Time to rationalise the patchwork retirement provisions for Hong Kong workers

The “offsetting” of the severance and long-service payments with an employee’s Mandatory Provident Fund is a contentious issue, but it does not need to be. The problem should be approached by examining the original purpose of the payment schemes to see whether there are better ways of fulfilling their aims without reducing employee benefits or increasing employer costs.

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Both the schemes for severance payments (introduced in 1974) and long-service payments (1986) predate the MPF scheme, which was established in 2000. Both are payable by an employer when the employee leaves, depending on the circumstances. They are calculated in the same way, but the employee cannot receive both at the same time.

Both have elements of retirement provision. But as the MPF scheme now provides basic retirement benefits for almost every employee in the private sector, we should consider whether the various schemes can be rationalised. The existence of “offsetting” shows that some benefits may be duplicated.

The severance payment is a form of unemployment benefit, since it is triggered by redundancy. Such benefits are best offered as insurance by a third party, such as the government, rather than the employer. The existing practice is unlikely to be financially viable, especially for small and medium-sized enterprises.

One purpose of the long-service payment is to provide for the retirement of the employee and a benefit in the event of death. These are already subsumed in the MPF scheme. However, since MPF contributions are not retroactive to before the scheme’s introduction, in the transition phase, adjustments are necessary so as not to reduce employee benefits or raise an employer’s obligations.

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A useful way to look at “offsets” is to consider someone entering employment for the first time after the implementation of the MPF scheme. This person would have retirement and survivor’s benefits, but not unemployment, or disability, benefits. Thus, an equitable solution would be to introduce mandatory unemployment and disability insurance and exempt employers from severance and long-service payments. The problem of “offsets” would simply disappear for these employees.

The principles of unemployment and disability insurance are well established in other developed economies, and are typically provided by the government. One reason for government involvement is to ensure the insurance pool is large enough and the expenses are low enough so premiums are affordable.

What about an employee who started with an employer before the MPF scheme began? First, he or she should also be covered by unemployment and disability insurance. Second, the potential liabilities for long-service payments could be calculated as of a certain date, after the establishment of this insurance. Third, the value of the employee’s MPF fund due to the employer’s contributions can be calculated as of the same date. If the employer’s liabilities are less than the value of the MPF account attributable to the employer’s contributions, then the employer will have no further long-service payment obligations. If the liabilities are greater than the value, the employer will have to make a one-time contribution to the MPF account equal to the shortfall.

In this way, “offsetting” will become a historical relic.

Lawrence J. Lau is the Ralph and Claire Landau Professor of Economics at the Chinese University of Hong Kong, and Kwoh-Ting Li Professor in Economic Development, emeritus, at Stanford University