China's pension system is in a state of flux. The old system under which employees relied on their employers for pension coverage is giving way to a complex three-tier arrangement where responsibility for pensions is shared between the state, companies and individuals.
While this may bring some relief to China's debt-ridden state-owned enterprises, foreign enterprises face an increase in welfare costs. Despite the expertise that foreign companies and insurers have in the area of pensions, multinationals are holding back from taking a lead in company-sponsored pensions until the nature of a new unified pension scheme becomes clear. In an atmosphere where foreign companies are under increasing pressure to pay more revenues to the government in areas such as taxation, pension contribution rules are awaited with apprehension.
"Foreign companies are seen as a wonderful source of new money," says Mr Peter Brew of London-based employee benefits consultants and actuaries Sedgwick Nobel Lowndes. It has been advising Chinese ministries on the establishment of a unified national pension scheme. The first of the new wave of pension regulations is expected before the end of the year, Brew believes.
The aim of establishing comprehensive social insurance was first outlined in the 1995 Labour Law which called for the setting up of five separate funds providing for pensions, unemployment, accidents and disability, medical costs and maternity leave. For most companies operating in China, pension funds require the largest single welfare contribution.
But the Labour Law was lacking in detail as to how these funds would be set up and the result has been a variety of municipal-level experimental schemes. Contributions from employers and employees vary widely from city to city. Local idiosyncrasies are particularly noticeable in the pensions field where differing demographic structures are pronounced. For example Shanghai, which has a large number of retired workers, stipulates that employers and employees should together make a 30 per cent contribution of average city wages to pension funds. Shenzhen, with a relatively young population, asks for only 14 per cent of the total payroll.
Understanding the system can be a headache, not least because the different municipal schemes are not always comparable, says Ms Wing Liu of the Hong Kong office of actuarial and management consultant firm Towers Perrin. "It is important not just to look at the contribution rate but to look at the percentage of 'what'. In some cities, contributions are tied to the average city wages rather than to individual wages," she says.
The next step is to move on from the experimental schemes to a national unified system of social welfare and insurance due to be in place by the year 2000. Pensions unification will lead the way. The national scheme will involve expanding the coverage of pensions and the stepping up of compliance levels. "This will have an impact on the pensions burden of foreign-funded enterprises," says Brew. For one thing, he believes there is likely to be considerable pressure on foreign enterprises to cover the additional employee contributions to pensions through pay increases.
While Brew expects regulations on the basic government-sponsored scheme to be out before the end of the year, he believes that private pension regulation may not be in place until the end of 1998. Others say that in practice, pension regulation may not be implemented for another two or three years.
The Chinese government is thought to be sympathetic to a 1996 World Bank proposal which outlines a 'three-pillar' system for China.
The first pillar would be a pooled redistributive social insurance scheme, requiring a contribution from employers of nine per cent of the payroll. The second pillar would be a compulsory system of individual accounts financed by both employers and employees to a total of eight per cent of salary.
To top this up, a third voluntary pillar of pension cover could be added, including employer-sponsored pensions and individual private pensions. Both the second and third pillar pensions would also need substantial reform and regulation of China's capital and financial system.
Consulting firm Watson Wyatt believes the basic structure of the World Bank scheme will be adopted this year but that the unified contribution rates will be higher. It estimates that about 12 per cent of employee salary will be paid into the pooled fund. A further 11 per cent will have to be paid into the individual accounts. For the individual accounts, the employee will bear responsibility for three per cent – a proportion that will rise by about one percentage point a year until it reaches eight per cent.
Benefits too low for FIEs
The level of benefits that these compulsory schemes would yield and qualification conditions for the schemes are additional concerns.
Under the World Bank proposal, 40 years' contribution to the basic pooled scheme should yield a basic pension of 24 per cent of national average wages. This part of the pension system would be partly funded, meaning that some of the contributions would be paid out immediately to existing pensioners with the remainder being invested. The individual accounts, which would be fully-funded, it is calculated would yield 35 per cent of final pay. The two government-mandated schemes would thus, according to the World Bank scheme, i give out a pension of around 60 per cent of the national average wage. Of course, higher paid employees, including many in foreign-invested enterprises, would not be covered to this extent by compulsory schemes.
According to Watson Wyatt, the scheme to be adopted would require at least 15 consecutive years of contribution before qualifying for full benefits. The firm believes that the basic retirement age will be set at 60 for men and 50 to 55 for women.
The capping debate
There are considerable worries among foreign investors over the required level of contribution to the social pool element of pension insurance. The salaries of their employees tend be higher than in the state sector. Therefore these schemes require higher company contributions into the pensions pool. This adds to the welfare costs of foreign employers without any direct benefit to their workers. In effect, they are being asked to subsidise state sector pensions.
"The big issue at the moment is whether contributions will have to be paid on the whole of the payroll," says Brew. "We are trying to influence the ministries to reduce the rate of the contributions and put a cap on the level of contribution." To further this aim, Sedgwick set up an Employee Benefits Forum in China which as well as advising the Chinese government on pension reform also acts as a lobbying group for foreign enterprises on pensions policy. The group currently has 18 members, comprising 14 multinationals and four Chinese state-owned enterprises. Up to 11 ministries with an interest in social welfare also attend meetings as observers.
Existing regulations on capping also show variations. "In Beijing there is a certain limit on the employer's contribution," says Ms Betty Ko of Coopers & Lybrand in Shanghai. "In Shanghai there is a cap on the employee's contribution linked to average city wages, but there is no limit on the employer's contribution."
However, Shanghai implementing regulations issued in March of this year do allow employers with employees earning more than 200 per cent of average city wages to channel an increased proportion of their pension contributions into individual supplementary accounts, rather than the citywide pension pool.
There is also a more general concern about the security of funds lodged with local governments. "The problems with funds paid into the local insurance bureau is that nobody really knows what happens to that money," says Brew. Even in Shanghai, usually regarded as one of the more financially sophisticated cities, there have recently been complaints over the decision to deposit the city's entire pension funds with the Pudong Development Bank.
One response to these fears is to develop in-house company pension schemes. Towers Perrin's Liu notes that, "representative offices pay [pensions) contributions to the Foreign Enterprise Service Company (Fesco). While they are aware that Fesco is doing something with the money, they may totally ignore that and set up their own scheme."
In-house company pensions already form a part of the government's strategy. Hong Kong consultants report that some foreign firms have negotiated partial exemptions from municipal pension schemes in some cities by highlighting their own company pension schemes. While the central government wishes to increase standardisation, the provinces and localities still have some leeway to cut special deals on welfare with favoured investors.
Other companies have decided to use their own in-house pension schemes to create a top-up pension arrangement. This effectively pre-empts the government's pension unification plans by creating a uniform contribution rate across the country. Novo Nordisk, the Danish biotechnology company, is trying to implement a uniform contribution rate of 20 per cent of employee salary.
Mr Humphrey Lau, Novo Nordisk's director of human resources and administration, is encouraged by the knowledge that what it is doing is in tune with the government's own plans. "I truly believe that they are moving towards unification and we are already seeing small steps everywhere," he says. Novo Nordisk, which specialises in diabetes care products and industrial enzymes, has investments in Beijing, Shenyang, Tianjin, Shanghai, Guangzhou and Wuhan. Apart from the obvious benefits of facilitating increased labour mobility, in-house company schemes may also be viewed as a staff retention strategy in the context of increasing competition for skilled staff among multinationals in China.
Mr Martin Powell, human resources manager of General Electric (China), believes that there is an issue over whether employees of foreign-invested enterprises value the benefits given to them. "Many of them simply look at the cost and think they are not established enough in the company to get involved in this type of long-term expense."
Lui also believes that the attraction of pension schemes may be limited. "Employees of foreign-invested companies tend to be young, so housing may be a bigger priority for them," she says. For Powell, the uncertainty makes it very complicated for multinationals. "Many are unsure over whether to be pioneers in a situation where there is a lack of guidelines or whether to sit tight and wait," he says.
Lui agrees that many foreign companies are considering setting up countrywide schemes but suggests that, "with the government trying to get its own schemes off the ground, it's probably a long shot". Brew also highlights the dangers of individual company initiatives. "The sensible ones have done absolutely nothing," he comments. "If you do something today it might be turned on its head tomorrow."
A May 1997 Watson Wyatt survey of the pension arrangements of 22 multinationals in China bears out these concerns, revealing that not a single company had established a company-sponsored pension plan. Furthermore, only one company was actively working on a pension plan, while 15 had no plans to provide in-house pensions.
Another uncertainty for those wishing to set up pension schemes is the lack of regulation. Foreign companies are prohibited by the 1995 insurance law from the group pension fund business and without a trust law there is doubt over the security of pension plans offered by domestic companies. How, then, can foreign firms legally and securely provide internal pension coverage?
Joint ventures are permitted to set up their own private social welfare funds, but in most cases the funds are simply placed in a bank account. The difficulty is that this is technically neither a pension fund nor a trust. "You should, as far as possible, give such a fund a distinct personality, although it has no legal basis," advises Mr Andrew Atter, of Hay Management Consultants in Hong Kong. For instance, an employee consultative
committee to oversee the fund and report back to employees could be established.
Question of trust
But the security of these funds in the event of bankruptcy or dissolution of a joint venture has not so far been tested. Lui plays down this worry. When it comes to pensions, "some employees trust their employer more than the government," he comments. "The possible bankruptcy of the foreign firm does not concern them." A further possible consideration here would be if the bank itself collapsed.
Novo Nordisk's Lau has chosen a different route, investing in a pension fund scheme organised by the Guangdong branch of the People's Insurance Company of China. "They are very professional and have been used by hundreds of foreign-invested companies," he says. Others note that some companies have been negotiating with local authorities to set up housing provident funds which include an element of pension provision.
While pension reform may cause labour costs to rise in the short term, foreign employers should not lose sight of the long-term benefits of a national Chinese pension system. The hope must be that pension and other welfare reforms will pave the way towards a true labour market in China where workers can move freely from city to city in search of work without fear of losing benefits.