3 June, 2020
Pension reform in Asia is progressing as the region faces numerous challenges: ageing populations, rising life expectancy and the erosion of traditional family and community support for the elderly. While the traditional state-provided pension may provide one potential source of retirement income, Manulife Investment Management believes that a comprehensive multi-pillar approach, such as that outlined by the World Bank, should be the best way forward. In this initial paper of a new series on retirement issues, Manulife Investment Management examines the challenges of pension reform in Asia and the innovations being explored to address them. Using our collective experience and learnings in markets across the globe, we look at the unique pension reform journeys in three Asian markets: China, Malaysia, and Hong Kong.
Seismic demographic shifts have strained pensions systems worldwide. Last year, the number of people aged 65 or above exceeded those under five years of age for the first time in history.1 Life expectancy continues to increase, with people born in developed countries since 1997 now having a 50-50 chance of living beyond 100 years.2 As a result, pension systems that were generally designed to support retirements of 10 to 15 years are faced with handling retirements that could last in excess of 40 years.
Compounding the issue is the plummeting global average fertility rate, which has halved since 1950.3 Many countries, such as China, will see the relative size of their working-age populations decline (Chart 1) as their retiree numbers swell, placing an unsustainable burden on pay-as-you-go systems that fund pensioners’ benefits through workers’ current contributions. Meeting the shortfall through government coffers will prove challenging, given the decline in the number of taxpayers concurrent with the increase in social welfare expenditure on the elderly.
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Due to these trends, state-funded pensions are facing stern challenges. A recent World Economic Forum paper puts the projected retirement savings gap across eight globally significant countries at US$70 trillion in 2015. Some 75% of this total comes from unfunded government-provided pensions and pensions promised to public employees.4 By contrast, just 1% of the gap consists of unfunded corporate pension promises, with the remaining 24% created by the shortfall in individual savings.
As such, the increasing shift towards mandatory occupational pensions and voluntary personal pensions in many Western economies over the past few decades has been both timely and appropriate.
The way these types of pensions are funded and the nature of the benefits they offer have also been changing. Given the strain on many traditional pension plans, there has been a shift away from defined benefit schemes to defined contribution schemes,5 as reflected by the share of assets held by each.6
Asian markets are not immune from these global trends. However, the issues and opportunities faced by each market vary, owing to considerable diversity in terms of demographics, economic development and means to save.7
Despite the relatively strong levels of economic growth across Asia and the rise of its middle class, retirement preparedness is still a key concern across the continent. There is a wide variance in retirement assets as a percentage of gross domestic products (GDP), with more-affluent markets generally having greater assets proportional to GDP, but there are exceptions (see Chart 2). Markets in Asia in general lag those in the West such as the US, UK and Canada, where pensions assets as a percentage of GDP are 130%, 121% and 108%, respectively.
Diverging levels of economic development in Asia translate into significantly different levels of pension coverage. Coverage is generally higher in Asia’s more developed economies and lower in the region’s less affluent markets, owing to lower overall income levels in the latter and the greater proportions of their populations employed in the rural and informal sector.
Even where there is coverage, pension systems may not provide enough income to cover people’s needs throughout retirement. This is due to factors such as a low level of contributions and low returns - exacerbated by the large share of retirement savings in Asia held as cash deposits (Chart 3).
Another issue is that even in markets with greater pension coverage, the early withdrawal of savings driven by the widespread underestimation of longevity risk has emerged as a problem.8 And steady advances in economic development and healthcare have meant that longevity can outpace people's expectations. Life expectancy across Asia stood at 74.2 years in 2016, up from 69.4 years in 2000 (see Chart 4),9 and further increases could be virtually assured. Leading the way forward are two of Asia's most affluent jurisdictions, Hong Kong and Japan, which have the world's most long-lived populations, with women expected to live in excess of 87 years and men over 81.
Taking these factors into account, the core focus of pension design in the future is likely to shift from asset accumulation to providing lifetime income in the form of decumulation solutions.10
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1 United Nations: https://www.un.org/en/sections/issues-depth/ageing/.
2 Lynda Gratton and Andrew Scott, “The 100-Year Life”, Bloomsbury (2016). The World Economic Forum also provides further context for life expectancy among individuals in developed countries. Financial Times: “Adapting to the word of the 100-year lifespan”, 11 August 2018.
3 James Gallagher, “‘Remarkable’ decline in fertility rates”, BBC, 9th November 2018: https://www.bbc.com/news/health-46118103.
4 The eight countries include: Australia, Canada, China, India, Japan, Netherlands, United Kingdom, and the United States. World Economic Forum, “We’ll Live to 100 – How Can We Afford It?” (May 2017): http://www3.weforum.org/docs/WEF_White_Paper_We_Will_Live_to_100.pdf.
5 World Economic Forum, ”Investing in (and for) Our Future” (June 2019): http://www3.weforum.org/docs/WEF_Investing_in_our_Future_report_2019.pdf.
6 A defined benefit scheme generally guarantees a specific income stream during retirement based on factors such as salary history and duration of employment, and is often funded on a pay-as-you-go basis. A defined contribution plan, on the other hand, is fully funded, taking the form of an occupational pension scheme where the benefits accrued are based on the accumulated contributions made by employees and their employers.
7 A common factor that is well understood is population ageing. Japan is at one extreme, where the old-age dependency ratio (the ratio of those aged over 65 to those in the working-age population) is at 46% and set to climb to 52.7% by 2030 (based on projections by the Economist Intelligence Unit, with the caveat that such forecasts are subject to considerable uncertainty around migration trends and policies). In Hong Kong, Singapore, Taiwan and South Korea, where fertility rates rank among the lowest in the world, the old-age dependency ratio is forecast to jump dramatically between now and 2030, to a range between 35.4% and 43.5%. The situation is less extreme in other markets, but places like Thailand and China will also see marked increases in their old-age dependency ratios, from 16.5% to 29.1% in the former and from 16.9% to 27% in the latter. In contrast, places like Indonesia, the Philippines and Malaysia, where there are still ten times as many people of working age as there are people aged over 65, making demographic ageing seem less of an immediate policy priority.
8 Manulife Investment Management, “Live long and prosper? Retirement and Longevity Risk”, Aging in Asia: Paper 5 (June 2014).
9 Julia Hollingsworth, "Hongkongers top life expectancy rankings worldwide for second year in a row", South China Morning Post, 29th July, 2017: https://www.scmp.com/news/hong-kong/health-environment/article/2104584/hongkongers-top-life-expectancy-rankings-worldwide.
10 Thinking Ahead Institute research, "Global Pension Assets Study 2019" (2019).
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