China s Pensions System

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1 2 1 first.com China s Pensions System the structure and its challenges At an event organised by the China Pension Forum and held in Beijing in September 2014, speakers and panelists discussed a range of pension issues in China. The forum looked closely at the current structure of pensions in China and the implicit and explicit challenges over the coming decades. Asia First and the Hong Kong Retirement Schemes Association both supported the event. Pensions and the Population The raw population statistics in China tell much of the story. By 2025, it is projected that over 200 million Chinese citizens will be aged 65 or above, which constitutes 14% of the total population. Compared with Japan, at 24%1 of the population over 65 (2012), the rate of ageing in China seems relatively low. However, that number in China will double by 2050 and the percentage of population will rise to 22.7%2. In absolute numbers, the challenge is also daunting, as the total number of Chinese citizens over 65 will exceed half of the entire US population by 2025 and more than that entire population by Establishing an adequate national pension framework to meet the needs of retirees is an urgent and necessary step for the government and has been work-in-progress for decades. But, commentators at the recent China Pensions Forum generally agreed that China has further work to do to reach a satisfactory end-point, where it can be confident that its system will meet the needs of its retired population. China is now facing a looming pension crisis and is in an urgent race against time for pension reforms. Stuart H. Leckie, Stirling Finance and Rita Xiao, CFA, pension Reforms in China A race against time, in the CFA Institute blog, February 2014.

2 first.com Only 2% of the elderly population in China say that they have enough income to adequately support their life in retirement. - Prof. Yang Yansui, Tsinghua University The structure of pensions in China and what they provide The current structure of China s pension system is relatively complex. It is a multi-level pension system designed primarily for urban employees. Although most aspects of the system reflect the structures recommended by international organisations such as the World Bank, overall implementation has been piecemeal and has its own unique characteristics. In 1997, the Chinese Government unified the basic old-age pension system (or insurance system as it is referred to) the BOAI, for private-sector employees in urban areas by supplementing the then basic pension with an employee personal account. The basic pension is determined by the government and is adjusted by reference to both inflation and increases in average pay. The employee personal account is effectively a state earnings-related component, based on final salary and years of contribution. Government workers, totaling 10 million, and employees of government-affiliated public service institutions, totaling more than 30 million, do not make personal contributions to any pension programs; in the meantime they receive more generous retirement benefits than other people in the workforce, including retirees from urban enterprises, who must make compulsory contributions to pension funds: Caring for the Elderly, by Tang Yuankai, Beijing Review, 30/12/2013 The current contribution rate for the BOAI for employers is 20% of an employee s salary and there is an 8% contribution for employees. These rates of contribution increased sharply in 1997 and are now at 28% in aggregate, one of the world s highest pension contribution rates. But the BOAI provides only for basic retirement needs, even when the earnings supplement is added see following. So in 2004, the government introduced a further voluntary contribution scheme called an occupational pension scheme (shown in the diagram as the blue 2 level 2).

3 This scheme is designed to encourage employees to contribute more of their earnings into an individual pension account. However, this scheme has been disappointing in terms of contribution rates over the past decade, with rates by employees in 2013, of only 5.38%. 4 And finally, in China s structure, there is a third tier. Historically, old-age security was generally achieved through self-saving (level 3) and family support. Urban household s per capita savings rate is 33.14% and 29.9% for rural household 5. This rate obscures the spending by households for future healthcare, schooling and maintaining the family. In any event, commentators are keenly aware that personal savings is an informal way of achieving security for the elderly in retirement and that birth rate policies may have changed the dynamics, fewer children supporting more parents see the chart below. The Challenges No doubt, the burden on employers is significant but are these contributions sufficient to support the basic pension needs of the current and future retirees and is the system universal enough does it cover enough of the population? Adequacy: The BOAI system is designed to meet people s basic needs after retirement. The average pension benefit under this system in 2013, including both components, was CNY 1,893 per month, which represents only 43.37% of the national average wage 4. According to research by Professor Yang Yansui, from Tsinghua University, a speaker at the forum, 49% of the current elderly population in China need support from other family members and only 2% of the elderly population say they have enough income to adequately support their life in retirement Coverage: In 2013, the number of people covered by BOAI reached million and the number of currently retired pensioners was million. But the current number of covered individuals still only represents 63.22% of the adult working population 5. China s current pension system Source Note 5 Funding strains: As is common with some other state managed systems, a part of the current contributions, designed to provide for the future retirement of current workers, are being applied to meet the basic pension needs for those who have already retired. In 2012, the amount applied to current pensions increased by another CNY 24 billion and reached CNY 560 billion 6. Political tensions: There are a number of structural issues or tensions in the system. The level of employer pensions contributions has not been without controversy. In a survey conducted by the Chinese Entrepreneur Survey System in March 2013, over half of the 1,000 entrepreneurs select social security and tax as the biggest obstacles in the process of business development 4. In a market where wages are increasing and eroding competitiveness in some industries, this could be an increasing concern and might lead to pressure for changes and perhaps even a reduction of burdens for employers and a greater, more structured, transfer of responsibility to the individual. 3

4 Inequalities: The current pensions system also contains significant inequalities. Private sector employees make an 8% contribution and receive a pension income currently ranging from only CNY 1,000 to 2,000 per month 2. In the public sector, which accounts for 1% of the working population, employees do not make any pension contributions and they receive a retirement income that ranges from CNY 4,000 to 5,000 per month. These liabilities to retired state employees are unfunded and paid out from government reserves. Structure and complexity: In addition to the challenges mentioned above, the forum also raised other issues including a lack of a unified structure too many government departments involved - and the absence of a government actuary driving the current pension system, leaving it more vulnerable to mistakes on the management of resources and the setting of both contribution and pensions payment rates. Possible Approaches to Reform Various proposals were made by speakers during the forum by the pension professionals and academics to address the current issues with China s pension system. Professor Yang proposed a Tsinghua reform plan to adjust the current structure and build a pension system based on a dual structure, where the government provides for basic pension needs and the individual also has a personal pension account for retirement, similar to the MPF scheme in Hong Kong or the DC schemes in the US. But this of course raises the perennial issue of incentives for employee saving and in particular tax incentives or allowances to encourage stronger contributions rates a failing in the level 2 scheme introduced in But also, in common with other systems (and societies), a significant issue is to educate people that they should not only rely entirely on the government for pensions or social welfare to meet 4

5 In the 1950s, life expectancy [was] still below 45 [b]ut 60 years on, a recent study showed the nationwide average age of retirement is still 53 even though the economy is transformed and the average life expectancy is now 75. Paying for the grey, the Economist, April 5, their needs in retirement. As Harry Smorenberg, founder of the China Pension Forum, said in his keynote speech to the forum, to educate people on the benefits and the need to save for the future should start from primary school. There are other steps discussed by the forum that would be desirable. Currently in China, the retirement age is 50 or 55 for women and 60 for men. As with much of Europe, extending the retirement age gradually is likely to be necessary. Also the government will need to create a more systematic and efficient way to invest pension savings. As Professor Yang pointed out in her presentation, in an advanced society, the purchasing power from the elderly population is fundamental. In China, the level of purchasing power from the elderly population is far below that of other developed countries like the US and European countries, in part due to the insufficient amount of the pensions provided by the existing pensions system. Professor Yang proposed a Silver Economy development strategy to (i) increase the purchasing power by improving the asset structure of savings and pensions held by the elderly population and (ii) to delay retirement and make the older population more economically productive, longer. The World Bank recommends a five pillar model for pension systems. They also recommend reasonable balance between the pillars in any such system. The current multi-level pension structure in China relies far too heavily on the first pillar (the BOAI in China s system) and even on the fifth pillar of informal, family and savings based provision for retirement. In the BOAI, although there is an 8% employee contribution to the individual account component, the assets are not visible to an employee and so the system, as a second pillar, is not as fully developed and transparent as, say, the self-managed MPF system in Hong Kong. Occupational pension plans which form part of the third pillar of the World Bank model, are also not playing a significant enough role in China s system, due the extremely low coverage and World Bank Five Pillar Model Non- Contributory Zero Pillar Income- SubsRtuRon First Pillar (2005) Mandatory Second Pillar Voluntary Third Pillar contribution rates. There is an ongoing discussion amongst pensions professionals about how to adapt the World Bank model for China and how to develop those parts of the system that are not fully developed, such as the occupational and voluntary elements of the system. And the government is aware of the need to establish a fairer and more sustainable pension system. The China Communist Party acknowledged in the recent 3 rd Plenum that they expect more reform of the system. - Article published on 21st October, 2014 Informal System Fourth Pillar Note 5 Note 1: Population by Age Group and Indices of Age Structure, Statistics Bureau, Japan Note 2: China Aging Social Security Development Report (2013), Prof Yang Yansui, School of Public Policy and Management, Tsinghua University Note 3: China's Social Security and Its Policy (2004) Note 4: The Basic old-age insurance of China: Challenges and Countermeasures, Zhen Li Note 5: Keynote speech From multi-level to Multi-pillar, Professor Li Zhen in China Pension Forum 2014 Note 6: China Pension Report 2013, Chinese Academy of Social Sciences 5

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