Corporate pension schemes have evolved dramatically over the past few decades from fixed benefit schemes into what is believed to be a more flexible fixed contribution type scheme with many options for investment.
Traditional schemes were in many cases used to attract talent, and long-term employees could look forward to a predictable income during retirement. The evolution to fixed contribution schemes has exposed a number of risks to retirees, while providing employers with a more predictable cost of funding employees’ retirement schemes. Nowadays employees essentially carry the risk of underfunding which could be caused by factors such as longevity, lower than expected investment returns and legislative changes. If these issues are not addressed in some form or another then we may well face a social issue where more and more people of old age will depend on government support to survive.
A higher life expectancy and a lower birth rate over the past decades has globally resulted in an increase in the old-age dependency ratio – the ratio of the population aged 65 or over in relation to the population aged 15 to 64, expressed per 100 people. The higher old-age dependency ratio means every working person supports more old people. Currently this ratio in Asia as a whole is relatively lower than in Europe and North America, but the rate is increasing very quickly. Looking at Asia by country, Japan has the highest old-age dependency ratio, followed by Hong Kong, South Korea, Taiwan, Thailand, Singapore, and China. Low birth rates in some regions – such as Hong Kong, Japan, Singapore, Taiwan, and South Korea – accelerate the speed of aging of these countries/regions. So, similar to other parts of the world, Asia is also facing aging population problem.
Compared to the other part of the world, Asia has some unique pros and cons in dealing with old age support, including:
- Traditionally, people in most Asian countries like to save.
- There is a culture in many countries that many generations live in one big family and support each other. But this culture of the extended family is moving towards western-style small family units.
- People retire at a younger age.
Based on an OECD study, the normal pension eligible age for various Asian countries are:
- 55 in India, Malaysia, Indonesia, Sri Lanka (50 for women), and Thailand.
- 60 in China (55 for women), Vietnam (55 for women), and Pakistan is 60 (55 for women).
- 62 in Singapore.
- 65 in Japan, Korea, Hong Kong, and Philippines.
As a result, people in most Asian countries have a longer expected retirement duration.
Based on the OECD’s pension model by using population mortality data:
- The expected retirement duration for men in Philippines, Korea and Pakistan is lower than the average (20.8 years); Malaysia, Sri Lanka, Indonesia and Thailand has a much longer expected retirement duration due to the low eligible retirement age.
- The expected retirement duration for women in Philippines, Korea and India is lower than average (25.8 years); Sri Lanka, Vietnam, Malaysia and China have a much longer expected retirement duration due to the low eligible retirement age.
- Most Asian countries are developing countries, thus many people cannot accumulate enough assets before their retirement.
The publicly managed, tax-financed social safety net in most Asian countries is not sufficient to cover retirement needs. At the same time the government’s role in retirement in many Asian countries is retreating, thus the employer’s role is becoming more important.
As mentioned above, people in most Asian countries have a longer expected retirement duration, hence they will need pension funding for a longer period of time. To manage the longevity risk, corporate pension funds could consider increasing the eligible pension age for some years. This has been done in Australia. However, as may be expected, this has created some discontent.
Many Asian countries still lack a comprehensive set of freely available retirement income products. In Hong Kong, for example, the Mandatory Provident Fund (MPF) has now been in existence for around 10 years, and while there is an active insurance sector over 80% of people recently surveyed believe they are under-funded for retirement. This indicated that significant opportunities exist for individual retirement policies in this region.
Another solution may be to develop a more sophisticated annuity market that can share the longevity risks between retirees. Another solution may be to encourage employees and retirees to use various retirement income instruments, such as savings, real estate, stocks, bonds, etc.
People live longer but still tend to retire at the official retirement age, so the expected retirement duration is increasing. People need more funds for their retirement life. In most Asian markets, similar to other markets of the world, the design of corporate pension plans still focused heavily on the accumulation period, and less on the withdrawal phase.
A simple lifetime savings and draw-down model developed by Mercer for the Australia market (projection assumptions: 9% contributions, from age 21, 4% pa wage increases, no employment break, 7.5% pa net investment return pre-retirement and 6.5% pa net investment return post retirement from age 67 retirement draw-down 60% of pre-retirement salary thereafter increased in line with inflation of 2.6% pa.) shows that the significance of the component of retirement income attributable to investment returns may seem extraordinary. Based on the modeling, 66% of retirement income sourced to investment returns during the post-retirement phase, 28% is sourced from investment returns earned during pre-retirement phase, while only 6% comes directly from contributions during the course of employment. Though the model is not developed for Asia countries, this model is still valuable to remind Asian employers and employees to think about retirement savings as a ‘whole-of-life’ accumulation process. The investment strategy should be long term, extending beyond working life.
But since people don’t know how long they will live, they usually use the normal life expectancy as a guideline to prepare their financial planning for retirement. This in itself involves some additional risks. For example, social-economic status has a strong relationship with life expectancy; medical improvements will extend life expectancy, etc.
Many people to not have the time and experience to manage their retirement portfolios and hence investment choices made at inception are in most cases never altered. This could lead to severe consequences. If there was some incentive or education available to encourage or even force at least annual reviews this may go some way to dealing with this risk.
At the end of the day the main incentive may still have to come from government sources. Governments need to encourage savings by means of tax incentives that are so attractive that investors will react.
Employee’s Engagement Risk
Many corporate pension funds have been negatively impacted by the global financial crisis. People’s confidence in corporate pensions has decreased, some people have chosen to reduce their pension contributions, and some people have shifted to a more conservative investment portfolio.
To increase new enrollment, retain the current members, and to increase employee contributions, there should be some form of education to employees in general about the ‘whole-of-life’ long-term investment strategy, communication with individual employees on their financial futures, provision of various channels for them to increase their contribution rates, or to switch investments between funds depending on factors such as market conditions and closeness to retirement age. In most Asian countries, employees are only provided with their corporate fund information a few times a year. An online account view could be provided to employees, together with financial planning calculation tools. By helping their employees to be better informed and prepared for retirement, an employer could see better employee engagement in corporate pensions.
Some Asian countries have not set up a well-defined corporate pension legislative system yet, so it is highly likely that current policies and practices might change from time to time.
In conclusion, Asia is facing similar challenges to those already being experienced in other parts of the world. Some innovative thinking, coupled with meaningful backing and incentives from government sources will be needed to alleviate this potential social problem.
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