Time is running out for China’s pension system. The one-child policy has created the 1-2-4 phenomenon within many of the country’s households – one child, two parents and four grandparents. With the dependency ratio doubling by the generation, China’s working-age population is expected to peak in 2010 and by 2040 there will be two workers for every one retiree, down from six to one in 2000. Based on current progress, there won’t be enough money in public or private pensions to support the elderly – and that’s discounting the rural population uncovered by the state system. Working with institutions such as the World Bank, the Organization for Economic Cooperation and Development and the Asian Development Bank, Stirling Finance chairman Stuart Leckie has run a number of projects looking at the holes, and potential plugs, in China’s pension system. He told CHINA ECONOMIC REVIEW how the present state of affairs came about and where the road may lead from here.
Q: How serious is China’s pension problem?
A: It is a race against time because the demographics are going to deteriorate very seriously in the next couple of decades. China is not going to collapse this week or next week because of pensions, but action needs to be taken now as someone being born today may well be drawing a pension in 90 years’ time. The World Bank says China’s implicit pension debt is 70-140% of one year’s GDP. If you take today’s GDP at almost US$2.5 trillion, what you are talking about an implicit pension debit of US$1.5-3 trillion.
Q: When the cradle-to-grave system first started breaking down, what was there to fill the gap?
A: In the 1950s and 1960s, most people – we’re talking about urban population – were working for state-owned enterprises. They didn’t get much money but could retire early on 80% of their previous salary. All these pensions were paid by the SOEs and it wasn’t much of a burden because people didn’t live as long as they do today. In the 1980s, life expectancy was increasing while the SOEs, under pressure to become profitable, wanted to downsize so they were making people retire early. The pension burden on the SOEs became so great they told the government that it should take responsibility.
Q: What came out of this?
A: The state started to take overall responsibility from the SOEs in the early 1980s and 1990s and started to charge the employers. Then some places started charging the employees 1-3% of salaries but was that going into individual accounts or into the central pot? This was pretty messy stuff. It’s amazingly difficult to understand what was going on across the entire country. There were huge regional differences. The central government realized it had to do something and, with World Bank encouragement, it turned to the three-pillar model (Pillar 1A – state old-age pension; Pillar 1B – state individual account pension; Pillar 2 – enterprise annuities; Pillar 3 – supplementary pensions that are non-qualified). Document 26 was issued by the State Council in 1997 and that really laid the framework for what we have today.
Q: And the National Social Security Fund (NSSF) was brought in as a strategic reserve to cover the shortfalls in the local schemes?
A: Within three years of bringing in the three pillar system, China realized that some of the provinces were in such a bad way that they couldn’t just fend for themselves, particularly the northeast. The NSSF was set up in autumn 2000 and various things were said: it was a strategic reserve; it was to help provinces that couldn’t help themselves; it was to build up a pot of money for when the demographics really get serious in China. Sometimes they said it was purely for pensions, other times it was for social security in general, including unemployment, medical, maternity, etc.
Q: The NSSF has allocated mandates for overseas investments, and it already gets 10% from international IPOs by SOEs. What do you make of talk about giving it stakes in all listed SOEs?
A: There have been lots of ideas put forward, but then there is the usual tension between the Ministry of Finance (MOF), the Ministry of Labor and Social Security (MLSS), the State-owned Assets Supervision and Administration Commission (SASAC), and everyone else. Generally, we would argue that the more money that is channeled, directly or indirectly, rightly or wrongly, into pensions is a good thing. The big weakness with the NSSF is that we know something about the money going in, we know something about the money being managed but we know nothing about when and to whom the money will be paid out.
Q: To what extent are enterprise annuities similar to the Western corporate model in which both employer and employee make contributions which aren’t subject to tax?
A: Enterprise annuities must be established under trust and they must have an administrator, a fund manager and a custodian. If you do all these good things, you should get tax relief. The trouble is, not everywhere in the country has decided on the tax relief rules. A number of cities and employers have said that enterprise annuities can get tax relief of up to 4% of total payroll, irrespective of whether it is the whole company or only part of the company in the enterprise annuity. Other people have come back with even higher rates, 5-6%; others have said absolutely nothing; others have said we’ll talk about it by negotiation.
Q: How many enterprise annuities are in existence?
A: We don’t know exactly how many there are right now – and the central government certainly doesn’t know either. China has licensed five trustees, 11 administrators, 15 fund managers and six custodians for enterprise annuities. If you speak to these people they will only tell you what they want you to hear. I’m pretty confident there were more than 100 enterprise annuity plans in place by the end of December and 200 more in the pipeline. It’s been talked about but whether it’s been announced to employees, documented and money changed hands and invested is another matter.
Q: Are enterprise annuities destined to become the dominant product?
A: Apart from enterprise annuities, there are a number of other voluntary pension systems in China. There is what I call the Shanghai forced contributions model [under which city governments have bullied employers into making extra contributions beyond the official cap of three times city average pay]; the Chinese insurance companies that have written group pension insurance; and the so-called 11 designated industries that have had their own special pension plans for years. These types of additional pension money are not supposed to enjoy tax advantages but they do. The idea is that they will transfer to enterprise annuity format to qualify for tax relief and to keep the MLSS happy. How quickly this will develop, we really don’t know.
Q: What would China Life have to do to move into enterprise annuities?
A: If I were China Life, I’d want to play it both ways. I’d be pushing for an enterprise annuity license as well as looking closely at my existing portfolio of business where, unlike enterprise annuities, there are no maximum fees or charges. In the long run, enterprise annuities will win if they sort out the tax position. In the short to medium term, a lot of smaller employers have contracts with China Life or Ping An don’t want to go to the lengths of having a trustee and a fund manager. They just want to buy a package.
Q: What can be done to provide for the poorer people?
A: They get state benefits if they are in the urban sector and in the formal workforce. The rural and migrant populations are not covered. What we are talking about is the 550 million people with urban hukou (residence permit), which might be 350 million when you take out the school kids and the elderly. The compliance rate is less than 50%, even in urban China; in Hong Kong, it’s something like 96%. China can’t hope to come anywhere near that level, but it certainly has to make huge efforts to boost the compliance rate.
Q: What can be done about people in the rural areas who aren’t covered?
A: They are allowed two children! Well, actually experiments have been carried out in some provinces whereby if the farmer puts some money into a special bank account, he’ll get a higher rate of interest as long as he promises not to touch it until he’s 60. Almost nothing is the answer.
Q: How do rural pension schemes work?
A: As far as we know, it is nothing more than encouraging people to save for retirement. In some cases, when the farmer has lost his land, he may be brought into the social security net. Instead of having land, he is entitled to some form of pension. We hear of experiments being carried out but the number of rural employees with pension money actually seems to be declining.
Q: How do you see China’s progress on pensions as a whole?
A: There is a whole range of things that need to be done: extending the retirement age; increasing compliance with the state system; sorting out this problem with forced contributions; resolving the tax situation for enterprise annuities; liberalizing investment restrictions. Training people and getting them used to pensions is a big issue and then there needs to be just one pension regulator in China, not the MLSS, CIRC and MOF. A lot has been done since 1998 and many people are aware of the issues but few understand the whole picture. We don’t think there are more than 20 people in China who really know what’s going on.