returns (net of costs), protect against longevity risk, safeguard against inflation and be flexible to adapt to changing requirements.
However, these needs differ significantly from what individuals want from their post-retirement investments. Most retirees want predictable income so that they can budget, be able to leave some legacy assets to family members; they want enough to live on and for the solution to be simple, according to Schroders’ report “Investment perspective: Live Long & Prosper”.
The three components of a post-retirement plan
While there is some degree of conflict between individuals' needs and wants, Schroders recommends a solution that provides a balance of these factors.
While considering an appropriate pension strategy, Schroders analysed three commonly used approaches to providing income in retirement and assessed how they fared against the four needs and wants of retirees, these three being: cash lump sum invested in an instant-access bank account (common in Hong Kong); individual investment accounts that provide non-guaranteed income; and fixed income annuities that provide longevity protection.
“Any of these components is unlikely, in isolation, to be suitable to meet the needs of retirees,” says Morgan. “An effective solution will be a combination of fixed annuity/longevity protection and an investment portfolio that returns growth above inflation.
“With lengthening life expectancies, we anticipate strategies that provide a growth and income account-based approach for the first 15-20 years after retirement with longevity protection engaging in later life,” she adds.
No market in the world has yet fully solved the puzzle of the most appropriate post-retirement strategy, says Morgan. “Many DC [Defined Contribution] members have not contributed enough, and they are living longer, which means they need to make assets in post-retirement work harder,” she says.
While annuity products are popular in Continental Europe, supported by regulation that has been put in place to provide guaranteed income for life, falling bond rates are putting a strain on such policies. “The challenge for such products is that the guarantees are difficult to provide, and this puts a question mark on how long they can continue,” says Morgan.
In some countries, reverse mortgage schemes, which allow people to borrow against the equity of their homes, remain unpopular. “It is very hard to make these work from an emotional and behavioural standpoint,” says Morgan, “because people like the idea of being able to hand their property on to their family when they die.”
A suitable solution for Hong Kong
As Hong Kong considers the launch of its annuity scheme, Morgan advises combining the annuity with a growth solution. “The combined plan will tick more of the boxes. You get the flexibility, you get longevity protection, you get the return potential in excess of inflation – and it is reasonably simple,” she says.
According to Schroders, the solution for Hong Kong should focus on maximising risk-controlled growth opportunities in the early stages before adjusting to protect against longevity risk later on, fitting the pattern of risk sensitivities as the retiree ages.
Employers and pension scheme sponsors voicing concerns
With lengthening life expectancies leading to increasing inflation and investment risks, plan sponsors could have a bigger role to play post-retirement to ensure that retirees make the right choices with regards to their investment choices during the “decumulation” phase. Currently plan sponsors have no legal responsibility to get involved in how their employees obtain an income when they retire.
“In our dialogues with institutional clients, we see increasing concern about whether Hong Kong employees have access to adequate retirement benefits,” says Chris Durack, CEO of Hong Kong and Head of Institutional Asia Pacific. “There is growing recognition that simply relying on a cash lump sum in retirement will not meet retirement funding needs.
“Instead, some employers and scheme sponsors are looking to implement well-designed investment solutions that address their employees’ key risks in retirement and help to maximise their hard-earned life savings,” Durack adds. “In this regard, Schroder could help with providing the right solutions.”
Please visit the post-retirement section on www.schroders.com.hk/post-retirement
Important Information: This document is intended to be for information purposes only and does not constitute any solicitation and offering of investment products. Investment involves risks. This material has not been reviewed by the SFC. Issued by Schroder Investment Management (Hong Kong) Limited.