Ho Lok-sang notes that steadily rising prices will erode returns offered by schemes to clients
The public annuity scheme proposed by the Hong Kong Mortgage Corporation (HKMC) offers for the first time a relatively attractive way to convert savings in one’s Mandatory Provident Fund account into a stream of monthly income, to be collected as long as one lives. This is on top of the reverse mortgages, another scheme launched by the HKMC, that offer homeowners the opportunity to draw down the equity in their homes and collect monthly stipends that will make life easier for retirees. However, there are risks that need to be considered, both on the part of retirees and the HKMC.
In the private market, even without government action, annuities are available at a price, as many insurance companies would offer annuity products to interested parties. But the implied rate of return is usually unattractive. This is because insurance companies have to consider the effect of “adverse selection” — those who expect they may not live very long would not buy annuities, leaving mostly people with longer-than-average lives. Because they are expected to continue drawing money for a long time, the monthly stipends have to be reduced accordingly. In principle, since the proposed scheme is voluntary, the problem of adverse selection is still relevant. Ignoring the problem of adverse selection may mean the HKMC could lose money. The promised stipends under the proposed scheme would let an investor receive all the money he or she had initially invested within 15 years. If they live longer than that, stipends collected after 15 years will constitute an extra gain. If the investor dies within 15 years, what remains of his or her initial investment would be left to the family. With the HKMC offering a guaranteed return, the terms appear very attractive. Such attractive terms amount to risks that must be taken up by the HKMC. This is probably the reason why the HKMC wants to cap the scheme to HK$10 billion (US$1.29 billion). If each subscriber puts in HK$1 million, which is the maximum investment allowed, the scheme could accept at most 10,000 retirees. If each subscriber puts in HK$50,000, the scheme could accept at most 200,000 retirees. But frankly it is not clear to me why people would put up with the hassle of subscribing such tiny amounts that would give them HK$265 (for women) or HK$290 (for men) a month.
Then there are risks that need to be recognized by subscribers.
The biggest risk for subscribers is inflation. The annuity scheme will offer a flat stipend through to the end. That is, if the stipend is HK$5,000 a month upon retirement at 65, it will still be HK$5,000 a month at age 90. Even if inflation is a low 3 percent per year, the amount to be collected then would be the equivalent of only HK$2,407 today. If inflation averages at 5 percent per year, the amount would become only HK$1,460. Thus the purchasing power would decline rather dramatically with each percentage point of inflation. Retirees would probably fare better if they hold shares of Real Estate Investment Trusts (REITs) that provide dividend incomes which will rise with inflation. But they need of course to buy only shares of reputable REITs.
Elderly people who own a home can combine the reverse mortgage with the public annuity scheme to generate a stream of decent monthly incomes. But the risks due to inflation apply all the same. Under a reverse mortgage, a level monthly stipend is created through a reverse mortgage loan with a bank. This loan has very special features. The elderly will never need to worry about repayment as long as they live and the stipend will continue until they die unless they opt for a fixed payment term. At the termination of the reverse mortgage loan, borrowers or their heirs have the preferential right to redeem the property by repaying to the bank in full the outstanding loan amount owed. If you give up the right to redeem the property, the bank will sell the property. If the sale proceeds exceed the outstanding loan amount owed by you, the bank will return the surplus. In the event of a shortfall, there would be no liability on the part of the original owners or their heirs, as an insurance arrangement would cover that risk.
Still, the institutions that underwrite the risks would be under tremendous pressure in the event of a housing price collapse. At the same time, inflation would also erode the purchasing power of the flat income stream for the elderly, just as it does for the annuity plan.
It would appear to me that given the considerations as explained above, there will be an imperative for the authorities to avoid a significant housing market reversal and to keep inflation low. A major housing market collapse would destabilize the financial institutions, while high inflation will cause a lot of stress on retirees. Moreover, the caps to both schemes mean they are at best a supplement to the current MPF system for a small number of retirees, and the drive to help retirees live a life free of anxiety will need to continue.
The author is dean of business at the Chu Hai College of Higher Education.