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“China’s Pension System”

BY

STUART H. LECKIE, O.B.E., J.P., F.F.A., F.I.A.

TEL: (852) 2147 9998

FAX: (852) 2147 2822

E-mail: shleckie@hkstar.com

22 March 2003

Actuarial Society of Hong Kong

SOA China Region Committee

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Map of ChinaMap of China

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PRC Population

Total:Total:Rural Population:Rural Population: + +Urban PopulationUrban Population

Consider:Consider:One Child PolicyOne Child PolicyGreatly improved lifeGreatly improved lifeexpectancyexpectancyDependency RatioDependency Ratiodeteriorating rapidlydeteriorating rapidly

Almost 1.3 billionAlmost 1.3 billion850 million850 million + +450 million450 millionAges:Ages:

0-140-14 100 million100 million15-6415-64 320 million320 million65+65+ 30 million 30 million

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Ageing PopulationAgeing Population

The speed at which China is ageing is increasingThe speed at which China is ageing is increasingMany developed countries took almost a century toMany developed countries took almost a century tohave an ageing population (e.g. France, Sweden,have an ageing population (e.g. France, Sweden,Germany)Germany)ChinaChina’’s one-child policy is putting a severe strain ons one-child policy is putting a severe strain onthe workers supporting the growing elderly (ie thethe workers supporting the growing elderly (ie thedependency ratio is deteriorating)dependency ratio is deteriorating)China is ageing in one generationChina is ageing in one generation

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Old System (‘Iron Rice Bowl’)

Workers employed for life by State Owned Enterprises (SOE)Workers employed for life by State Owned Enterprises (SOE)

Low Wages but Total SecurityLow Wages but Total Security

Pension at 60 (Males) or 55 (Females) = 80% of final salaryPension at 60 (Males) or 55 (Females) = 80% of final salary

Pensions paid by SOEsPensions paid by SOEs

No Pre-funding or Reserves (i.e. pay-as-you-go), but what ifNo Pre-funding or Reserves (i.e. pay-as-you-go), but what ifSOEs unable to pay pensions?SOEs unable to pay pensions?

China is very concerned about social unrest resulting fromChina is very concerned about social unrest resulting fromunpaid pensions and the unemployedunpaid pensions and the unemployed

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World BankWorld Bank

In early 1990s, World Bank studied how best to solveIn early 1990s, World Bank studied how best to solvepension issues in Chinapension issues in ChinaWorld Bank suggested a three pillar approachWorld Bank suggested a three pillar approach•• Government run basic pensionGovernment run basic pension•• Privately run individual accountsPrivately run individual accounts•• Voluntary employer / individual savingsVoluntary employer / individual savings

1993 and 1996 announcements on social security1993 and 1996 announcements on social securityreformreform•• Unify social security pension systemUnify social security pension system•• Create individual accounts within basic social securityCreate individual accounts within basic social security•• Enhance with Supplementary Pension PlansEnhance with Supplementary Pension Plans

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Pension Principles for Future

Reduce pension expectationsReduce pension expectationsCost burden to be shared by employer and employeeCost burden to be shared by employer and employeeMove towards pre-fundingMove towards pre-funding

Reasons?Reasons?

Population projectionsPopulation projectionsSOE restructuringSOE restructuringDevelop domestic capital marketsDevelop domestic capital markets

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New System (New System (‘‘Safety NetSafety Net’’))

New Unified Pension System Reform (July 1997)New Unified Pension System Reform (July 1997)Expand coverage to all urban employeesExpand coverage to all urban employeesGradually raise retirement age (to age 65 years forGradually raise retirement age (to age 65 years formen & women)men & women)

BenefitsBenefitsPillar I = Basic Pension of 20% of average local wagesPillar I = Basic Pension of 20% of average local wagesPillar II = Individual Pension based on 11%Pillar II = Individual Pension based on 11%contributionscontributionsPillar III = Voluntary Supplementary BenefitsPillar III = Voluntary Supplementary Benefits

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New System - Contributions

EmployeeEmployee

EmployerEmployer

= = 6% 6% salary contributionsalary contributionincreasing by 1% every 2 yearsincreasing by 1% every 2 yearsup to 8%up to 8%

= Approx 20% of salary= Approx 20% of salarycontributioncontribution(subject to salary maximum and(subject to salary maximum andlocal variation)local variation)

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New System New System –– Implementation Issues Implementation Issues

ComplianceComplianceAdministrationAdministrationPreservationPreservationPortabilityPortabilityTransitional issuesTransitional issuesEducationEducationTaxationTaxation

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Pension Assets

Pillar I and II pension assets approximately RMB 125bn (US$15bn) inPillar I and II pension assets approximately RMB 125bn (US$15bn) ingovernment bonds and deposits, managed by Social Security Bureaus; howevergovernment bonds and deposits, managed by Social Security Bureaus; howevernot enough for future obligationsnot enough for future obligations

Pillar III pension assets managed by insurance companies; fully funded schemesPillar III pension assets managed by insurance companies; fully funded schemes

The government is considering several initiatives to meet the pensions shortfallThe government is considering several initiatives to meet the pensions shortfall

•• Special taxesSpecial taxes

•• LotteryLottery

•• Issue of recognition bondsIssue of recognition bonds

•• Sale of State Owned assetsSale of State Owned assets

•• Launch of Chinese Tracker FundLaunch of Chinese Tracker Fund

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3 3 DevelopmentsDevelopments

National Social Security FundNational Social Security FundLiaoning Pilot ExperimentLiaoning Pilot ExperimentEnterprise Annuity PlansEnterprise Annuity Plans

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National Social Security FundNational Social Security Fund

In the event that some provinces have insufficientIn the event that some provinces have insufficientfunds for Pillars I & II, the State Council hasfunds for Pillars I & II, the State Council hasestablished a established a ““fund of last resortfund of last resort””Council for National Social Security Fund to act asCouncil for National Social Security Fund to act asTrusteesTrusteesIncome: State Shares equal to 10% of IPOIncome: State Shares equal to 10% of IPO’’ssInvestment Management: will appoint externalInvestment Management: will appoint externalmanagersmanagersOutgo: to be decidedOutgo: to be decided

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Liaoning ExperimentLiaoning Experiment

Liaoning -- industrial province in north eastLiaoning -- industrial province in north eastVery serious funding problemsVery serious funding problemsDocument 42 (July 2001)Document 42 (July 2001)Basic pension -- 30% of local average earningsBasic pension -- 30% of local average earningsIndividual accountIndividual account•• EmployeesEmployees’’ contributions only (8%) contributions only (8%)•• Must be properly fundedMust be properly funded

Major problem of back funding to be solvedMajor problem of back funding to be solved

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Enterprise Annuity PlansEnterprise Annuity Plans

Existing Supplementary Pension Plans throughExisting Supplementary Pension Plans throughdomestic life companiesdomestic life companies““Enterprise AnnuityEnterprise Annuity”” (EA) proposals by MLSS (EA) proposals by MLSSEAEA’’s to be offered by entities licensed by Ministry ofs to be offered by entities licensed by Ministry ofLabour and Social SecurityLabour and Social SecurityTax concessions to encourage EATax concessions to encourage EA’’ssBy 2005 international insurers can write groupBy 2005 international insurers can write groupbusinessbusiness

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Opportunities for FundOpportunities for Fund ManagersManagers

Pillar I; NoPillar I; NoPillar II;Pillar II;•• Short term Short term –– No; No;•• Medium Term Medium Term –– Outsourcing by Social Security Outsourcing by Social Security

Bureaus;Bureaus;•• Long-term Long-term –– like 401(k) plans? like 401(k) plans?

Pillar III; Via Insurance Companies;Pillar III; Via Insurance Companies;•• Later segregated funds?Later segregated funds?

National Social Security Fund; PossibleNational Social Security Fund; Possible

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Develop Capital MarketsDevelop Capital Markets

SOEs to be restructured: 1,000 -- 2,000SOEs to be restructured: 1,000 -- 2,000Merge, close, downsize or corporatizeMerge, close, downsize or corporatizeList on Stock Market through A shares?List on Stock Market through A shares?How much capital is required in the next 5 years? 10How much capital is required in the next 5 years? 10years?years?How to apply pension assets to capital markets andHow to apply pension assets to capital markets andmaximize returns (deposits + bonds + equities +maximize returns (deposits + bonds + equities +mutual funds + real estate + infrastructure)mutual funds + real estate + infrastructure)World Bank estimates pension assets of US$1.8World Bank estimates pension assets of US$1.8trillion by 2030trillion by 2030

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Regulation Regulation –– Financial Services Financial Services

Banking Banking –– P.B.O.C. P.B.O.C. –– C.B.R.C. C.B.R.C.Investment Funds Investment Funds –– C.S.R.C. C.S.R.C.Insurance Insurance –– C.I.R.C. C.I.R.C.Pensions Pensions –– (M.L.S.S., M.O.F., C.S.R.C., C.I.R.C.) (M.L.S.S., M.O.F., C.S.R.C., C.I.R.C.)

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Possible Developments in ChinaPossible Developments in China

Open-ended FundsOpen-ended FundsJV Investment CompaniesJV Investment CompaniesChinese Tracker FundChinese Tracker FundLiberalisation of Pension and Insurance Funds InvestmentLiberalisation of Pension and Insurance Funds InvestmentDevelopment of Unit-linked Insurance and member choiceDevelopment of Unit-linked Insurance and member choicePensionsPensionsMerging of Stock MarketsMerging of Stock MarketsMerging of A and B SharesMerging of A and B SharesFree Market for Foreign InsuranceFree Market for Foreign InsuranceFutures ExchangeFutures ExchangePrivatisation of Second Pillar Pensions( Individual Accounts)Privatisation of Second Pillar Pensions( Individual Accounts)Convertibility of RenminbiConvertibility of RenminbiInternational Investment by InstitutionsInternational Investment by Institutions

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ConclusionsConclusions

Pensions Reform in China isPensions Reform in China is•• Essential to maintain social stabilityEssential to maintain social stability•• Integral to overall financial reformsIntegral to overall financial reforms•• Fundamental to development of capital marketsFundamental to development of capital markets

Thank you!Thank you!