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Growing pains of Taiwan's second pillar

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Being four years old, relatively speaking, makes the LPF one of Asia’s more mature pension systems and in fact this is already the second iteration of corporate pensions in Taiwan. As many Asian economies - China and India notably - are only now beginning to introduce meaningful pension reform, Taiwan is at a point in time where it can review a system that has now stabilized in terms of both the asset base and the relevance to the overall retirement market.

Like many maturing economies, Taiwan is faced with a rapidly ageing population and a social security system that is both unaffordable for the government and insufficient for the recipients. The “second pillar” system in place until 2005 - Labor Pension Scheme (LPS) - was Defined Benefit in nature and largely ineffective due to the restrictive vesting rules. [see sidebar1 for details of the LPS system]

In 2005, the government introduced sweeping pension reforms, replacing the LPS system with the new LPF Defined Contribution system. The LPF was modeled on other Defined Contribution systems around the world and has the following key features:

Employer contributions required at 6% of monthly salary

Employee contributions are voluntary and tax efficient up to a limit of 6% of monthly salary

Investments are centrally managed by the Labor Pension Fund Supervisory Committee with no employer or employee investment choice but guaranteed minimum interest rates

Benefits payable as a lump sum on retirement

Out with the Old and in with the New

The transition to the LPF system was effective from 1 June 2005. New employees or those changing jobs were only offered membership of LPF pension plans. Existing employees were given a one-off choice to either remain in the LPS system or join the LPF system for future service benefits.

Many employees switched from the LPS to the LPF system meaning that the pension landscape changed overnight. It also began a rapid accumulation of assets under management in the LPF system.

In the four years since its introduction the assets invested in the DC accounts have grown from zero to US$11.3 billion as of April 2009. This rapid growth means the assets held under management in the LPF system are now almost the same size as those now invested to support the old LPS system (which stand at approximately US$13.9 billion as of April 2009)).

Investing for the people

Investment of assets under the LPF system is very much in the mould of the Singaporean Central Provident Fund. The contributions are invested centrally and managed by a government office who then guarantees a minimum level of investment return.

The rapid growth of assets under the LPF system has put the government under some pressure to ensure the funds are being managed appropriately and effectively. In 2007, the government established the LPF Supervisory Committee to oversee the investment strategy for the contributions. This was in part a defensive measure to ensure appropriate risk management but also to allow a more diverse investment strategy as the fund size matured. Up until 2007, the funds had been managed very cautiously and a clear objective for the committee was to take on more risk - in the form of equity investment - and to make use of external investment managers.

As of August 2007, over 95% of the LPF assets were invested in internally managed bank deposits yet by April 2009 this figure is down to less than 50%. In just two years, over 40% of the LPF assets have been passed to external managers to help facilitate a more aggressive investment strategy.

The future of the LPF

The LPF is viewed by many (both inside and outside of Taiwan) as a relatively successful pension system. The contribution structure whilst low by Western standards is broadly appropriate in an Asian context where private savings for retirement are much higher. Add in the improvements to the investment of contributions and the system now looks relatively efficient and effective.

The big change that is likely to come in the next couple of years is employee choice over the investment of their contributions. This change has been mooted for a number of years and is widely supported by employers and employees. It would help transform the LPF into a Defined Contribution system that can be an example to the rest of Asia.

Allowing freedom of investment choice would also bring significant competition to the LPF fund management market which should be to the long term benefit employees and the system in general.

Introducing investment choice does also bring a far greater need for employee education in relation to investment decisions. At present, the level of support available to members is very low and this will need to be significantly strengthened as the system modernizes. The trick will be to ensure the cost of this education does not outweigh the efficiencies that are introduced by increased competition in the fund management arena.

The LPS pension system - ineffective vesting rules

Under the LPS Defined Benefit pension system, employees were entitled to a lump sum benefit of 2 months final pay for every year of service up to 15 years and then and additional one month of final pay for every year of service thereafter.

On paper, this is a generous benefit but the catch is in the vesting conditions which mean that employees do not receive anything unless they work a minimum of 15 years with the same company. With relatively high staff turnover rates in Taiwan it is estimated that only about 25% of the potential recipients meet the eligibility conditions and receive any benefit from the system. The remaining 75% receive nothing and rely solely on social security and private savings.

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  • QN-2546

    Asset class: Real Estate Equity Fund (non listed).
    Asset region: Europe.
    Size: Total CHF 600m, approx. CHF 100-300m per fund investment.
    Closing date: 2019-06-28.

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