Recent articles in the Western and Chinese press have described foreign investment managers poised to enter the China pension funds market and foreign insurance firms on the brink of licenses for business in China.
In reality, the significance of China's new pension policies is much greater, as are the challenges to implementation. In an effort to move the process along, the World Bank last month injected US$5m into China's ‘new pension system' to support a three-year pilot programme in pension reform in Heilongjiang province and Qingdao.
The new pension system- is based on a State Council decision announced in July 1997 and implemented at the end of 1998. This regulation establishes the guidelines for a national pension scheme, while allowing provincial and municipal governments discretion to determine savings rates and manage funds.
A market-oriented social security system was actually drafted back in 1993. It provided for a comprehensive and multi-tiered structure jointly financed by employees and employers. However, it was the 1995 Labour Law that officially established pensions as a social insurance benefit along with unemployment, work-related accident and disability, medical and maternity insurance. The law stipulated that funds would be contributed by both employers and employees.
The unified collection of pension, medical and unemployment insurance funds initiated on January 22, 1999 provided for by the Provisional Regulations on the Collection and Payment of Social Insurance Payments marks an important step in a national campaign to provide unified pension coverage in the public and private sectors.
The restructuring of China's state-owned enterprises (SOEs) and changing demo-graphics have presented an immediate need for reform. In practice, SOEs continue to foot the costs of social security benefits for both current and retired employees. However, the former pay-as-you-go system that allowed employees to receive a lump sum at retirement with no individual contribution has proven to be too much of a burden for financially strapped SOEs.
To replace this system, China has opted for a mandatory savings programme requiring contributions from both individuals and enterprises. The provisional regulations mark a change in policy from the government-subsidised pay-as-you-go system, in which set pensions were issued directly to employees upon their retirement, to a three-pillar system incorporating multiple fund sources. Employees and employers are now required to contribute to both pooled and individual pension accounts.
Enterprise contributions comprise the first pillar of the three pillar system. The enterprise is expected to contribute 20 percent of total wages, subject to minimum and maximum rates determined at the discretion of local authorities. Foreign invested enterprise contributions are currently capped at a rate of 300 percent of the average local wage.
The second pillar comprises the employee's individual account, consisting of 11 percent of wages, of which 4 percent is to be contributed by the employee and 7 percent by the employer. The employee contribution is stipulated to increase at a rate of 1 percent every two years at a cap of 8 percent of the wages.
The third pillar is based on voluntary contributions from the employee or employer within a permitted range. Employee contributions up to 5 percent of wages are tax deductible. To the FIE, the voluntary supplementary scheme presents a viable means of attracting and maintaining local employees.
The current policy is designed so that benefits are distributed independently of the employer/enterprise. Personal pension accounts are portable and allow for greater job mobility. In addition, pension funds are transferable to family members in the amount of the individual account upon an employee's death. At retirement, employees receive the sum of the individual account plus part from the pool. If the employee has worked for at least 15 years from the initiation of the reform, he/she receives the equivalent of a monthly salary. Those who retire before the completion of 15 years are awarded only the sum of money in their individual account.
The liability of individuals and enterprises poses a serious problem given the ageing profile of the Chinese population. According to a report by the World Bank, at current pension rates 40 percent of China's wages will be used to cover pensions over the next three decades.
In order to resolve the issue of under-funded liabilities, the government is supporting measures to improve management of funds, including the separate management of current pensions from individual account funds. Investment of pension assets is limited to government bonds and bank deposits. Linking funds to the capital market for an increased rate of return could lead to higher rates of return, rather than the low uniform rates set by the People's Bank of China. However, because of the volatility of China's stock and bond markets, emphasis remains on improving compliance rates. Meeting future demand will require upgrading regulation of pension funds, disclosure of information and supervision of funds.
In common with other reforms in China, policies are tested prior to official implementation. This is the case with the World Bank three-year pilot programme in Heilongjiang and Qingdao. Its loan to the Ministry of Labour and Social Security will facilitate development of the pension insurance policy, an information network and training of personnel. It has been reported that new regulations related to the management and supervision of pension funds can be expected after the programme's implementation.
Despite recent efforts to achieve compliance, it is clear that the road to pension reform will be rocky. Due to changing demographics and extensive layoffs, deficits in the allocation of pensions to employees were reported last year – even in Shanghai, the nation's financial centre with a relatively experienced pool of fund managers. It remains a serious challenge to the Chinese government to achieve its asserted goal of a unified pension system by next year.
Freshfields 1999. Freshfields in an inter-national law firm. Most of its offices through-out Asia, Europe and North America include China specialists. For further details, contact Lucille Barale in Hong Kong (tel: +852 2846 3400) (email: firstname.lastname@example.org) or Matthew Cosans in London (tel: +44 171 936 4000) (email:email@example.com).
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