Compounding MPF mistakes
Next Magazine (Second opinion A006, 2012.12.13)
Mandatory Provident Fund (MPF) schemes have used compulsion to require funds now worth $412 billion to be taken from the wages of employees and invested with approved providers. Over the 12-year life of the scheme, the aggregate returns have been 3.4% after fees and charges. The current fund expense ratio is 1.74%, the highest in an Ernst and Young cost study of comparable country schemes.
The EY report is insightful. Although polite about the scheme and the MPF Authority (MPFA) that commissioned the report, it shows that costs are high because the scheme is poorly structured and administratively complex. Processes are paper-based and expensive, there are many small employers and self-employed participants, scale remains below comparable countries, providers don’t co-operate effectively and there is insufficient pricing competition. They note a proliferation of accounts (many dormant) and need to clarify the role of scheme sponsors and trustees.Although not mentioned by EY, embedded in many of these processes are the cumbersome requirements of the MPFA, which must approve many transactions, and these add time and complexity to providers dealing with our money.All of these costs have a real impact on beneficiaries on retirement. A contributor earning $20,000 per month in current dollars for 40 years would have funds that could buy an annuity providing roughly $10,200 monthly income in current dollars if the EY savings can be made, but just $ 9,400 if expense reforms cannot be made. If investors were able to save with the same discipline and invest the money themselves, administration costs would be considerably less and a final monthly payout of $11,900 could be feasible on the same investment return assumptions.
The compulsion, lack of choice, low returns and high expenses are all concerns for those who must contribute to this plan. Yet the MPFA, established with a $ 5bn capital grant and spending $ 412 mn per year to administer the scheme, seems to have other priorities.The Chair of the Authority, Anna Wu said in presenting the cost report and proposals for reform that:“The MPF System is a social policy aimed at providing retirement benefits to the working population. Purely relying on market forces to set fee levels may not be enough and more needs to be done.”This comment shows a bias against the market and ignores the important points in the EY analysis that shows MPF to be a heavily designed political compromise that is expensive to operate rather than a market answer to retirement incomes.The MPFA makes four proposals for change to the MPF schemes that are equally at odds with both the EY report and an antipathy to market solutions. They call for “1) Capping the fees of MPF funds, 2) Mandating various types of low-fee funds in each MPF scheme, 3) Providing a type of basic, low-fee, default fund arrangement, and 4) Introducing a not-for-profit operator to operate a simple and low-fee MPF scheme.” All these measures underline the failings of compulsion in the MPF scheme.
Capping fees does not address the drivers of high costs. Mandating low fee funds is effectively making a default asset allocation choice, which could hinder performance. Introducing a not-for-profit provider would further impose complexity and a burden on the public purse. Such providers are rarely drivers of efficiency as they gilt-edge service in their own rather than members’ interests.The MPFA Management Board is lawyer heavy with a paucity of economics and investment skills. Little wonder that they continue to advocate a system with poor incentives and unintended consequences that creates processes and structures that have a high cost to investors.Full portability of funds and choice is only a partial solution. The economic evidence is clear that compulsion distorts the labor market by taxing employment and imposing financial constraints on low-income households.MPF has taken money out of a highly efficient private savings market with low costs, high flexibility, almost no tax distortions and little “moral hazard”. It has put that money in a high cost scheme with relatively high risk and delivered mediocre performance.Markets have not failed in retirement income policy: they have not been tried.
Bill Stacey is in his 10th year as a resident of Hong Kong and is Chairman of the Lion Rock Institute.
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