Asia's wall of money
THE TAIWANESE ARE a resourceful people and accustomed to working things out alone. So when the inadequacies of their existing pension schemes became apparent the government moved quickly to reform the system.
The problem was not so much underfunding – the difficulty in many Asian countries. In Taiwan the funds were barely funded at all. Bessie Liu, senior vice-president and general manager, department of trusts, at Central Trust of China, and the administrator of the existing labour pension scheme, explains. “We want to provide a social security system for workers,” she says, “but under the existing scheme, less than 10% of workers could get any retirement benefit under the law and amounts are small.”
This is principally because the existing scheme has draconian qualification requirements. “According to the law, the old system was a lump-sum payment to workers who have worked for the same company for more than 15 years,” says Lai Chin-Lin, deputy minister of the Council of Labour Affairs, the administrator of Taiwan’s new labour pension scheme. “In Taiwan, most companies are small and medium size, so they often can’t afford the payments.”
Athough a majority of employees failed to qualify for the existing pension schemes, even for those that did, employers often failed to make payments, meaning the system was clearly failing.
As a result of the years of failure, Taiwan’s pensions shortfall is now serious. According to JPMorgan, the age dependency ratio (the ratio of retired population to those of working age – 15 to 65), now 20%, will increase to 42% by 2025. Taiwan’s pension schemes offer one of the lowest coverage ratios in Asia. The estimated replacement ratio, the proportion of post-retirement pension benefit to pre-retirement income, is Asia’s lowest, along with Thailand, at just 7%. That compares with a World Bank estimate of 60% to 70% replacement ratios required to provide adequate retirement income.
The government has now acted to address these serious problems. In July, it launched a new labour pension scheme, under the Labour Pension Act, the structure of which is very different to the existing schemes. “We want to change from a defined benefit scheme to defined contribution,” Lai says, “So the savings can become portable. Plus there’s no stipulation of minimum length of service.”
Companies cough up
The new scheme will collect mandatory contributions from employers of 6% of an employee’s monthly salary. Workers can make voluntary contributions up to an equivalent sum and receive tax benefits. The government will provide a guaranteed return on the new funds equal to the two-year certificate of deposit rate.
The scheme is designed to be as flexible for employees as possible to encourage them to save additional sums. “Because the new scheme is portable,” says Lai, “the labourer can bring the funds wherever he wants, so it’s much better for workers.”
Not everyone is likely to be as enthused about the new scheme’s terms as Taiwan’s workers, however. Companies in Taiwan are already grumbling about the additional costs of the new scheme and some international fund managers have raised questions about possible negative effects on corporate earnings from the mandatory pensions contributions. Such arguments receive short shrift from Lai. “If companies had already contributed to the old scheme,” he says, “then the new system would not be a problem. But those companies that never bothered to contribute to the old system regard the new scheme as a burden. If companies don’t pay, they will get penalized.”
Companies with more than 200 employees can opt out of the new scheme and purchase private annuity plans. However, the government is sufficiently worried about the possible effects on the corporate sector of the new scheme to draw up plans to provide soft loans through state-controlled banks of up to half of the mandatory contributions to companies struggling to meet payments. That might not prove to be a sensible use of government funds but since many companies are cash-rich, most of the complaints seem unjustified.
Whoever ends up footing the bill, what is certain is that the new pension fund will accumulate capital rapidly. That offers global fund managers a significant opportunity. ABN Amro expects mandatory contributions to personal pension accounts under the scheme to amount to at least US$6 billion a year.
According to Lee Shyan Yuan, a commissioner with the Financial Supervisory Commission, Taiwan’s financial markets’ regulator, new pension fund assets are expected to amount to US$88.1 billion in 20 years and total pension savings US$1.215 trillion by the same date. Lai’s expectations for his new labour fund are a little more modest, but still impressive in overall size. Lai says: “By the end of 2005, the fund is targeted to reach NT$50 billion [US$1.49 billion] and by the end of 2006 NT$120 billion. In the longer term, we expect there to be NT$1 trillion of assets.”
Investment decisions
With Taiwan’s pension schemes accumulating significant amounts of new capital by the month, managing these assets is the next task on the minds of Lai and other officials. The good news for global fund managers is that most Taiwanese officials are determined to outsource a meaningful amount of their newly acquired capital. “The major way to manage the new fund will be to outsource,” says Lai, “except for the money deposits for the fixed-income portfolio. We intend to outsource to both domestic and international fund managers. If their past performance is good enough any fund manager can tender.”
International fund managers are likely to feature strongly in the new labour pension fund. “We want a globalized portfolio,” says Lai. “Judging by the past volatility of Taiwanese securities, it would be best to have the majority [of the fund’s assets] in international securities, and Taiwan contributes less than 1% of the global [securities] market. But because the money has been collected from domestic workers a percentage will of course be invested in Taiwanese securities.”
Lai is not alone in seeing the benefits of investing pension assets in international securities. Liu of the existing labour pension funds says: “We have our own guidelines, and we can invest up to 10% of funds overseas. But we currently have only 1% [invested] internationally.”
The final decision on awarding mandates will be made by the supervisory committee of the new fund. This committee will be quasi-governmental, says Lai, and its formation is still pending the approval of the legislature. Nonetheless, Lai believes that the committee will be especially powerful in setting investment objectives and awarding mandates. “We’ll hire as many professionals as possible,” he says. “So they will be able to make very good investment decisions. Because of their professionalism, although they’ll outsource a lot of the fund management, they can do some fund management themselves.”
Multiple beneficiaries
Outsourcing of investment mandates is definitely the trend among Taiwan’s other state pension funds. In October, another of Taiwan’s state pension funds, the Labour Insurance Fund, awarded four investment mandate contracts for the first time. All four mandates were awarded to international fund management firms: Alliance Capital, Pimco and Wellington International Management.
In addition to the Labour Insurance Fund, the Public Service Pension Fund and the existing Labour Pension Fund have awarded investment mandates. Yet despite this, according to Lee Shyan Yuan, just US$5.1 billion of pension fund assets have been outsourced by Taiwan’s existing four state pension funds, out of a total asset pool of US$35.4 billion. Add to that sum the new Labour Pension Fund and its growing asset pool and Taiwan’s state pension schemes offer a significant source of new business for global fund managers.
Critics of Taiwan’s state pension funds point out a tendency among the funds to focus too much on short-term performance among external fund managers. That approach does not sit well with the management of long-term pension fund assets and is a lesson the pension fund administrators and trustees will have to learn as outsourcing becomes increasingly popular.
It will not be just the asset management industry, domestic and international, that will benefit from Taiwan’s pensions reforms, but also Taiwan’s capital markets. Taiwan’s need for additional returns to address its demographic challenges means that pensions contributions can no longer be left on deposit, but must find their way into the equity markets. The effect of these sums on the market is profound, a point that is not lost on the authorities. “In Taiwan, the majority of market players are retail investors,” says Lai. “[With the new reforms], we will have more institutional investors, including the government pension funds. Because we will invest in local companies, we can force them to improve their corporate governance standards and we can push regulators to improve the market.”
Taiwan’s principal markets regulator, the Financial Supervisory Commission (FSC), is also hoping that the state pensions reforms will contribute to the island’s developing capital markets. Taiwan, like many other Asian countries, harbours ambitions to promote itself as a regional financial centre and it is clear that the opportunities presented by the pensions reforms provide opportunities to further those ambitions.
“The new pension fund will have a huge impact of the financial markets,” says Kong Jaw-Sheng, chair of the FSC. “That will help us. It’s critical for the development of our capital markets. We’ve set out our goal to be a regional financial centre and a mutual funds centre.”
Whether Taiwan can parlay its considerable power to award management of significant assets to international fund management businesses into a regional asset management centre remains to be seen.
Curiously, despite the firepower at its disposal, Lai says that there are no plans to seed the local fund management industry by awarding investment management contracts to start up domestic fund managers, a strategy that proved successful in Singapore, which arguably sits in pole position in claiming the regional asset management role.
“We don’t plan to outsource to Taiwanese fund managers – not to new fund managers,” says Lai. “We need to see the track record. All our outsourcing must only be in the best interests of the fund, not considering the local market, or the regional asset management concept.”
That approach, at least as far as furthering Taiwan’s ambitions as a regional financial centre is concerned, might yet prove to be a mistake. What the authorities have got right, however, is the restructuring of the country’s state pensions schemes, the speed and extent of the reforms and embracing the outsourcing model, which is more likely to achieve the kind of fund performance Taiwan’s increasing number of pensioners will need. These are instructive lessons that other Asian countries could usefully heed.
