Launched in 1984, the mandatory scheme required employers to contribute between 2% and 15% of the employee’s gross salary into a Labor Fund. While the intention was to provide a source of retirement income, to receive benefits an employee had to work for the same employer for more than 25 years or be 55 with at least 15 years of tenure. In Taiwan, though, average tenure is 8.6 years and the life span of firms not much more than a decade. Less than 10% of the private sector workforce qualified.  

“It is said that 97.7% of companies in Taiwan are small and medium-sized businesses (SMBs) and their average life expectancy is 13 years, so many simply did not survive long enough for their employees to qualify for a pension,” says Chao-Hsi Huang, chairman of the Taiwanese Labor Pension Fund Supervisory Committee.  

Partially, this reflects the SMB life cycle, but many companies deliberately folded to avoid paying contributions. Phoenix-like, a similar firm, run by the same owners, would soon arise. “Within your sight but never in your pocket,” was a common phrase among frustrated workers. “There was a growing realization from all sectors in society that the inability of employees to qualify was a significant problem,” says Huang. “The system offered little joy for workers.” 

RETURNING TO THE DRAWING BOARD, Taiwan drew up the innovative New Labor Pension System, introduced in 2004. While the previous scheme (now known as the Old Labor Pension Fund) was defined benefit (DB) in nature, the new one has a defined contribution (DC) structure to address portability and underfunding issues. 

Each member has an individual retirement account and employers must contribute a minimum of 6% of the employees’ salaries up to NTD150,000 ($4,690) monthly. Employees can voluntarily contribute up to an additional 6%. Notably, the scheme offers several unique design twists. Unlike other DC schemes where the individual shoulders risk, the Taiwanese scheme provides a minimum guaranteed return. If the annual return is less than the two-year deposit rate of the local banks (approximately 2.65% in 2008 and 0.92% in 2009) then the government covers the difference and the amount, calculated at retirement, is paid at a compound rate. 

“When the reforms were undertaken, the emphasis was on protecting employees and their benefits, particularly those in the middle to lower income brackets where awareness of financial issues is limited,” explains Huang, whose Supervisory Committee oversees both the Old and New Funds. 

“Overseas models were studied, but there was also in-depth discussion about what would best protect the economic security of employees within the Taiwan context. This led to features such as the minimum guarantee,” he outlines. “Research showed employees were insecure when it came to financial issues, a factor that has only increased after the recent crisis. The minimum guarantee is a popular feature as it provides employees with extra confidence in the system.” 

Yet, the guarantee rate quickly becomes irrelevant in times of high inflation. Future retirees would only be able to stand by and watch as accounts stagnate against rapidly rising costs of living. “That’s why the guarantee is the minimum, but we are actually seeking a much higher target,” chairman Huang adds. 

“In future, the goal is to ensure that at a minimum the return rate is higher than the guarantee rate plus the CPI [consumer price index]. This is the best way to protect the value of the employees’ retirement funds.”

THE NEW LABOR PENSION SCHEME now has a membership of 4.75 million (an 83% participation rate) with assets under management of $14.7 billion. An additional $3.1 billion flows in annually making it the fastest growing pension fund in Asia. 

Initially, the funds were held in banks, but investment in assets commenced in 2008. This turned out to be bad timing as the global crisis meant the fund suffered a rate of return of -6.06%. Compared with the average losses of the domestic Taiex index (-46.03%), though, its performance was stable and healthy.  

The loss was counterbalanced by a rate of return in 2009 of +11.84% and chairman Huang stresses that in both the Old and New Funds the P&L has been well above the guaranteed income. Underlying the funds’ investment approach is the notion of PIMCO’s “New Normal,” (see Getting to the new normal) that foresees an investment environment of low growth and high unemployment. As a consequence, the fund is emphasizing high-quality, more-stable asset classes in its investments. 

To help manage assets, the committee initiated a dynamic asset allocation approach as well as a simulated management model to aid decision-making. While there is also a small in-house team of investment experts, the committee has awarded 15 separate mandates to a collection of leading international financial firms to manage overseas investments for both the Old and New Funds.  

The committee has also noted the strategies of pension and university endowment funds (such as CalPERS in the US, the Yale Endowment Fund and the Dutch APG civil servants’ fund) to invest in non-traditional sectors for diversification. Increasingly, it will invest in areas like absolute return products and securities such as real estate and infrastructure. 

Huang believes the New Labor Pension System has delivered three benefits for Taiwan. First, it embraces a wider sector of the workforce and provides greater pension security. Second, it has been good for the economy as employees no longer feel bound to one company, making the labor market more competitive. Finally, from the companies’ perspective, it makes the total costs of hiring a new employee more transparent, as the 6% pension liabilities are more readily calculable into operating costs.

As Huang sums up: “It’s proving good for companies, good for employees and good for the economy.”

Published by PROJECT M in April 2010

(Photo: gettyimages/Andrew Unangst)