LegCo Subcommittee on MPF System
Information Note
Report on Outstanding Issues -
Administrative Fees of the MPF System

Purpose

This paper presents the information requested by Members at the Subcommittee meeting held on 10 April 1997 in respect of issues relating to the Administrative Fees of the MPF System.

LegCo’s Comments

2. Members made the following requests :

  1. Members requested the Administration to set out the basis of our assessment of the fees payable to MPFA, which are estimated to be 0.05% to 0.2% on scheme assets.
  2. Members expressed concern over the overall administrative fees of the MPF System and quoted the World Bank as saying that the administrative fees of privately managed mandatory retirement fund system could be as high as 5%. Members requested the Administration to review the relevant World Bank Report and report the findings to the Subcommittee.

MPFA Fees

Annual Fee Estimate

3. As set out in the information note "Administrative Fees of the MPF System", we propose to impose an annual fee of 0.05% to 0.2% on scheme assets to cover the operating cost of MPFA. Based on our preliminary assessment, this fee level will be able to keep MPFA self-financing in the long run.

Key Assumptions Made

4. Our estimate has been made on the basis of following major income and expenditure assumptions (at 1996 price):

  1. The Government will inject a capital of HK$5 billion as seed money to finance MPFA’s operation at its inception.
  2. The initial set up costs of the MPFA will be HK$400 million. The initial set up cost will cover capital expenditure such as :
      Computer system hardware and software;
      Office renovation and furniture costs; and
      ; Miscellaneous office equipment.

  3. There will be an additional capital expenditure of HK$200 million every six years to replace depreciated assets.
  4. The annual operating cost of MPFA will be HK$350 million.
  5. For prudence sake, a relatively conservative investment strategy will be adopted for the investment of the seed money, with a substantial portion in money market and bonds.
  6. Both the rate of investment return and inflation rate will be assumed to be 8.5%.

5. On the basis of the above assumptions, we have projected, for illustration purposes, the accumulated surplus available to meet MPFA’s operating costs under the following scenarios:

  1. Where the MPFA does not impose any annual fee.
  2. Where the MPFA imposes fees on the basis of a sliding scale, such as :

Year of operation

Fee (% of scheme assets)

Option I


Year 1 to 2

0.2

Year 3 to 4

0.15

Year 5 to 6

0.1

Year 7 onwards

0.05

Option II


Year 1 to 2

0.15

Year 3 to 4

0.12

Year 5 to 6

0.09

Year 7 onwards

0.06

6. Based on our preliminary estimate, if the MPFA does not impose any annual fees, the seed money of HK$5 billion will be used up in 12 years’ time (see Annex A).

7. If the MPFA annual fee is charged on the basis of Option I set out in paragraph 5(b) above, the accumulated surplus available to MPFA will gradually decrease within the first 16 years of operation from HK$5 billion in Year 1 to about HK$1.2 billion by the end of Year 16. It will then start to increase. The accumulated surplus will amount to about HK$1.4 billion by the end of Year 20 (Annex B).

8. Alternatively, if the MPFA adopts Option II, the accumulated surplus available to MPFA will gradually decrease within the first 14 years of operation to HK$1.5 billion by the end of Year 14. It will then start to increase gradually to about HK$2 billion by the end of Year 20 (Annex C).

Justification

Self-financing nature of MPFA

9. The MPFA will be a self-financing body, rather than a regular government department, operating on a similar basis as the Hong Kong Monetary Authority (HKMA) and the Securities and Futures Commission (SFC). To achieve the self-financing objective, the MPFA must have a stable source of income to support its operations. We, therefore, propose to supplement the government injected capital of HK$5 billion by a low level of fee. This will enable the MPFA to maintain a reasonable level of surplus to meet any contingent expenditure and to generate investment income to finance part of its operating expenses.

Fee Structure

10. We propose to impose the annual fee on the basis of a percentage of scheme asset. This will ensure all MPF schemes, regardless of its asset size, will bear an equitable share of the MPFA’s costs. This will protect low-income earners from excessive cost burden.

11. The MPFA fee will also be maintained at a low level so that the effect on scheme members will be kept to a minimum. We have, for illustration purposes, estimated the accumulated surplus of the MPFA under two different sets of fee scales, with different maximum and minimum levy rates. Under both scenarios, the levy rates will be reduced incrementally within the first ten years of the implementation of the MPF System. The sliding fee scales have taken into account the estimated increase in MPF scheme assets. Based on our estimate, such low fee levels will be sufficient to meet MPFA’s operating requirements in the long run.

12. The impact of the MPFA fees on scheme members’ accrued benefits should be minimal. Based on our estimate that the total administrative fees of the MPF System will be in the range of 1.63% to 2.44% of scheme assets, the MPFA fees would only account for a mere 8% of the total fees at the maximum rate of 0.2%, and 3% at the minimum rate of 0.05%.

Major Assumptions

13. Initial Set Up Costs : Our preliminary estimate is that the initial set up costs of the MPFA will be around HK$400 million. A large portion of the set up costs will be computer system installation cost. An advanced information system will be necessary to facilitate communication with service providers and enhance the effectiveness of MPFA’s supervisory role. We also consider a regular capital outlay of HK$200 million for every 6 years necessary to cater for technological improvement of the information system and replenish worn out equipment, furniture, fitting outs, etc.

14. Annual Operating Expenses : The annual operating expenses for the MPFA of HK$350 million represents a very crude estimate of the operating needs of the Authority. In making the assessment, we have taken into account the operating expenses of similar regulatory bodies such as the HKMA and SFC.

15. Investment Strategy : In our estimate, we have assumed that the MPFA will take a relatively conservative strategy in the investment of the government injected capital, to take into account the liquidity requirement and contingency needs of the Authority. As such, the MPFA may only be able to invest a substantial portion of its seed money in liquid assets such as bank deposits, short term money market and debt instruments. This will inevitably limit the investment return that can be generated.

World Bank Report

16. We have reviewed the relevant sections of the World Bank’s report Averting the Old Age Crisis (1994) on privately managed mandatory retirement system and administrative fees. We cannot find any reference to annual administrative fees of 5% on accrued benefits for privately managed retirement system. Instead, the World Bank report has made a number of comments on the administrative fees of public and privately managed retirement systems, which tend to support our own estimate that the cost is much below 5%. A summary of these comments are set out in paragraphs 17 to 21 below.

Comparison of Publicly and Privately Managed System

17. The report points out that it is difficult to make a direct comparison of the administrative fees of publicly and privately managed retirement systems because the two systems :

  1. adopt different criteria in the measurement of costs; and
  2. have different operating requirements.

Different Measurement Criteria

18. The World Bank report holds the view that publicly managed retirement systems may appear to be cheaper than they are, in contrast to privately managed ones. This is because privately managed companies, as profit making entities, have an incentive to keep track of their costs carefully. However, publicly managed programmes may omit some inputs and may receive others at below-market rates. For example, depreciation often does not appear on the public pension agencies’ budget, and their rent and other utility costs may be subsidized. Privately managed schemes charge a risk premium for the inflation and interest rate risk they assume. Publicly managed schemes do not charge this premium explicitly but instead pass it along to the rest of society implicitly. The relatively lower costs of public plans are, therefore, more apparent than real.

Different Operating Requirements

19. According to the World Bank report, decentralised privately managed systems usually allow scheme members to switch their investment options and to transfer their pension accounts. This will incur higher operating costs than centralised plans which do not offer such options. Privately managed companies also need to incur costs for performing such functions as marketing, investment research and processing.

20. Nevertheless, the report also says that, due to competition, privately managed systems tend to operate more efficiently than public plans that have a monopoly in a compulsory system. Competition also drives down fees in the long run. For example, the administrative fees in the Chilean System is reduced from 3.8% of the scheme assets in 1985, to 2.3% in 1990, to 1.6% in 1992 and 1.3% now . Most importantly, the report points out that the additional costs mentioned in paragraph 19 above enable privately managed systems to achieve higher return than their public counterparts.

Ways to Reduce Costs

21. The World Bank report has suggested a number of ways to reduce the costs of the privately managed systems, including :

  1. Increasing transparency on fees and providing information on investment performance over a longer term may help to keep operating costs down. This is in line with our proposals for the MPF System under which we require all fees and charges of MPF products to be fully disclosed. We also require trustees to disclose in the scheme annual report a three year summary of the investment performance of the scheme (e.g. net investment income, investment assets).
  2. A level playing field will help to keep the market competitive and reduce costs. This is in line with our proposals for the MPF System under which any individual, local or offshore company that meets the approval criteria will be eligible to be MPF approved trustee.
  3. Economies of scale will help to reduce the cost of the system. The MPF System will be participated by about two million people in Hong Kong. As discussed in the Information Note "Administrative Fees of the MPF System", the economies of scale derived will help to drive down the overall administrative fees of the System.
  4. Improving participant’s knowledge of the system will undoubtedly enhance efficiency. This is in line with our proposal to launch a series of educational campaign to enhance the working population’s understanding of the MPF System.

Mandatory Provident Fund Office
Financial Services Branch
29 April 1997

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