The HK Government fails to identify the obvious solution and instead pursues a doomed approach of perpetuating MPF plus LSP. That will either result in taxpayers fully funding a windfall to existing employees or the Government losing a judicial review for overriding the implied terms of existing employment contracts and violating employers' legitimate expectation of not having to pay twice.

Solving the MPF-LSP offset problem, again
30 March 2018

Four years ago, Webb-site proposed a perfectly workable and obvious solution to what is known as the MPF-LSP offset problem. The Government has ignored the obvious and instead is hell-bent on indefinitely maintaining two interventionist and mutually incompatible systems for retirement provision - the Mandatory Provident Fund (MPF) and Long Service Payment (LSP), both funded by employers, while removing the employer's right to offset one against the other, thereby making them pay twice. Now the Government proposes to throw in HK$17.2bn of taxpayers' money to partially subsidise the additional cost to employers of paying both, and it won't be enough.

The detailed history is in our 2014 article, but let's just be clear about one thing. When employers entered into existing employment contracts, they had the clear understanding and legitimate expectation that, by setting money aside as contributions to the MPF funds, they were paying in advance for their LSP obligations. The Government told them this at least 3 times in the Legislative Council, in 1990 and 1992 (during amendments to the Employment Ordinance) and in the 8-Mar-1995 debate (p75) on the proposed MPF Schemes Ordinance:

"At present, the employer's contributions to a retirement scheme may be set off against any amount he has paid out for severance payments or long service payments. Employers do not pay twice. Severance payments and long service payments are not designed as supplementary retirement schemes. They are intended to be alternatives to these retirement schemes. That is why the offsetting provisions exist under the present voluntary system of occupational retirement schemes. We do not intend to change it under the MPF."

It has since become a popular misconception, promoted by left-wing media and politicians and implicitly endorsed by a back-tracking government, that employers are "stealing" or "raiding" money from employees when using the employer's accumulated MPF contributions to settle LSP obligations (the employee's contributions, on the other hand, are never touched). Since the MPF was launched in Dec-2000, employers have been pre-funding their LSP obligations by paying 5% on top of the salaries they were already paying, unless they already had a similar or better voluntary scheme covered by the Occupational Retirement Schemes Ordinance. Of course, there are times when the LSP is not payable, in particular, if an employer terminates an employee within 5 years of hiring, or for misconduct, or if she resigns before reaching the age of 65, as many do. Then the employer's MPF contributions stay in the MPF or ORSO account.

It would be wholly inequitable for the Government, by statute, to move the goalposts on existing employment contracts so that an employee, upon retiring at 65 or later, would receive both the accumulated funds from the employer's MPF contributions as well as an LSP payment of up to HK$390k. Subsidising half the extra costs for a few years doesn't make that right.

The solution, again

Ultimately, the only way to remove the conflict between the 2 systems is to have 1 system or none: either scrapping the MPF, the LSP or both, while preserving accrued benefits. If the MPF is to stay, then the LSP should go. The expectation of LSP (to the extent that it exceeds the accumulated employer's MPF contributions) is implicitly part of existing employment contracts, so those rights should be protected, but accruals and the amount offsetable should be frozen on a transition date, and after that, there would be no further accruals and all new employment contracts would not be subject to LSP. Full portability of all MPF contributions should then be introduced to improve efficiency.

Even with the abolition of LSP, the Government would still provide social security (CSSA) for those who find themselves unemployed, under 65 and with insufficient savings outside the MPF. That would surely be cheaper than throwing taxpayers' money at the LSP as proposed.

Judicial review

If the Government proceeds with its dual MPF+LSP approach, then it will either have to make substantially all the LSP payments until all existing employment contracts end, giving a windfall to employees, or it will face judicial review from employers who entered into contracts in good faith with a legitimate expectation of the making the offset and not paying twice. Webb-site, via a perpetually loss-making company, has employed 1 person in HK since 2003 to help maintain the site's database. We face the possibility of eventually having to pay an additional HK$390,000 that the employee never expected and for which the employer did not budget, so we would be in a position to launch that judicial review, and so would many others.

Other unintended consequences

A secondary effect of pursuing the MPF+LSP approach is that for new contracts, or when adjusting salaries, employers would have to take into account the future cost of paying twice, reducing take-home salary so that they could afford the possible payments.

The MPF+LSP would also reduce labour flexibility, because if an employee is within a few years of reaching 65, then he is more likely to stick around to enjoy the eventual double-payment than resign and forego the LSP.

Finally, as the government proposes a time-limited and reducing subsidy for LSP, it would make sense to terminate older employees while the subsidy is highest, before hiring them back on new terms which reflect the future costs. So the subsidy could end up costing a lot more than the Government estimates.

One bad intervention leads to another

The MPF has always been inherently flawed  - it should have been named "Mandatory Payments of Fees". HK residents have always been good at saving when they can, partly because of the low social safety net which encourages self-provision, and partly because they are not penalised by taxes on interest, dividends or capital gains, unlike savers in other places. The MPF forced employees to divert some of their earning capacity into managed funds rather than self-managed savings. Remember, what matters to employers is the total cost of employment, not how the employee spends or saves it.

By the MPF Schemes Authority's own reckoning, over its first 17 years to Dec-2017, the internal rate of return (i.e. dollar-weighted) averaged 4.8% p.a. net of costs. But inflation in the same period averaged 1.8% p.a., leaving a 3% net real rate of return. During the same period, asset managers, custodians, administrators, trustees, auditors and others took out an average of about 2% p.a., so the gross real return was about 5%. Therefore 2/5, or 40% of that real return went in costs. By comparison, the Tracker Fund of HK (2800) had a total return over that period of 7.5% p.a. (ignoring dealing costs), or about 5.7% after inflation.

So independent savers could have done far better than pay away 2% per year to the industry in a compulsory savings scheme. Thousands of people in HK do nothing more productive than manage, sell and administer the MPF funds of everyone else. Furthermore, if an MPF victim survives until 65, he can then take the lump sum to pay off his debts or bet it all at Happy Valley before falling into the social safety net, so if the purpose of MPF was to protect spend-thrifts from themselves then it fails.

But it seems that the Government has invested too much political capital in the MPF to stop now, and it is compounding the error by perpetuating the conflict with LSP. The Government should scrap the LSP scheme. For the detailed steps, see our 2014 article. There's no point in repeating the obvious.

©, 2018

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