China s Pension System

Transcription

1 Assets (RMB bn) Net cashflows (RMB bn) CHINA The Basic Pension has cashflow problems -1,000-1,500-2,000 Source: MoHRSS (Urban Basic Pension), Global Demographics, Macquarie Research, June 2014 Pension assets over the next decade Basic Pension Employers' Annuity Private pensions Source: MoHRSS, CIRC, Global Demographics, NCSSF, Macquarie Research, June 2014 Analyst(s) Scott Russell scott.russell@macquarie.com Jian Li, CFA jian.li@macquarie.com Will Li will.li@macquarie.com 17 June 2014 Macquarie Capital Securities Limited The definitive guide After searching high and low for a definitive guide to the China pension system and coming up empty, we have produced our own. This report critically assesses the structure and sustainability of the pension system with a particular focus on opportunities for the insurance sector over the next decade. Many more retirees supported by a shrinking workforce The recent demographics analysis of our colleagues shows that over 100mn people will enter the 65+ age bracket over the next 15 years. By contrast, the workforce will reduce by 12mn people. This highlights a pressing need to ensure a sustainable pension system and a major opportunity for private pension providers. The current system is buckling under pressure We believe the structure of China s pension system at present is inadequate to support the nation s pension needs over even the next five years. Issues include: inadequate asset coverage, unsustainable cashflow positions, large unfunded liabilities, reliance on very large & rising Govt injections, suboptimal asset allocations and low levels of engagement. Reforms in transition to a modern pension system Pension reforms have been anticipated in China for many years. Whilst progress has been slow, we think reforms are inevitable given compelling demographic trends and profound sustainability threats. This shift would be consistent with trends in many other major countries. The most obvious reform is in taxation, where China is unique in not providing tax concessions to private pensions. Aligning tax in the private system with the public system would remove a major competitive constraint for private pension providers. We estimate that 223mn workers in China (29% of the workforce) currently incur tax and therefore would find a tax concession valuable. Pension assets to increase almost 6x by 2023 We estimate the overall pension system contains total assets of RMB 5.4trillion currently, representing only 10% of GDP and US$638 per capita. Over the next decade, under a scenario where the Govt undertakes meaningful pension reforms, we forecast pension assets rise to over RMB 31trn (US$5.1trn), implying 19.2% CAGR. We expect life insurers to be major beneficiaries. Insurers are well-positioned and offer a free option Our projections imply that private providers will administer 60% of pension assets by 2023 (up from 23% today). We value this business at 10-37% of current market caps, which we believe is not currently priced in. This major longterm opportunity supports our attractive view of the insurance sector. We highlight China Life as our preferred exposure to this theme as both a pure play on the life & pensions industry, and the highest exposure to pensions among peers. We estimate that the order of exposure to pensions is (highest to lowest): China Life, CPIC, Ping An, Taiping, PICC L&H, NCI. Please refer to page 58 for important disclosures and analyst certification, or on our website

2 Executive summary Inside Executive summary 2 An overview of China s pension system 5 Demographics of China population 10 Structural features of the system 12 Adequacy of the system 27 Sustainability of the system 31 Government policy 36 How insurers participate 42 Quantifying the industry outlook 45 Appendix: Projections of pension assets 49 Glossary 56 Retirees numbers are rising and the workforce is shrinking Over 100mn new retirees over the next 15 years The system is unsustainable in its current structure China s population is shifting towards older age groups. In a recent demographics analysis, our colleagues showed that over the next 15 years, >100mn people will look to retire whilst workforce numbers will reduce by 12mn people. These structural observations imply that workers pension contributions are unlikely to fund retiree benefit payments for very much longer. Current system is buckling under pressure China s pension system consists of 3 pillars the Govt Basic Pension, corporate annuities and private/commercial pensions. The scale of the latter two categories remains very small. We believe the structure of China s pension system at present is inadequate to support the nation s pension needs over the next 5-10 years for several reasons: Whilst coverage is very broad (as measured by population), depth of coverage is very poor (as measured by assets); Relative to GDP and population, China s pension assets compare very poorly with other countries; Massive demographic changes are taking place as more people retire and the workforce shrinks; The system is premised on ongoing asset injections from provincial governments which are increasingly under pressure in a slowing economy; In the Basic Pension, retirement benefits are often unfunded as supporting assets have been loaned to other sub-funds; In order to simply meet retiree benefits over the next decade, our projections imply that the Govt will need to inject an aggregate RMB 8.6trn into the Basic Pension system (refer Fig 1 below and the Sustainability section of this report); The lion s share of assets are invested in relatively short-duration, lower-yielding classes such as term deposits; Consumer engagement levels are generally very low, particularly amongst younger people and part-time workers. As such, the system is inadequate and unsustainable in its current structure. We believe these issues will become increasingly obvious over the next few years. We see no other sustainable alternative than for significant reforms in future and a conscious shift towards the private sector. 17 June

3 E 2015E 2016E 2017E 2018E 2019E 2020E 2021E 2022E 2023E E 2015E 2016E 2017E 2018E 2019E 2020E 2021E 2022E 2023E Net cashflows (RMB bn) Macquarie Research What reforms should be expected? We identify numerous areas for reform We think the 3-pillar system is appropriate and we expect the Govt-administered Basic Pension (ie. Pillar 1) to remain the bedrock of the system for the foreseeable future. However we identify a number of potential reforms over the next few years including expansion of the private pension sector (ie. Pillars 2 and 3), tax incentives, capital concessions, product innovation and asset diversification. These initiatives would help alleviate State fiscal pressures. There is currently little incentive for customers to supplement their Govt-provided pension with voluntary and private pensions. We see this dynamic changing as Government increasingly introduces policies designed to increase the takeup of private pensions. There have already been examples of this last year in the employers annuity space (eg. tax incentives) and we expect this to be extended to private annuities in the future, in one way or another. In this report, we estimate that ~223m people incurred a tax liability in 2012, equivalent to 29% of the workforce. This would imply a substantial number of people attracted by tax concessions. Projecting a massive market opportunity We estimate the overall pension system contained total assets of RMB 5.4trillion at Dec These pension assets represent 10% of GDP and RMB 4,014 (US$638) per capita, both of which compare poorly with other major countries. Over the next decade, we forecast pension assets rise to RMB 10.2trn, implying a 6.5% CAGR. However under our reforms scenario, we forecast pension assets rise to RMB 31.4trn (US$5.1trn), implying a 19.2% CAGR, as set out in Fig 2. Fig 1 Urban Basic Pension cashflows... Under pressure due to more retirees & fewer workers Fig 2 Pension assets... Under our reforms scenario, pension assets rise substantially over the next decade (bn RMB) 35,000 30,000 25,000 20,000 15,000 20% 15% 10% -1,000 10,000 5,000 5% -1, % -2,000 Basic Pension (includes NSSF) Employers Annuity Private Pension Total Pension Growth Note: Projections assume no reforms implemented and Govt subsidies remain flat from 2013 levels. Source: MoHRSS, Global Demographics, Macquarie Research, June 2014 Source: MoHRSS, CIRC, Company Data, Global Demographics, National Council for Social Security Fund, Macquarie Research, June June

4 Pensions as % total premiums Valuation (US$bn) Macquarie Research Who will benefit? We expect the life insurance sector to be a major beneficiary We expect the life insurance sector to be a major beneficiary as the bulk of forecast pensions growth would be focused on the private sector. Our projections imply that private providers will administer 60% of pension assets by 2023 (up from 23% today). From a manufacturing perspective, we believe the private life insurers have the necessary products available and are already prepared to help the Govt outsource the fiscal burden of looking after pensioners. From a distribution perspective, the insurers have established networks of agents, banks and employers to take advantage of this opportunity. The large and rising inflows that we expect also offer substantial investment opportunities for asset managers. Whilst the bulk of these inflows are managed in-house at present (either by Govt or by insurers asset mgmt companies), we expect the range of asset classes to broaden and the list of asset managers to lengthen. Currently the asset allocation of China s pension system is constrained by available domestic asset classes, a narrow shallow bond market and a suboptimally high allocation to cash. Over the next decade, we expect the allocation to increasingly diversify. We see no reason why alternative and foreign asset classes would not also benefit from the substantial expansion of China s pension market. Insurance stocks offer a free option on pensions expansion The life insurers in China are currently trading on x FY14E P/EV and <5x new business multiples. This generally implies zero growth in future new business. We consider this outlook excessively cautious even without the reforms described in this report. To the extent that Chinese life insurers can participate in the development of the private pensions system to a similar extent as developed-market peers, we see substantial new business growth potential for the Chinese life industry over the next decade. We value the corporate & private pensions businesses of the six listed life insurers at over US$50bn, comprising 10-37% of current market caps. Our preferred stock exposure to this theme is China Life (2628 HK, HK$21.60, Outperform rating, target price HK$27.50). Not only is the company a pure play on this attractive theme, it already generates the highest proportion of business from pensions among peers (refer Fig 3) whilst also offering the most valuation upside (Fig 4). Fig 3 Private pensions inflows (2013)... China Life most exposed to pensions Fig 4 Estimated valuations of pension activities over the next decade 25% % 15% 10% 5% % China Life CPIC Ping An Taiping PICC L&H NCI Employer's Annuities (Pillar 2) Private annuities (Pillar 3) - China Life CPIC Ping An Taiping PICC L&H NCI Employers' Annuities (Pillar 2) Private annuities (Pillar 3) Note: Includes Pillar 2 (ie. Employers Annuities) and Pillar 3 (ie. private pensions). Denominator includes premium from life, private annuities and EA. Source: Company data, CIRC, Macquarie Research, June 2014 Note: Adjusted for minority stakes in life and pension subsidiaries. Source: Macquarie Research, June June

5 An overview of China s pension system The China pension system consists of three major pillars and one segregated fund pool. The three pillars are: Pillar 1: Basic pension (administered by the Government); Pillar 2: Supplementary pension (mostly employers annuity); Pillar 3: Commercial private pension products. The segregated fund pool is called the National Social Security Fund (NSSF). Fig 5 sets out a simple schematic explaining how the various pillars work together. We discuss how each of these components function later in this report. Fig 5 China s pension system: Simple schematic Pillar 1: BASIC PENSION (backed by NSSF) Pillar 3: COMMERCIAL PENSIONS Pillar 2: EMPLOYERS ANNUITY Pillar 1-3 NEW RURAL PENSION SYSTEM (NRPS) Pillar 1-2 URBAN BASIC PENSION Pillar 1-1 Private pensions Mostly provided by SOE s Rural residents & unemployed Urban employees Civil servants and state workers Source: Macquarie Research, June 2014 Starting with some key facts about the pension system... We set out below some key facts about the following aspects of the pension system in China: National demographics; Population coverage; Total assets; Total inflows; Pension assets relative to total consumer assets; Adequacy of the system. We explore all of these issues throughout this report. 17 June

6 Population (million) Macquarie Research National demographics Over 100mn new retirees over the next 15 years... China s population is shifting towards older age groups. The 65+ age group is expected to more than double in size over the next 15 years, as over 100mn people enter this age bracket. Meanwhile the workforce (aged 20-59) is shrinking. The retiree-workforce ratio bottomed out in 2011 and is estimated to increase by 8ppts to 31% by This implies that workers pension contributions appear likely to reduce in size relative to retiree benefit payments. Separately, Macquarie s recent demographics report on China showed that the best demographic target is urban, working-age empty nesters (defined as urban-dwellers, aged 40-64, with income > RMB 120k pa). This bracket will increase spending at a 21% CAGR from 2013 to Population coverage By the end of 2013, the Basic Pension (ie. Pillar 1) covered 820mn people, or 61% of total population. This includes the workforce, retirees and the unemployed. Population coverage of Pillars 2 and 3 (ie. corporate and private pensions) was much lower at only 21mn and 1mn, respectively. These people are very likely to be also covered under the Basic Pension. Relative to a national workforce population of 767mn, the population covered by the pensions system is high. Fig 6 sets out the 10-year history of participation among different demographic groups. It shows the substantial uplift in rural coverage from 2011 as part of NRPS implementation. Fig 6 China: Population covered by the Basic Pension over time 1,400 1,200 1,000 Urban - Not covered Urban retirees - Covered 800 Urban workforce - Not covered 600 Urban workforce - Covered Rural - Not covered Rural - Covered Source: NBS, MoHRSS, Macquarie Research, June June

7 Total assets By the end of 2013, the total assets supporting pensions amounted to Rmb 5.4trn, on our estimates. This comprised: Pillar 1 (Basic Pension): RMB 3.1trn; Pillar 2 (Employers Annuities): RMB 604bn; Pillar 3 (Private Pensions): RMB 649bn; and NSSF RMB 1.1trn (of which we estimate ~RMB 182bn overlap with Pillar 1). Fig 7 shows this asset breakdown by pillar type. We note employers annuities and private pensions comprise 23% of pension assets. Our projections (set out later in this report) imply that this rises to 60% by Fig 7 Breakdown of total pension assets (2013) NSSF 20% Private Pensions 12% Basic Pension 57% Employers Annuity 11% Note: NSSF assets are based on our 2013 estimate. Source: MoHRSS, Macquarie Research, June 2014 Fig 8 shows the build-up of assets in the pension system since Over the past 5 years, pension assets in China have grown at a 24% CAGR. Fig 8 Build-up of assets ( ) (bn RMB) 6,000 5,000 4,000 3,000 2,000 1, Basic Pension (includes NSSF) Employers Annuity Private Pension Source: MoHRSS, Company Data, Macquarie Research, June June

8 Pension assets relative to total consumer financial assets As at end-2013, we calculate that consumer financial assets amounted to RMB 83.7trillion. This comprises: Pensions: RMB 5.4trn (as above); Life insurance: RMB 6.8tn; Consumer deposits: RMB 46.8tn; Public offer funds: RMB 4.2tn; Wealth management products (WMPs) : RMB 9.5tn; and Trusts: RMB 10.9tn. We note overlaps exist among the six categories, such as Pension Pillar 3 and the life insurance sector. However, generally these overlaps are relatively small. Fig 9 shows that pensions only comprise a small portion of total financial consumer assets (6.5% in 2013), and this has been flat or falling since Fig 9 Breakdown of consumer financial assets in China (billion RMB) 90,000 80,000 70,000 60,000 50,000 40,000 30,000 20,000 10, Trusts WMPs Life Insurance AUM Total Public Offering Fund Consumer Deposit Total Pension AUM Note: 2013 consumer deposits is our estimate based on total deposits because the latest data for the former was not available yet. Source: MoHRSS, Wind, NBS, Company Data, Macquarie Research, June 2014 Total inflows In 2013, the pension system generated total inflows of RMB 2.6trn. This comprised: Pillar 1 (Basic Pension): RMB 2.3trn; Pillar 2 (Employers Annuities): RMB 142bn; Pillar 3 (Private Pensions): RMB 109bn; and NSSF: RMB 111bn. 17 June

9 Fig 10 shows how this has accumulated over time. Fig 10 Pension system inflows ( ) (RMB billion) 3,000 2,500 2,000 1,500 1, Basic Pension Employers Annuity Private Pension Products NSSF Note: EA inflows are estimates based on the inflows of the 5 pension companies reported by CIRC grossed up using their market share of EA assets. Source: MoHRSS, Wind, Company Data, Macquarie Research, June 2014 Adequacy of the system Putting together the above statistics, assets per participant were RMB 6,645 (US$1,055) and 10% of GDP in This highlights that whilst the system offers good breadth of population coverage, the depth of coverage is severely deficient. Fig 11 Assets per capita ( ) (RMB) 8,500 8,000 7,864 8,287 7,500 7,000 6,500 6,000 5,500 6,970 5,972 5,767 6,645 5, Total Pension System Source: MoHRSS, Company Data, Macquarie Research, June 2014 A public system unable to cope on its own... We estimate that over RMB 290,000 needs to be provided at retirement for a typical retiree given the current retirement benefits and life expectancies. Whilst there are clearly insufficient assets in the system at present, the pay-as-you-go nature of the system relies on workforce contributions to fund benefit payments to retirees. However the system s 43% replacement rate (ie. the ratio of annual retirement benefits to final-year salary) implies reasonably generous retirement incomes. Our projections show that a substantial cashflow deficit will therefore open up (and keep deteriorating) by Further discussion is set out later in this report, where we conclude that the system is neither adequate nor sustainable in the long term. 17 June

10 Demographics of China population Before we dive in, we thought it important to set out some basic demographic data which highlight the increasing burden of the ageing (and retiring) population. The burden of an aging population What do the demographics say? Fig 12 compares the composition of China s population by age group between 2010 (source: national demographics survey) and 2030 (source: Swiss Re projections). The shift towards older age groups is clear. Fig 12 Population beehive chart: 2030E vs 2010 Shaded bars refer to 2010; non-shaded bars refer to Swiss Re s 2030 projection. Source: Swiss Re, Macquarie Research, June 2014 Fig 13 shows an alternative perspective of the same data; the 65+ age group is expected to more than double in size over the next 15 years, as over 100mn people enter this age bracket. Fig 13 Change in composition of adult population by age group: E Source: Swiss Re, Macquarie Research, June June

11 Pressure on the pension system over the next decade In December 2013, Macquarie s Head of Asia Emerging Leaders, Jake Lynch, together with Founder of Global Demographics, Clint Laurent, conducted an in-depth analysis of China s demographics in Demographic Techtonics- A V-shaped age profile for China. A shrinking number of workers funding a rapidly expanding number of retirees. The key conclusions from their analysis are set out below: The relaxation of the one-child policy will help boost the number of urban youth (<14 years) by 50% over the next ten years. However this does nothing for the urban age group 15-39, which will fall 4% by Youth population will shrink by 13mn over the next decade. The urban bracket will surge with a 4.6% 5 year CAGR, adding 118mn new consumers by The sweet spot is urban with income > RMB 120k pa. This bracket will increase spending at 21% CAGR from 2013 to This is China s best demographic target and aligns very neatly with the target market of life insurers. The database used in the demographics report is summarised in Fig 14 below. Our demographics analysis shows the clear increase in retirees relative to the workforce. In particular, we note: The workforce population (age 20-59) will shrink by 12mn over the next decade; The retiree population (age 60+) will increase by 60mn over the next decade; The retiree-workforce ratio bottomed out in 2011 and is estimated to increase by 8ppts to 31% by Fig 14 Macquarie demographics forecasts: Workers vs retirees (million) 1,200 32% 1, % % E 2015E 2016E 2017E 2018E 2019E 2020E 2021E 2022E 2023E Work Force (20-59) Retiree (60+) Retiree-to-Work Force Ratio 20% Source: Global Demographics, Macquarie Research, June June

12 17 June Structural features of the system Fig 15 A summary of the 3 pillars (and sub-pillars) of China s pension system Pillar System Group Source of Contribution 1-1 Basic Pension Civil Servants & State Sector Workers Govt fiscal expenditure Participation compulsory or voluntary Compulsory DC or DB Not Applicable (fully funded by Govt) Investment Strategy ND Administration Expenses Pension Benefit Around 80% replacement rate Benefit Payment Type Monthly benefit for whole of life Tax Treatment & Other Incentives No tax implications Assets as at Dec13 (RMB bn) ND (Govt fiscal expenditure) Number of Participants (covered population) Around 50mn 1-2a Basic Pension Social Planning 1-2b Basic Pension Individual Account 1-3a NRSP Social Planning 1-3b NRSP Individual Account 2 Employers Annuity (aka Enterprise Annuities) Other Urban Employees Other Urban Employees Rural Residents & Unemployed Rural Residents & Unemployed Large Profitable Corporate (mostly SOE) Employees 20% of salary by employers 8% of salary by employees Central govt subsidy + provincial /municipal expenditure Individual payment with options Employers and employees pay together Compulsory DB Govt Bond / Term Deposit Compulsory Eligibility requires participation in Pillar 1-3b Voluntary Voluntary for employers to initiate Both DC & DB features Not Applicable (fully funded by Govt) Both DC & DB features Mostly DC Govt Bond / Term Deposit ND 1-year Term Deposit Determined by Fiduciary Actual operating expenses directly deducted from total fund balance after audit & approvals process Fixed % or Fixed $ charged to customers (program specific) Combination of regional avg salary and personal salary Personal Account Balance / 120 (ie. 10 years paid monthly) Regional-prescribed minimum benefit Personal Account Balance / 139 Monthly Payment based on Personal Account Balance Monthly benefit for whole of life Monthly Benefit till Death Monthly Benefit till Death Monthly Benefit till Death Monthly Annuity / Single Lump Sum, Programspecific Contributions are taxdeductible. Benefits are not taxed. Contributions are taxdeductible. Benefits are not taxed. No tax implications Contributions are taxdeductible. Benefits are not taxed. (1) Deferred personal income tax for employer & employee contributions; (2) investment income tax free. (3) Benefits taxable. 2, mn mn mn 3 Commercial Private Pension Individuals with Higher Pension Demands Single Premium / Annuity Premium for insurance products Voluntary Not Applicable (annuities products) Controlled by Insurance Companies Policy fees charged Policy Specific Policy-specific No tax implications. 649 Around 1mn Notes: DC refers to Defined Contribution schemes; DB refers to Defined Benefit. ND = not disclosed Source: Macquarie Research, June 2014

13 Pillar 1: The Basic Pension Pillar 1 represents the social security system administered by the Government through the MoHRSS. It is by far the largest and broadest pillar of the pension system. This section describes how the Basic Pension system works. An overview The Basic Pension is principally a set of defined benefit schemes where annual retirement benefits are defined relative to salaries in the final year of employment. Contributions are funded by employees, employers and Govt subsidies. Contributions are deposited into the Special Account, of which ~80% are invested in government bonds and the balance in term deposit. Historically the Basic Pension system has been focused on Govt and urban employees; since 2011 the system has expanded into further coverage of rural areas. This has necessitated the establishment of various sub-pillars to distinguish between urban and rural areas and employees of Govt vs corporate entities. The various sub-pillars are: 1. Civil servants & state sector workers, which we term Pillar 1-1 for the purposes of this report; 2. Urban employees (non-government), which we term Pillar 1-2; 3. Rural residents & the unemployed, which we term Pillar 1-3. Each of these sub-pillars (excluding Pillar 1-1) has a further breakdown into two account types: Social Planning fund: Contributions are made by employers and/or Govt on behalf of participants; Individual Accounts: Contributions are made by the participants themselves. This allows participants to build up an additional personal account on top of the Social Planning pool. This means that two separate contributions are made for each worker (into each fund), who can collect two separate benefit streams upon retirement. The basic features of each sub-pillar are summarised in Fig 15 above, and a fuller description of each sub-pillar is set out below. As urbanisation continues, we expect the Govt to centralise the sub-pillars over time. 1. Civil servants & state sector workers Govt employees are covered under this sub-pillar which comprises ~50mn participants (~10mn civil servants and ~40mn state sector workers). This sub-pillar is opaque to outsiders as very limited information is publicly disclosed. We were unable to find any detail on the size, returns or allocation of assets supporting this pillar. We understand annual retirement benefits vary by province and represent ~80% of salary in the employee s final working year. There are no explicit contributions made by employees, and as such the scheme is entirely funded out of the Govt fiscal budget. This sub-pillar is a defined benefit scheme as retirement benefits are not linked to accumulated contributions. The Govt therefore assumes the risks of any contribution shortfall (relative to promised benefits) as well as longevity. Whilst we note public perception of generous benefits to civil servants is poor, we do not expect the Govt to make any material reforms here in the near term. As transparency is poor and the private sector is unlikely to participate in this Govt-run subpillar in the future, we do not discuss this sub-pillar in any depth in this report. 17 June

14 2. Urban employees (non-government) This sub-pillar is compulsory for urban employees. It is by far the largest pillar of the pension system. In Dec-13, it had accumulated RMB 2.8trn in assets. Fig 16 Urban Basic Pension: Accumulated fund balance ( ) (billion RMB) 3,000 2,500 2,000 1,500 1, % 35% 30% 25% 20% 15% 10% 5% % Accumulated Fund Balance Growth Rate Source: MoHRSS, Macquarie Research, June 2014 As at Dec-13, there were 322mn participants in the urban sub-pillar, comprising 242mn workers and 80mn retirees. Growth of the workforce is slowing. Fig 17 outlines the historical number of participants and the growth trends of both workers and retirees over the past decade. We note that growth of the workforce in more recent years has been slowing. Fig 17 Urban Basic Pension: Number of participants ( ) (million) Work Force Retiree Growth for Work Force Growth for Retiree 12% 10% 8% 6% 4% 2% 0% Source: MoHRSS, Macquarie Research, June 2014 As described above, there are two account types in this sub-pillar: the Social Planning fund and the Individual Accounts. We describe the key features of each of these below. Key features of the Social Planning fund (Urban Basic Pension) The Social Planning fund is a Defined Benefit (DB) scheme funded by employer contributions. We set out key details below: Assets backing this fund were RMB 2.4trn as at Dec-13; Contributions are made monthly by employers and defined as 20% of employees Accountable Salary (refer Glossary) before tax; 17 June

15 Retirement benefits are formula-based: 20%-25% of the regional average income of previous year, plus a certain percentage (which varies by region) of Base Index (historical average of Accountable Salary to last year regional average income ratio); Contributions are tax deductible for employers and benefits are not taxed in the hands of retirees; The Social Planning fund utilizes a pay-as-you-go method such that outgo of the year is funded by contributions made during the same year. Government assumes both the risk of any shortfall in meeting retirement benefit payments and the longevity risk as the population lives longer; Funds are entirely invested in government bonds and term deposits. Participants have no control over the allocation of the investment assets; Whilst aggregate data is publicly available, participants are unable to view their account balance (by definition of a DB scheme). Key features of the Individual Accounts (Urban Basic Pension) These Individual Accounts apply to the same population as the Social Planning fund (described above) and offers additional retirement benefits. It offers an individual account which possesses both DC and DB features. We set out key details below: According to CASS, account balances were >RMB 3.0trn by 2012; Total assets available were only RMB 415bn as Dec-13. This shortfall is a result of a reallocation of assets several years ago in order to fund benefit obligations in the Social Planning fund. This highlights the sustainability and inequity issues inherent in the current system, which we discuss later in this report (refer Sustainability of the system section). Contributions are made monthly by employees and defined as 8% of Accountable Salary before tax. No additional voluntary contributions are possible; Retirement benefits are based on the accumulated personal account balance at retirement. They are set at a monthly payment of 1/120 th of the accumulated balance. Contributions are tax deductible for employees and benefits are not taxed at retirement; Retirement benefits are paid for whole of life, and the Government therefore assumes the longevity risk. Participants have no control over the allocation of the investment assets. Funds are invested in government bonds and term deposits, with a small portion entrusted to NSSF (which has a ~30% allocation to equities). Individual Account is transparent. Participating employees can log on to the municipal MoHRSS bureau s system to check their accounts, including payment history, interest proceeds and account balance. 3. Rural residents & unemployed (aka NRPS) NRPS applies to rural residents (and the unemployed, which we will just say rural residents for simplicity) and is voluntary. It is formally known as the New Rural Pension System (NRPS), implemented in Pension coverage of the rural population is at 77% which represents a high coverage of the rural workforce. The establishment of NRSP is the government s first attempt to formally build a pension program for rural residents. The voluntary NRSP is welcomed by rural consumers because considerable government subsidies were provided to support the Social Planning pool entirely. As a result, we have seen the dramatic rollout of coverage over the past four years. In Dec-13, NRPS had accumulated RMB 301bn in assets. We summarize some key facts about this sub-pillar below: Fig 18 shows the growth in assets backing the NRPS over the past decade. This remains relatively small due to much lower incomes in rural areas. 17 June

16 Fig 18 NRPS: Accumulated fund balance ( ) (billion RMB) Accumulated Fund Balance Source: MoHRSS, Macquarie Research, June 2014 The number of participants was 498mn as at Dec-13. Fig 19 shows that this number has increased rapidly in the last few years as NRPS was rolled out; The NRPS covers ~77% of the rural population currently and this continues to be rolled out across the country. The government plans to cover all rural areas by 2020; Fig 19 NRPS: Number of participants (million) Number of participants Source: MoHRSS, Macquarie Research, June 2014 As described above, there are two account types in the NRPS: the Social Planning fund and the Individual Accounts. We describe the key features of each of these below. Key features of the Social Planning fund (NRPS) The Social Planning fund is a Defined Benefit (DB) scheme funded by Govt subsidies. We set out key details below: Eligibility is based on participation in the NRPS Individual Accounts (described below). That is, to receive benefits from the Social Planning fund, participants must contribute to their Individual Account, which is voluntary. Contributions are funded by municipal fiscal expenditures with subsidies from central government (100% for mid-western regions, 50% for eastern regions). We understand that the determination of annual Govt contributions is on a discretionary basis. No personal contributions are made by participants. 17 June

17 Retirement benefits are made monthly and paid for whole of life. Minimum amounts are determined regionally by provincial / municipal governments. As an example, current practice in Shanghai (as implemented at Jan 2014) is RMB 540 per month. As is the case for the Urban Basic Pension, the Government assumes both the risk of any shortfall in meeting retirement benefit payments and the longevity risk as the population lives longer. Key features of Individual Accounts (NRPS) These Individual Accounts apply to the same population as the Social Planning fund described above, and offers additional retirement benefits. It offers an individual account which possesses both DC and DB features. We set out key details below: Participants have contribution options ranging from RMB 100 to 2,300 per annum. Participants can voluntarily determine how much to contribute within this range; Different regions have different practices, e.g. Shanghai contributions currently range from RMB 500 to 2,300 pa; Retirement benefits are based on the accumulated personal account balance at retirement. They are set at a monthly payment of 1/139 th of the accumulated balance. Contributions are tax deductible for participants (although the majority of participants do not exceed tax-paying thresholds in China) and retirement benefits are not taxed; Retirement benefits are paid for whole of life, and the Government therefore assumes the longevity risk. Participants have no control over investment options. We understand funds are currently invested entirely in term deposits. The sub-pillar is modestly transparent for the participant. Statements containing payment history and account balances are mailed annually to participants. The National Social Security Fund (NSSF) NSSF was established in It is managed and operated by the National Council for Social Security Fund as a strategic reserve fund for the Basic Pension scheme. That is, NSSF functions independently from the 3 main pillars of the pension system so as to provide support to Pillar 1 in the event of a funding shortfall. Size & scale According to the latest data of 2012, NSSF held assets or RMB 1.1trn. Fig 20 shows the historic build-up in these assets. Over the past 5 years, NSSF assets have grown at a 20% CAGR. In 2012, there were RMB 182bn of assets overlapping with Basic Pension. Fig 20 NSSF: Assets (RMB bn) 1,200 1, Source: National Council for Social Security Fund of PRC, Macquarie Research, June June

18 Sources of funds Government contributions and subsidies are the main source of funds of NSSF. Fig 21 shows the composition of fund income between government contributions and investment returns. Fig 21 Fund income ( ) (RMB billion) Government contributions Investment return Source: National Council for Social Security Fund of PRC, Macquarie Research, June 2014 NSSF assets are managed for several purposes on behalf of the following constituents: Social Security Fund: Income from central government fiscal support, sale of SOE shares, national lottery sales, investment income. Individual Accounts: Central government s initiative to resolve the asset-liability issues of Individual Accounts by entrusting NSSF to manage the assets. Guangdong Fiduciary Assets: Guangdong provincial government had signed agreement that allowed a portion of Guangdong basic pension to be managed under NSSF. Fig 22 shows the breakdown of assets by source of funds. Fig 22 NSSF: Asset breakdown by source (2012) Individual Accounts 7% Guangdong Fiduciary 10% Social Security 83% Source: National Council for Social Security Fund of PRC, Macquarie Research, June June

19 Investment allocation Fig 23 shows that these were invested predominantly in fixed income assets and almost a third in equities. Fig 23 NSSF: Assets breakdown by investment class (2012) Cash Equivalents 1% Others 16% Equity 32% Fixed Income 51% Source: National Council for Social Security Fund of PRC, Macquarie Research, June 2014 Investment returns Fig 24 shows a history of NSSF s investment returns. Over the past decade, NSSF has averaged 7.3%pa. However NSSF s investment returns have ranged widely. If we exclude the extraordinary returns in 2007 and 2008, the average return of the past decade was 5.7%pa. This seems a reasonable return given: the China equities market (measured by SHCOMP index) has returned an average 2.5%pa over the past 10 years; and the 10-year Govt bond yield has averaged 3.7% over the past 5 years. Fig 24 NSSF: Historic investment returns 50.00% 40.00% 38.93% 30.00% 20.00% 16.12% 10.00% 0.00% 2.71% 3.32% 3.12% 9.34% 4.23% 0.84% 7.01% % % Source: National Council for Social Security Fund of PRC, Macquarie Research, June June

20 Pillar 2: Supplementary Pensions Whilst there are several supplementary pension programs designed to complement the Basic Pension, the most prevalent is Employers Annuities (EA), which are also known as Enterprise Annuities. These pensions are all voluntary and typically provided by financial institutions (mostly banks) for customers without access to EA. The Welfare Pension Plan is one such example. On materiality grounds, we focus this section on EA. Employers Annuities (EA, aka Enterprise Annuities) Size & scale EA was first implemented in At end-2013, EA assets were RMB 604bn. Fig 25 shows the history of EA assets. Over the past 5 years, EA assets have grown at 26% CAGR. Fig 25 Assets backing Employers Annuity since inception (billion RMB) % 70% 60% 50% 40% 30% 20% 10% % EA Fund Accumulated Balance EA Fund Growth Rate Source: MoHRSS, Macquarie Research, June 2014 The number of participating employers/employees has been increasing steadily over the past 8 years to 66,100 and 21mn, respectively (Fig 26). Fig 26 shows the similar growth trends over time. Fig 26 Number of employers & employees participating in EA programs ( ) Number of Employees (million) Number of Employers 70,000 60,000 50,000 40,000 30,000 20,000 10, Number of Participating Employees Number of Participating Employers Source: MoHRSS, Macquarie Research, June June

21 How does EA function? EA are simply corporate annuities. Most employers that operate EAs are state-owned enterprises (SOEs). Non-SOE companies have so far not been motivated to start EA programs due to a lack of tax incentives and high qualification hurdles. Recent changes allow for both employee & employer contributions to be tax deductible (refer Government Policy section later in this report for more details on these changes). There are several parties involved in any EA program. Fig 27 below sets out a simple schematic highlighting the various responsibilities. The following parties exist: Principal: The employer who establishes the EA plan for its employees. Fiduciary: An organization licensed to act as EA fiduciary. These organisations are listed in Fig 27. Responsibilities include asset allocation and supervision. Account manager: An organization licensed to act as EA account manager; must have no less than RMB 500mn net assets. Trustee: An organization licensed to act as EA trustee; must have no less than RMB 5bn net assets. Investment manager: This licensed organisation can be one of the following: qualified security companies with no less than RMB 1bn net assets; qualified pension management companies with no less than RMB 500mn net assets; qualified trust companies with no less than RMB 300mn net assets; qualified fund management companies, insurance asset management companies, security asset management companies or other qualified investment companies with no less than RMB 100mn net assets and registered capital. Fig 27 Parties involved in EA business and responsibilities Principal Sign trust management agreement Fiduciary Set EA fund asset allocation strategy AND Select/ monitor/ change Fund Account Management establish employer/individual EA fund account record/check/report investment gain/loss calculate EA benefit Trustee secure EA fund assets open fund accounts and security accounts on behalf of EA fund allocate EA fund assets to Investment Management according to Fiduciary s strategy Investment Management invest EA fund assets establish EA investment management risk reserve report to Fiduciary reconcile accounting and valuation results with Fund Account Management Source: Macquarie Research, June June

22 Investment management strategies are determined by the Fiduciary and employees generally do not have investment choice. Administrators of EA programs charge fees, either a fixed percentage of fund assets or a fixed dollar amount. These fees are subject to maximum caps. Fig 28 sets out these caps as well as typical fees charged. We note the fees charged currently are only ~50% of the caps set by MoHRSS. This is due to natural competitive constraints, which also suggests to us that EA is likely to be fairly low margin for administrators. Fig 28 EA Service Fees and Commissions Source: BBVA, CIRC, Macquarie Research, June 2014 Employers have flexibility to design program features when initiating, however most programs are structured as defined contribution schemes. A typical example is set out in Fig 29, which illustrates what a typical EA program looks like from an employee s perspective. Fig 29 Cashflows for a typical EA program (from customer s perspective) Cash inflow EA STARTS Yearly/monthly EA annuity benefits Timeline Cash outflow Work age term Yearly/monthly EA annuity payment contribution (employers + employees) RETIREMENT Retirement benefit term Source: Macquarie Research, June June

23 EA business providers Currently eligible fund managers of EA schemes include insurance companies, mutual funds, and trust companies. Financial institutions are required to obtain licenses to engage in each component of EA business. Fig 30 sets out the banks, trusts, funds, insurance companies and pension companies licensed to conduct EA business as either a fiduciary, account manager, trustee or investment manager. We note three financial institutions have all 4 licences: ICBC, CMB and CITIC We note four insurers holding 3 licenses: China Life, Ping An, CPIC (Changjiang), Taikang. We expect that providers who are able to integrate the four business functions to serve as comprehensive EA providers are likely to be more successful in simplifying the process for employers by integrating functions such as plan design, customer service and IT. Banks are naturally in a relatively strong position in EA due to a broad customer base, wide networks of branches and strong internal financial support. Fig 30 Financial institutions licensed to participate in EA (as at June 2014) Fiduciary Fund Account Management Trustee Investment Management Changjiang Pension China Life Pension CITIC Bank Changjiang Pension China Life Pension Taikang Pension SPD Bank China Taiping Pension China Taiping Pension Ping An Pension ABC Ping An Pension Ping An Pension Changjiang Pension China Minsheng Bank China Life Taikang Pension China Life ICBC Taikang AMC CCB Taikang Life BoC Huatai AMC ICBC NCI CCB PICC AMC CMB CPIC Life BoComm CITIC Securities Shanghai Trust CCB CMB CICC CITIC Trust China Minsheng Bank China Everbright Bank Guotai AMC China Credit Trust BoC ICBCCS Hwabao Trust ICBC GF Fund Management BoComm SPD Bank CMB China Everbright Bank CITIC Trust Hwabao Trust China Southern AMC Bosera AMC China AMC Harvest Fund Fullgoal Fund Management E Fund Management Yinhua Fund Management China Merchants Fund HFT Investment Management Source: MoHRSS, Macquarie Research, June June

24 Pillar 3: Commercial private pensions The final Pillar in the pension system involves private pensions. These are annuity products issued by life insurance companies. Without any Government support, tax incentives or concessional treatment, this segment remains very small. However we expect supportive Government policies in the future to drive rapid growth in this segment. Size & scale Consumer takeup of private pensions is very low historically. Pillar 3 covered only ~1mn policyholders in 2013, according to CASS. Premium and assets data for private pensions are not well disclosed. At the industry level, we were unable to find any breakdown of premium or assets for annuities products. So we have made our own estimates of premiums and assets supporting annuities products. We relied principally on the available premium data provided by 5 major life players (i.e. China Life, Ping An, CPIC, NCI and Taiping). We have taken the following approach: By assuming the 5 companies combined market share of the total life industry (ie. 67% during 2013), we backsolved for overall industry annuity premiums. Whilst their market share of annuities may actually be higher or lower than its market share of other life products. We then assumed that the industry commenced selling annuities in 2003 and annuity assets were accumulated from that time. Whilst annuity assets were likely to have been very small in 2003, we do not know what they were at that time. We have assumed that all annuities are structured as deferred annuities with average ten years to retirement. Therefore calculations assume no annuitant payments have yet been made as policyholders have not yet retired as at Our estimates of assets may therefore be somewhat overstated to the extent that immediate annuities (that pay retirement income from day one) were common. Fig 31 shows these calculations. Fig 31 Estimating Pillar 3 premiums & assets (RMB billion) Aggregate annuity pension premium (the 5 life insurers) Life insurance premium as % of industry (the 5 life insurers) 47% 47% 44% 45% 66% 73% 72% 68% 69% 68% 67% Estimated annuity premium (industry total) AUM buildup Opening Assets of Pillar Income of Annuity Premium Annuity Benefit Payments Investment Income Investment yield (%) 2.7% 2.9% 3.6% 5.8% 12.2% 1.9% 6.4% 4.8% 3.5% 3.4% 5.0% Closing AUM of Annuity Pension Source: Company Data, Macquarie Research, June June

25 We estimate that total assets supporting Pillar 3 annuities was ~RMB 649bn by end This represents only 9.5% of total pension assets in China. Fig 32 illustrates the historic build-up of these annuity assets. Over the past 5 years, our estimates imply that these assets have grown at a 34% CAGR. Fig 32 Estimated assets backing private pension annuity products (RMB billion) AUM of Private Pension Source: Company Data, Macquarie Research, June 2014 Key providers Fig 33 shows our estimates of market shares of private annuity providers. China Life (RMB 50bn in annuity premium) was the clear dominant player in private annuities in Fig 33 Market shares of private annuity premium 2013 Others 33% Taiping 0% NCI 1% CPIC Life 14% China Life 46% Ping An Life 6% Source: Company data, Macquarie Research, June June

26 How annuities work A basic annuity product is fairly straightforward. It offers an accumulation phase (where premiums are aggregated towards retirements benefits) and a payout phase (where a regular annuity stream of payments is made, usually from retirement). Further complexity can arise where products offer flexibility of investment options. For example, benefits can be linked to certain asset values and unit prices and may also offer guarantees at certain points in time. Key differences in product features are therefore: Premium term: The consideration can be made as a lump sum (single premium) or via numerous ongoing contributions (regular premium). Deferral period: Retirement benefits can commence immediately (immediate annuity) or can be deferred to commence many years in the future (deferred annuities). Policy term: Duration of retirement payments can be a fixed term (fixed term annuity) or for whole of life (lifetime annuity). Investment options: Many variations exist globally. In China however, annuities typically provide guaranteed investment returns, either as participating or non-par benefits. Fig 34 illustrates cash-flows of a typical annuity pension product from the perspective of the customer. Fig 34 Policy cashflows for a typical deferred annuity product (from customer s perspective) Cash inflow POLICY STARTS Premium term Yearly/monthly annuity benefits Timeline Retirement benefit term Cash outflow RETIREMENT Single premium: large lump sum OR Yearly premium payments Source: Macquarie Research, June June

27 Assets per capita are low... Adequacy of the system In this section, we investigate the adequacy of China s pension system. Overall we conclude that the system offers good breadth of population coverage, however the depth of coverage is severely deficient in most areas. We have investigated several measures of adequacy: Assets per capita & GDP; Global comparisons; Consumer longevity risk; Replacement rates. We discuss each of these measures below. Assets per capita Assets per participant have been falling since 2010, as shown in Fig 35. In 2013, assets per pension participant (ie. excluding those not covered by the pension system) were RMB 6,645 (US$1,055). This varied widely by Pillar: Pillar 1 (Basic Pension): RMB 3,816, within which the Urban sub-pillar was RMB 8,774; Pillar 2 (employers annuity): RMB 29,353 Pillar 3 (private pensions): RMB 648,708 (based on our estimated 1mn policyholders). Overall, assets per capita/participants are low. The substantial drop in 2010 and 2011 is due to the dramatic increase of the covered population. The introduction of NRPS has been lifting the number of rural participants since 2010 without any additional asset injections. This has therefore diluted the overall assets per pension participant. This appears to have bottomed out in Fig 35 Total pension assets per pension participant Fig 36 Total pension assets per capita (ie. total population) (RMB) 8,500 8,000 7,500 7,000 6,500 6,000 5,500 6,970 7,864 8,287 5,972 5,767 6,645 (RMB) 4,500 4,000 3,500 3,000 2,500 2,000 1,500 1, ,443 1,900 2,224 2,706 3,356 4,014 5, Total Pension System Total Pension System Source: MoHRSS, Company Data, NBS, Macquarie Research, June 2014 Source: MoHRSS, Company Data, NBS, Macquarie Research, June June

28 Global comparisons of pension assets China lags developed markets... The charts below show how China s pension assets compare with other countries. Overall, China lags developed markets in comparison with both per GDP and per capita level. Considering China s very high savings rate 50.1% (relative to Japan 0.8%, Korea 3.8%, US 5.6%), China s pensions penetration is very low. Fig 37 Global pension assets per capita (2012) US$ 80,000 70,000 67,636 60,000 53,666 50,000 44,859 43,291 40,000 30,000 37,202 28,542 20,000 10,000-12,845 7,864 6,023 2, Source: Towers Watson Global Pension Assets Study, Macquarie Research, June 2014 Fig 36 shows that China s pension assets represented only 9% of GDP in 2012, well behind that of other major countries 2012 levels. Fig 38 Global pension assets as % GDP (2012) 120% 112% 108% 100% 97% 86% 80% 60% 67% 63% 56% 40% 35% 34% 20% 0% 11% 10% 10% 9% 1% 0% Source: Towers Watson Global Pension Assets Study, Macquarie Research, June June

29 Government currently assumes longevity risks Determining how much retirement costs relies on many variables. Whilst future investment returns are obviously a factor, improving mortality rates increase the risk of living longer than expected, which reduces the adequacy of pension assets. At present, the Government currently assumes all longevity risk in the Basic Pension, a situation which does not seem sustainable. As the population ages, it would seem sensible to transfer this substantial liability to private sector risk professionals, such as life insurers. We show below the substantial shortfall implied by existing assets relative to pension benefits required over a typical life expectancy. How much does a typical retiree need to fund retirement? This is obviously a deep and meaningful question, and beyond the scope of our work to truly do justice. However we have attempted a simple calculation, as summarised in Fig 37. The key inputs are: A typical 60-year-old urban retiree can expect to live until age 75 on average; He/she currently earns an annual salary of RMB 46,769; Assuming a 55% replacement rate implies annual retirement benefits of RMB 25,723; The NPV (at 5%) of these retirement benefits over 15 years is RMB 292,718. This estimate obviously rises with improving mortality (ie. longer life expectancy). Fig 39 Estimating the pension payout for a typical urban retiree For a hypothetical 60-year-old urban worker just got retired: 2012 urban average income (RMB pa) 46,769 Target replacement rate 55% Retirement benefit needed (RMB pa) 25,723 Discount rate 5.0% Life expectency 75 Age Retirement benefit (RMB) 25,723 25,723 25,723 25,723 25,723 25,723 25,723 25,723 25,723 25,723 25,723 25,723 25,723 25,723 25,723 25,723 Discount Factor PV of retirement benefits (RMB) 25,723 24,498 23,331 22,220 21,162 20,155 19,195 18,281 17,410 16,581 15,792 15,040 14,324 13,641 12,992 12,373 NPV of retirement benefits (RMB) 292,718 Source: NBS, Macquarie Research, June 2014 How much funds are available in the system? Having determined how much a typical retiree needs, we turn to how much funds are available. Assets per capita today are very low; in the Urban Basic Pension, assets per urban participant are only RMB 8,774. Whilst this is obviously a substantial shortfall relative to the value of typical retirement benefits calculated above, it overstates the problem as a retiree can also expect the workforce to make further contributions in future. Estimating the value of future workforce contributions is not straightforward. We show in later sections of this report that workforce contributions appear to be insufficient to fund the increasing number of retirees from as early as June

30 Replacement rate of income Replacement rate is a widely recognised measure of defined benefit pension adequacy relative to final-year salary. Promised retirement benefits are relatively generous... The overall replacement rate for Pillar 1 in 2011 was 42.9% according to CASS. We note several recommendations made by global organizations for adequate replacement rates for pension systems, most notably: 70% by the World Bank; and 55% by the International Labour Organization. By comparison, China s 42.9% compares poorly but does not suggest a major shortcoming. Indeed, Fig 38 shows that China s replacement rate is similar to that of USA, UK, Japan, and Korea. Fig 40 Pension replacement rates 100% 80% 60% 40% 20% 0% China Pension System Civil & State Other Urban (Pillar 1-1) (Pillar 1-2) United Kingdom United States Spain Netherlands New Zealand Italy Japan Korea France Germany Greece Canada Australia Replacement rate = compensation after retirement under pension program divided by income before retirement. Source: CASS, Macquarie Research, June 2014 However we note substantial inequity within the Basic Pension system. CASS s estimates show that the 42.9% replacement rate is an average of 80% for civil servants & state sector workers (ie. Pillar 1-1 using our labelling), whilst that of other urban employees (ie. Pillar 1-2) is only ~40%. The replacement rate as a measurement of pension adequacy makes no assessment of the ability to fund the defined benefits in the future, nor the availability of supporting assets. We have noted the asset shortfalls that exist at present. In the next section, we assess the sustainability of the system over the next decade given these shortcomings. 17 June

31 Assets spread more thinly across the population as the system expanded. Drawing on personal accounts to fund pooled benefits... Sustainability of the system In assessing the pension system s sustainability, we have focused on Pillar 1 on materiality grounds (ie. covering 820mn population and occupying 58% of assets). We also note Pillars 2 and 3 are administered largely by commercial operators who are more likely to be motivated by sustainable profits. We discuss the following issues in this section: Assets vs Liabilities: Account balances are not fully funded. Poor cashflow outlook: The workforce cannot afford to support retirees. Asset injections: Government subsidies and the NSSF backstop will only buy time. Assets vs Liabilities... Account balances are not fully funded The Urban Basic Pension system currently has insufficient assets to fund its retirement obligations. Whilst there are probably many actuarial techniques to demonstrate this point, we simply highlight that there is a RMB 173bn shortfall between available assets and individual account balances as at Dec-13. The Basic Pension is a concerning case study in inequitable practice The current Basic Pension system (i.e. Pillar 1) was first established in 1991 and was later refined in 1995 and As described above, the urban sub-pillar is by far the dominant pillar within the Basic Pension scheme, both in terms of participants and assets. As described above, this pillar comprises both a pooled scheme (known as the Social Planning fund) and Individual Accounts. As the system expanded to cover more people, no additional assets were injected and so the existing assets were spread more thinly. In the early 1990s, the pooled Social Planning fund faced a significant shortfall. There were several reasons for this shortfall: The employer contributions of several unprofitable SOEs were in arrears; In some regions, many profitable SOEs contributions were required by the government to exceed the 20% prescribed level in order to cover the arrears of others; this exacerbated the problem and put more companies into arrears. Improving mortality: Retirement ages (60 for male and 55 for female) were determined in the 1950s. Pension payments have increased as life expectancy has improved. In 1982, the average male life expectancy was 67.8; by 2012 it had risen to To compensate for the shortfall and to help fund retirement benefit obligations in the Social Planning fund, most of the assets in employees Individual Accounts were loaned to the Social Planning fund. Whilst this is clearly inequitable in isolation, we understand the Government intends to return the funds to the Individual Account holders in time. Indeed, the whole Basic Pension system appears to be premised on ongoing asset injections from the Government. In 2013, Govt subsidies comprised Rmb 302bn and have risen ~20% CAGR over the past decade (refer Appendix). These subsidies need to continue rising in order to fund the ageing population. As at Dec-13, there were RMB 2.8trn in assets residing in the Urban Basic Pension. We note CASS estimates that Individual Account balances on their own are ~RMB 3.0trn. This suggests that: A shortfall of RMB 173bn exists already; Govt injections are needed; and/or Over 100% of the retirement obligations promised in the pooled Social Planning fund will need to be funded from future workforce contributions. We address the cashflow challenges posed by this latter point in the next section. 17 June

32 Poor cashflow outlook: The workforce cannot afford to support retirees This is the crucial question for the Basic Pension, regardless of the current asset-liability position of the system. We focus our answer on the Urban Basic Pension given materiality (comprises ~90% of Pillar 1 assets) and access to data. We address two key issues: The relationship between workers and retirees; and Fewer workforce contributions relative to rising retirement benefits... The system s net cashflows. The relationship between workers and retirees We assess two ratios measuring the magnitudes of workers and retirees by population and by cashflow. Firstly, Fig 41 shows the ratio of retirees to workers, also known as the collection rate. Then Fig 41 shows the ratio of retiree benefit payments to workforce contributions. Over the past decade, both of these ratios have remained flat. However, if we look at the next decade using demographic forecasts provided by Global Demographics, we project that worker numbers and therefore workforce contributions will not keep pace with retiree numbers and their pension payments. Over the next decade, we project the collection rate rises ~1.4pts to 26.4%. Fig 41 Urban Basic Pension: Relationship between the numbers of retirees and workers 26.5% 26.0% 25.5% 25.0% 24.5% 24.0% (million) % E 2015E 2016E 2017E 2018E 2019E 2020E 2021E 2022E 2023E Urban work force under Pillar 1 Urban retiree under Pillar 1 Collection Rate 0 Note: Collection rate = proportion of population contributing monthly payments within total covered population Source: Global Demographics, MoHRSS, Macquarie Research, June 2014 Over the next decade, Global Demographics projections imply that the dependency ratio rises from 3.0 to 3.7. Overall, these projections imply that the collection rate and dependency ratio will deteriorate over the next decade as the population ages. This implies fewer contributions from workers and higher benefit payments to retirees. 17 June

33 Fig 42 Urban Basic Pension: Dependency ratio history and forecast E 2015E 2016E 2017E 2018E 2019E 2020E 2021E 2022E 2023E Note: Dependency ratio = average retiree benefit / average work force contributions. Source: Global Demographics, MoHRSS, Macquarie Research, June 2014 Cashflows to/from the Basic Pension system Fig 43 shows the income of the Urban Basic Pension. Historic cash flows have been considerable over the past decade such that 2013 cash inflows were RMB2.3trn. Fig 43 Urban Basic Pension: Income vs. Outgo (billion RMB) 2,500 30% 2,000 1,500 1, % 20% 15% Income Outgo Income Growth Outgo Growth 10% Source: MoHRSS, Macquarie Research, June 2014 The Urban Basic Pension has two main sources of income (refer Fig 44): Worker contributions: These have historically shown a steady increase at around 20%pa over the past decade to RMB 1.9trn. Looking forward, we expect this level of growth to slow as wage inflation is likely to slow (from 20%pa over the past decade) despite the number of workers continuing to rise. Government fiscal subsidy: Government subsidy has been increasing gradually over the past decade to RMB 302bn in The magnitudes of subsidies among regions differ substantially as some can afford themselves but some cannot without the government s help. These subsidies are typically funded by local government. 17 June

34 Net cashflows (RMB bn) Macquarie Research Fig 44 Urban Basic Pension: Sources of fund income (billion RMB) 2,500 2,000 1,500 1, Workers' contributions Government Fiscal Subsidy Source: MoHRSS, Macquarie Research, June 2014 Fig 45 sets out our projection of the net cashflow picture; that is, workers contributions less retiree benefits. Whilst historic cashflows do not suggest any problem, China s demographic changes imply a substantial deterioration in cashflows has commenced. Looking ahead, our projections show that outflows will continue increasing but inflow growth will start slowing down, such that the Urban Basic Pension will suffer deficits from We discuss this fully in the Quantifying the industry outlook section later in this report. Reforms to the system seem inevitable... So what can the Govt do? Importantly, our projections assume that Government subsidies remain flat from 2013 onwards. This is clearly conservative as the system seems to be entirely premised on ongoing asset injections from the Government. Rather than guess at future Govt subsidies, we have estimated how much is required for the system to remain breakeven. Based on our projections, we estimate that the Govt will be required to inject RMB 8.1trn (US$1.3trn) in order to break even over the next decade. Furthermore, the NRPS will need RMB 497bn in Govt subsidies. Whilst sales of SOE ownership stakes and asset sales may help fund these subsidies, we doubt this option is palatable. More likely, we believe reforms to the system are inevitable. Fig 45 Urban Basic Pension: Projected annual net cashflows ,000-1,500-2, E 2015E 2016E 2017E 2018E 2019E 2020E 2021E 2022E 2023E Note: The projections assume no reforms are implemented and Govt subsidies remain flat. Refer Quantifying the industry outlook section for further detail. Source: MoHRSS, Global Demographics, Macquarie Research, June June

35 Govt subsidies and the NSSF will only buy time We have pointed out above that the system suffers from a shortage of assets (ie unfunded pension liabilities) and that worker contributions will be insufficient within the next five years to meet retirement benefit payments. Many would argue that Government subsidies and the NSSF exist to pick up any shortfall. We believe this is not a sustainable solution and would only buy time. Future Government subsidies appear to be constrained Fig 44 above highlighted that Govt subsidies have comprised up to 16% of overall Urban Basic Pension contributions. Going forward, we estimate that local governments will need to increase these subsidies substantially simply to break even. Without any increase in subsidies, we forecast that Pillar1-2 net cashflows turn negative in 2017, rising to RMB 2.0trn by The financial strength of most local governments is not high and their ability to increase subsidies therefore appears limited. Fig 46 sets out the debt burdens carried by the 26 major provinces. The average outstanding debt in 2012 was RMB 413bn relative to average revenue base RMB 405bn. Fig 46 Provincial Government Fiscal Income vs. Indebtedness (2012) Indebtedness 200% 175% Chongqing Shanghai 150% 125% 100% 75% Hainan Ningxia Qinghai Beijing Hebei Jilin Shaanxi Yunnan Hunan Hubei Liaoning Guangxi Gansu Shanxi Fujian Anhui Zhejiang Jiangxi Henan Xinjiang Sichuan Shandong Jiangsu Guangdong 50% ,000 1,200 Fiscal income (RMB bn) Indebtedness = outstanding debts by 2012 / fiscal income during 2012 Source: Government data, Macquarie Research, June 2014 NSSF funds not yet large enough In addition to the fiscal subsidy from the Government, the NSSF fund pool was also established as a backstop if a shortfall were to occur in the social security system. NSSF has assets of RMB 1.1trn in This seems likely to be called upon at some stage in the next few years. However relative to RMB 2.0trn in annual net cash outflows in the Urban Basic Pension scheme alone by 2023, this is unlikely to be sufficient to fund an ageing population beyond the medium term. We conclude that neither Govt subsidies nor NSSF are a sustainable solution for the viability of the pension system. 17 June

36 Government policy Retirement income is generally a very political issue in most countries. We summarise below some of China s current policies and recent initiatives in this area. Specifically, we have looked at the following topics: Tax treatment of pensions; Pilot pension programs; Increasing the retirement age; Other recent initiatives. We discuss each of these topics below. Tax treatment of pensions We have evaluated the tax treatment of pensions by assessing the following issues: Current tax arrangements on pensions; Country comparison of tax arrangements; How valuable would tax concessions be to the consumer? Next steps. Current tax treatment of pensions in China The tax treatment of pension contributions and pension assets is currently inconsistent between Pillars. At present, the arrangements are as follows: Pillar 1 (Basic Pension): Personal contributions and employers contributions are 100% tax-deductible; Pillar 2 (Employers Annuities): Both employers contributions and employees contributions (subject to 4% ceiling of monthly salary for employees) are tax-deductible. Investment earnings are tax free. Upon retirement, benefits are taxable. Pillar 3 (Private Pensions): No tax concessions. Country comparison of tax treatment for life & pensions China is unusual in that insurance premiums and contributions to private pensions are not tax deductible. Fig 47 sets out a simple summary of taxation arrangements with regards to life & pensions in selected major countries. Fig 47 Country comparison: Do concessional tax arrangements exist for private pensions? COUNTRY ON CONTRIBUTIONS ON INVESTMENT RETURNS ON WITHDRAWALS China No No No Hong Kong Yes No Yes Japan Yes Yes Yes Korea Yes Yes No Taiwan Yes No Yes Singapore Yes Yes Yes Malaysia Yes Yes Yes Thailand Yes Yes Yes Indonesia Yes Yes Philippines No No Yes India Yes Yes No US Yes No No UK Yes Yes Yes Australia Yes Yes Yes Canada Yes Yes Yes Source: Macquarie Research, June June

37 How valuable would tax concessions be? We estimate 223m taxpayers in China... By definition, tax deductions are only valuable for those who actually pay tax. A common pushback to the notion of attractive tax deductions is that only a minority of Chinese consumers pay tax. So how many consumers pay income tax in China? Whilst data is scanty, we have tried to answer this question using a recent survey of income distribution conducted by the National Statistics Bureau (NBS). The survey was based on 65,981 urban households and 73,750 rural households. Whilst this represents only 0.03% of the total population, NBS selected the data based on 95% confidence interval for <3% error. Cities were categorized into 3 tiers and sample sizes were based on population. So whilst the survey is skinny, we think the sampling error in applying this data to the national population should only be modest. The results of this survey are set out in Fig 48, which shows annual income per capita, average household size and average number of employed persons per household for seven urban income groups and five rural groups. Fig 48 Income per capita statistics by region and income groups Geography & income category Annual income Avg household Avg employed Annual income per per capita size per household employed person (RMB) (# people) (# people) (RMB) URBAN Lowest 10% 9, ,199 Low 10% 13, ,795 Lower middle 20% 18, ,909 Middle 20% 24, ,411 Upper middle 20% 32, ,501 High 10% 43, ,770 Highest 10% 69, ,450 Subtotal - Urban 26, ,747 RURAL Low 20% 4, ,367 Low middle 20% 6, ,009 Middle 20% 9, ,358 Upper middle 20% 13, ,742 High 20% 25, ,694 Subtotal - Rural 11, ,034 TOTAL CHINA (estimated) 19, ,521 Source: NBS, Macquarie Research, June 2014 From these statistics, we can calculate annual income per employed person. The total nationwide income per employed person is the weighted average of all income groups in both urban and rural areas. We have set out the results in Fig 49, which shows average incomes for each income category. We have also shown how these income bands compare with the RMB 42,000 annual income tax-paying threshold. We note that even the highest-earning 10% of rural workers remains on average below the tax-paying threshold. However 4 of the12 income groups earn more than the tax-paying threshold. We attempt to quantify the population within these four groups. 17 June

38 Annual income (RMB) Macquarie Research Fig 49 Average incomes for each geography / income grouping 120, ,000 80,000 60,000 40,000 20,000 0 RURAL: low 20% RURAL: low middle 20% RURAL: middle 20% RURAL: upper middle 20% RURAL: high 20% URBAN: lowest 10% URBAN: low 10% URBAN: lower middle 20% URBAN: middle 20% URBAN: upper middle 20% URBAN: high 10% URBAN: highest 10% RURAL URBAN income group tax-paying income threshold Source: China Statistical Yearbook 2013, NBS, Macquarie Research, June 2014 Our next step was to apply this data to the national working population. We have divided the workforce population (of 767mn in 2012) into the 12 income groups by assuming an urban workforce population 371mn and rural workforce population 396mn (source: NBS). Fig 50 shows our estimated breakdown of the population by geography & income, as well as the average income for each group. Fig 50 China workforce population by income group (767m workers in 2012) RURAL: avg annual income RMB 18 '000s 79mn RURAL: avg annual income RMB 32 '000s 79mn URBAN: Avg annual income RMB 23,000 37mn URBAN: Avg annual income RMB 29,000 37mn URBAN: Avg annual income RMB 36,000 74mn RURAL: avg annual income RMB 13 '000s 79mn URBAN: Avg annual income RMB 46,000 74mn RURAL: avg annual income RMB 10 '000s 79mn RURAL: avg annual income RMB 7 '000s 79mn URBAN: Avg annual income RMB 111,000 37mn Source: China Statistical Yearbook 2013, Macquarie Research, June 2014 URBAN: Avg annual income RMB 60,000 74mn URBAN: Avg annual income RMB 75,000 37mn From here, we estimate that there were ~223mn urban workers incurring income tax liabilities in This is the sum of the four highest-earning income groups above, and equates to 60% of the urban work force (371mn) and 29% of the national workforce (767m). We believe this is a materially high number of workers who would find a tax deduction for their pension contributions of value. 17 June

39 Next steps Rectifying an uneven playing field... Working for longer would help fund the Basic Pension On the other hand, some The absence of tax incentives in Pillar 3 is an obstruction to the development of the private pension market as the tax incentives offered under Pillars 1 and 2 make these relatively more attractive. Pillar 1 is also mandatory for many employees. The private pensions industry (ie. life insurers) has long awaited the tax-deferred pension pilot program to commence in Shanghai. We have no knowledge of the timeframe for this initiative (nor even if the pilot program will go ahead). However we do expect harmonisation of tax arrangements for Pillar 3 to occur at some stage. As shown above, we observe that tax concessions on pension contributions and assets are common across Asia and in most developed markets around the world. We expect similar policies to be introduced in China at some point in the near future. This intention was made clear by senior policymakers after the Plenum session in November In this regard, the estimated 223m tax-incurring population would provide substantial demand for the private pensions sector. Pilot pension programs We discussed above the unfunded liabilities of the Urban Basic Pension, where Individual Accounts were loaned to the Social Planning fund in order to fund near-term retirement benefit payments. Several pilot pension programs have been conducted across China over the past years designed to address this shortfall and unfunded liabilities of the Urban Basic Pension. These programs have not been successful. In 2001, Liaoning province prohibited the reallocation of assets from Individual Accounts into Social Planning pools. This served to highlight that the inflows from contributions alone were insufficient to fund retirement benefit outgoes. 13 other provinces have since attempted a similar exercise. The government originally planned to implement the reform to all provinces gradually, however none of these pilot programs solved the shortfall. Since that time, the Urban Basic Pension appears to have resumed operating as a mixed pool, in that it does not seem to distinguish Individual Accounts from the Social Planning fund. This remains a critical issue for the sustainability of the pension system in China. Increasing the retirement age The Ministry of Human Resources and Social Security (MoHRSS) is currently working with Chinese Academy of Social Sciences (CASS) and university scholars to propose new policies that increase the retirement age from 60 to 65. We note this would be consistent with trends in many countries around the world. This would help mitigate the funding stress in the Basic Pension. On the other hand, some have expressed concerns about social equity and the impact on the unemployment rate of younger workers. If approved, the Government is likely to start with a gradual increase of the retirement age rather than an instant 5-year increase. The formal document would not likely be released until Later in this report (refer Quantifying the industry outlook section), we consider the impact of this initiative in our projections of total pension assets over the next decade. 17 June

40 Insurance stocks rocketed after the 2013 Plenum session Hopes are that tax concessions will incentivise more employers to participate in EA market. Other recent initiatives 2013 Plenum session of the CPC In November 2013, the most senior political figures in China gathered for the Third Plenum session in Beijing to discuss major national issues. Historically this forum has determined the direction of long-term reforms in China. Following the Plenum session, a document was released summarising the discussions. There were several initiatives relating to reforms in the pensions system by 2020, which we summarise below: In the Basic Pension, actuarial projections will be incorporated into the determination of contribution rates required to fund the Social Planning fund and Individual Account; In the Basic Pension, reforms to solve the inequity issue; In the Basic Pension, NRPS to merge with other smaller pension schemes; In the NSSF, promote diversified and market-oriented investment and operation; Develop EA and private pensions, specifically using tax incentives; Gradual delay of retirement age. We note several of these initiatives have already been either implemented or further details have been proposed. We expect ongoing newsflow on this theme which will act as a positive catalyst for insurance stocks. Looking ahead, however, there is no clear timeframe for reforms. Establishing milestones is therefore difficult as much of the discussion is not made public. However we note the following meetings of senior politicians scheduled for 2014: Executive meetings of the State Council (usually held on weekly basis); The Central Economic Working Conference (usually held in December); The Comprehensive Deepen Reform Leading Group Meetings (6 th June). Urban and rural residents unified Basic Pension On 7 February, 2014, the State Council announced that NRPS would combine with all other Basic Pensions to form the new Urban and Rural Residents Uniformed Basic Pension. Very few details have been made public about this proposal. EAs receive tax concessions On 6 December 2013, MoF, MoHRSS, and State Administration of Taxation released a document entitled Circular About Individual Income Tax of Enterprise and Occupational Pension Schemes (EOPS), in which they announced several new tax initiatives for the EA market. The new initiatives were implemented on 1 st June 2014 and included the following tax concessions for employees: Employee's contribution will be tax deductible: EA participants will enjoy tax deduction for their contribution to the schemes. This tax deduction is subject to a 4% ceiling of participants' monthly salary. Previously, employees had to contribute from post-tax income. Recognition of employer contribution: Previously the employer's contribution to the scheme was regarded as part of personal income and taxed accordingly. Going forward, the employer's contribution will be deductible from individual income tax. Investment earnings tax fee: The Circular also specified that investment return of EA funds will be tax deductible. Previously this was a gray area. EOPS participants will pay individual income tax when they receive scheme benefit in the future. Taxed upon drawdown (ie. Lump sum benefit at retirement): Previously, EA retirement benefits were not taxed. Withdrawals will now be taxed. This new tax deferral treatment makes EA more beneficial to all participants. The government hopes that this new measure will provide greater incentives for employers other than SOE to participate in EA market. 17 June

41 Whilst we doubt the impact of assets inflow will be material to insurers' earnings in the near term, we believe the insurance sector is well placed to benefit in the longer term as the natural manager and administrator of EA funds. We think the tax incentive policy reflects the government's resolution of using commercial solutions to complement insufficient social security coverage. We believe the next step is to give tax incentives to insurance retirement products. Reform initiatives of Civil Servants and State Sector Workers In April 2014, State Council initiated a process to commence reforms in the social security provided to civil servants and state workers. Whilst details have not been confirmed yet, we understand these reforms seek to establish a system of formal contributions for state sector workers (not yet for civil servants). This would therefore operate in a similar fashion to the Urban Basic Pension. Whilst there are concerns that some employers will not be able to afford the additional expense, we see this initiative as another indication that the Government intends to reform the pension system. Reverse mortgages? Reverse mortgages have gained mixed traction in various markets around the world as an alternative pension product allowing retirees access to income without the need to sell the family home. A reverse mortgage is an insurance contract that uses the equity in a policyholder s property as collateral to finance an annuity income in retirement. Typically the insurer claims the property after the policyholder dies. The State Council has promoted reverse mortgage as a pension alternative since September CIRC announced in June 2014 that a reverse mortgage pilot program would be implemented in four major cities: Beijing, Shanghai, Guangzhou, and Wuhan. Not likely to suit Chinese culture: Most Chinese typically prefer to let their children inherit their property rather than use it as reverse mortgage. As a result, despite being a relatively hot topic last year, we doubt this initiative attracts much customer interest. On the other hand, non-consensus on the value of some properties built in early years and ownership issue (urban individuals in China only have 70-year of usufructs instead of permanent ownerships on their properties) make trading harder, further preventing the program being widely adopted. 17 June

42 How insurers participate The current pension-related activities of life insurers are currently undertaken within Pillars 2 and 3, which represents a relatively small percentage of Chinese life insurers operations and profits. Considering retirement products are typically core business for life insurers in developed markets, this market segment offers a substantial growth opportunity to Chinese insurers in future. In this section, we discuss the current activities and potential additional activities that insurers undertake in each of Pillars 1, 2 and 3. Pillar 1: Basic Pension Currently the Basic Pension is entirely administered and managed by MoHRSS. We expect that the large asset management operations of the insurance companies could increasingly receive mandates to manage some of these funds. This outsourcing to the private sector would be consistent with the investment management of Govt-provided pension funds in many developed markets. Pillar 2: Employers Annuities (EA) Pension insurers are active participants Five of the listed insurance companies have a pension subsidiary operating in the EA marketplace. These five subsidiaries are: China Life Pension; Ping An Pension; Changjiang Pension (subsidiary of CPIC); China Taiping Pension; Taikang Pension. NCI does not currently conduct EA business whilst it awaits CIRC approval of New China Life Pension. The core business of these pension companies is EA. This is distinct from the commercial private pensions business which is carried out by life insurance companies in Pillar 3. Fig 51 sets out the history of asset growth over the past 5 years. The EA assets of these 5 pension companies have risen rapidly to RMB 250bn by 2013 and account for 41% of the total EA assets. China Life is the largest player (RMB 102bn by 2013). Fig 51 EA assets: 5 EA pension insurers vs. Others (RMB billion) Source: CIRC, Macquarie Research, June EA pension insurers others EA providers 17 June

43 Pillar 3: Private pensions & annuity products All life companies in China offer annuities as part of their overall product suite, distributed via agents, bank branches and group channels. Presently, annuities account for a relatively small component of life companies total business. Fig 52 shows our estimates that the contribution from annuities products has been steadily rising in recent years. In 2013 we estimate that annuities delivered ~9% to premiums and assets. The low composition of annuities is mostly due to the lack of incentives associated with these products. Going forward, we expect tax arrangements to be harmonised across all Pillars of the pension system such that private pensions also attract favourable tax treatment. This was discussed more fully in the prior section Government Policy. Fig 52 Pillar 3: Estimated contribution of annuities products to industry assets & premiums 12.0% 10.0% 8.0% 6.0% 4.0% 2.0% 0.0% AUM Premium Source: Company data, Macquarie Research, June 2014 What sort of profit margins do annuities earn? Margins on pensions are unclear None of the companies provide information on the profitability of their annuities books. Common opinion is that annuities are a low margin product. This is not necessarily the case in China, where profit margins depend on the actual benefits provided. In the case of a fixed term annuity, profits are largely generated from an investment spread. In China, these products are generally structured as participating annuities. As such, we believe that participating annuities generate similar margins to par endowments, where investment spreads are typically a healthy ~90bp per annum. In the case of a lifetime annuity, where the company assumes the longevity risk, a profit margin for mortality risk is also built into the pricing. As such, we believe both fixed-term and lifetime annuities offer reasonable margins. Ultimately however, the returns & profitability available in the private pensions market in the future will depend entirely on the type of product offered. It is also not clear, however, what sort of pensions products will attract Govt incentives in the future. If the product offerings migrate towards fee-based, defined-contribution savings plans (which seem most likely to us), we would expect lower margins than guaranteed lifetime annuities. Furthermore, in a tax-advantaged system, we would not expect sustainable returns to be significantly more than the cost of equity. 17 June

44 Pensions as % total premiums Macquarie Research Putting it all together Whilst the companies do not segment their pensions activities, we have estimated the contribution to each company from pensions activities, including both Pillars 2 and 3. The business contribution from pensions is still low Given we do not know the profit contribution of either EA or private annuities, and EA business generates fee revenues (as opposed to investment spreads on annuities), it is difficult to quantify the contribution of these businesses on a like-for-like basis. Fig 53 shows the 2013 premiums/inflows received by each company in both EA and private annuity activities. We have then expressed this as a percentage of total life and annuity (including EA) premiums to assess the relevance of pensions to each company. Fig 54 shows that the listed companies generated 1-22% of premium revenues from the pensions business in FY13, and the order of pensions exposure (from highest to lowest) was: China Life, CPIC, Ping An, Taiping, PICC L&H, NCI. Overall we consider these contributions relatively low in a long-term sense, and we expect the contributions from pensions to rise substantially over the next decade. In the next section, we forecast the scale of each company s pension activities in both Pillar 2 and 3, and also estimate the value of these pension businesses. Fig 53 Pillars 2 & 3 (ie. EA & private annuity premiums): Exposure of listed insurers (2013) Fig 54 Pensions as % of total life & pensions inflows (2013) (RMB million) 80,000 70,000 60,000 50,000 40,000 30,000 20,000 10,000 25% 20% 15% 10% 5% 0 China Life Ping An CPIC PICC L&H Taiping NCI 0% China Life CPIC Ping An Taiping PICC L&H NCI Private annuity (Pillar 3) Employer's annuity (Pillar 2) Private annuity (Pillar 3) Employer's annuity (Pillar 2) Note: PICC is estimated based on its life market share. Source: Company data, CIRC, Macquarie Research, June 2014 Note: Denominator includes premium from life, private annuities and EA. Source: Company data, CIRC, Macquarie Research, June June

45 Substantial growth potential, driven largely by the private sector Quantifying the industry outlook In this section we have projected total assets in China over the next decade for each Pillar of the pension system. This not only highlights where we see the growth coming from in the future, it highlights where the main pressures will arise. We have also set out a rough valuation of this business opportunity for each of the six listed life insurers. Overview We have based all of our projections on the format of data provided annually by MoHRSS for each Pillar. We have also relied on the demographic projections by our colleagues and Global Demographics described earlier. Given the inherent uncertainty of Govt policy, we have established two scenarios to form a range of estimates. These scenarios can be described as follows: Status quo scenario; and Reforms scenario. Status quo scenario: Pension assets rise 88% to RMB 10.2trn In our status quo scenario, we assume no material reforms are made and the pension system continues under the current structure. We project total pension assets grow to RMB 10.2trn by Whilst this implies 10Y CAGR 6.5%, Fig 55 shows that assets actually start to fall. Fig 55 Status quo scenario: Pension assets projected to 2023 (bn RMB) 21,000 18,000 15,000 12,000 9,000 6,000 3, E 2015E 2016E 2017E 2018E 2019E 2020E 2021E 2022E 2023E Basic Pension (includes NSSF) Employers Annuity Private Pension Total Pension Growth 20% 15% 10% 5% 0% Source: MoHRSS, CIRC, Company Data, Global Demographics, National Council for Social Security Fund, Macquarie Research, June 2014 Reforms scenario: Pension assets rise 477% to RMB 31.4trn In our reforms scenario, we assume that a series of reasonably likely reforms are implemented. The reforms that we have considered are all discussed earlier in this report and include: Tax incentives on private pensions are implemented prompting strong takeup ; Recent tax concessions in EA promote greater participation by employers and greater engagement by employees; Retirement age is increased to 65 (from 60 currently); Insurance companies become more proactive at developing and marketing retirement income products; Government promotions aimed at encouraging more contributions, particularly voluntary contributions; Consumers gradually become more aware of the need to save for retirement. 17 June

46 Under the reforms scenario, we project that total pension assets grow at a 19.2% 10Y CAGR to RMB 31.4trn by Fig 56 shows that the bulk of our projected growth will emerge in private pensions. Full detail of the assumptions underpinning our projections for each Pillar is set out in the Appendix. Fig 56 Reforms scenario: Pension assets projected to 2023 (bn RMB) 35,000 30,000 25,000 20,000 15,000 10,000 5,000 20% 15% 10% 5% E 2015E 2016E 2017E 2018E 2019E 2020E 2021E 2022E 2023E Basic Pension (includes NSSF) Employers Annuity Private Pension Total Pension Growth 0% Source: MoHRSS, CIRC, Company Data, Global Demographics, National Council for Social Security Fund, Macquarie Research, June 2014 A description of our projection for each major Pillar is set out below. Basic Pension (Pillar 1) We have developed projections at the sub-pillar level considering the Urban Pension, NRPS and NSSF. The charts above include NSSF in the Basic Pension given their inter-reliance. We have ignored the Basic Pension provided to civil servants on materiality and transparency grounds. Govt subsidies comprise a major contribution to Basic Pension funds. Whilst this item is difficult to forecast, we acknowledge that the system is premised on ongoing injections of State funds. We estimated earlier in the report that the Govt will be required to inject an aggregate of RMB 8.6trn over the next 10 years in order to break even. For the purposes of our projection, we have assumed that future Govt subsidies are flat hereon. Under the Status quo Scenario, our projections imply that assets decrease by 82% to RMB 558bn by We have adopted the following key assumptions: Urban Basic Pension: Growth in average contributions slows from 9.8% but remains high in line with wage inflation. Growth in retirement benefits per capita remains flat at 11% level. NRPS: Growth in average contributions is zero given low wages in rural areas and most people contribute the bare minimum at present. Growth in retirement benefits per capita remain flat at 2.5%. Under the Reforms Scenario, we project assets will grow 162% to RMB 8.2trn by We have adopted the following assumptions: Urban Pension: Growth in average contributions remains high as voluntary contributions pick up. Growth in retirement benefits falls from 11%pa level as consumers migrate towards EA and private pensions. NRPS: Growth in average contributions remains steady at 10%. Growth in average retirement benefits continues at 5%pa. 17 June

47 Urban Basic Pension has major cashflow pressures without Govt injections Earlier in this report (refer Sustainability of the System section), we highlighted the substantial cashflow shortfall facing the Urban Basic Pension (refer Fig 44 on page 35). This was based on our Status quo scenario. Fig 57 shows how this shortfall is somewhat addressed under our reforms scenario. Specifically, lifting the retirement age to 65 from 60 means more workforce contributions and lower retirement benefit payments. In any event, this initiative only delays the cashflow threat of an ageing population. We think the only sustainable alternative for the Government is to better promote and incentivise people to take up private pensions. Fig 57 Macquarie Projections: Net Annual Cash-flows of Pillar 1-2 (bn RMB) ,000-1,500-2, E 2015E 2016E 2017E 2018E 2019E 2020E 2021E 2022E 2023E Reforms Scenario Status quo Scenario Source: MoHRSS, Global Demographics, Macquarie Research, June 2014 Employers Annuity (Pillar 2) Under the status quo scenario, we project assets will grow 381% to RMB 2.9trn by We expect the recently-introduced tax concessions to drive consumer demand. We assume EA will cover 55% of SOE employees and 25% of multi-national corporate employees by Under the reforms scenario, we project assets will grow 975% to RMB 6.5trn by In this case we assume additional multi-national corporates join the EA. We assume EA covers 100% of SOE employees and 50% of multi-national corporate employees by 2023 (representing 7.5% and 5% growth pa respectively). Private pensions (Pillar 3) Under our status quo Scenario, we project assets will grow 248% to RMB 2.3trn by We forecast that the market experiences only moderate growth (13% CAGR) whilst private pensions operate at a competitive disadvantage (ie. no tax breaks). Under our reforms Scenario, we project assets will grow 1781% to RMB 12.2trn by On our numbers, private pension assets will comprise 39% of total pension system assets by This relies on policymakers aligning tax treatment of contributions with that of Pillars 1 and 2. We also suspect that funding and inequity issues in the Basic Pension will become increasingly concerning to an ageing population. 17 June

48 Quantifying the impact on insurers Setting out a rough valuation framework.. Whilst very difficult to be definitive about the economics of such a fledgling industry, we have attempted to value the pension businesses that we expect the insurers to build over the next 10 years. This is necessarily rough but we think provides an indication of the potential value in expanding pension operations. We have taken the following approach: We apportion the 2023 projected assets to each listed insurer. We assume market shares consistent with current market shares, with some allowance for new licenses to be issued in the future (eg. NCI is awaiting EA license; we assume NCI gathers 3% share by 2023). We have undertaken this for Pillar 2 and Pillar 3 separately, and then aggregated. In this regard, our estimates ignore any involvement in the Basic Pension (eg. if investment management mandates were to be awarded to the insurers asset mgmt companies). We assume that profit margins on EA are 30bp of assets (post tax) and private commercial pensions offer higher margins at 50bp, both of which we consider to be low margin. We have then conservatively capitalised these profits at 15x PER and discounted back to today at 11%. We have allowed for minority stakes in the life and pension companies. Fig 58 shows that these rough valuations sum to over US$50bn, comprising 10-37% of current market caps for the six listed life insurers. Over 80% of this valuation is in respect of private pensions sold in Pillar 3. Fig 58 Quantifying the potential valuation impact on the listed life insurers RMB bn unless stated China Life CPIC Ping An Taiping PICC L&H NCI SUBTOTAL Pillar 2: Employers' Annuity Market share of assets (Dec-13) 17% 6% 12% 5% 0% 0% 40% AUM (Dec-13) Market share of assets (assumed, 2023) 17% 6% 12% 5% 4% 3% 47% AUM (projected, 2023) 1, ,031 NPAT (at 30bp profit margin) Capitalisation factor (15x, net of 10Y discounting) 5.9x 5.9x 5.9x 5.9x 5.9x 5.9x Ownership stake 92% 52% 100% 100% 100% 100% Valuation today (RMB bn) Valuation today (US$bn) Pillar 3: Private pensions Market share of premium (Dec-13) 46% 14% 6% 1% 7% 1% 75% Estimated AUM (Dec-13) Market share of assets (assumed, 2023) 46% 14% 6% 1% 7% 1% 75% AUM (projected, 2023) 5,563 1, ,194 NPAT (at 50bp profit margin) Capitalisation factor (15x, net of 10Y discounting) 5.9x 5.9x 5.9x 5.9x 5.9x 5.9x Ownership stake 100% 98% 100% 75% 100% 100% Valuation today (RMB bn) Valuation today (US$bn) PENSIONS VALUATION (US$bn) as % of current market cap 37% 28% 10% 30% 28% 11% 25% Source: Macquarie Research, June June

49 17 June Appendix: Projections of pension assets Fig 59 Urban Basic Pension assets (Pillar 1-2): Macquarie projection of Status quo scenario Status quo Scenario E 2015E 2016E 2017E 2018E 2019E 2020E 2021E 2022E 2023E (1) Work Force (mn) (2) Retiree (mn) (3) Urban Population % 42% 43% 44% 46% 47% 48% 50% 51% 53% 56% 57% 58% 59% 60% 61% 62% 63% 64% 65% 66% (4) (5) (6) = (1)*(3)*(4) (7) = (2)*(3)*(5) (8) (9) (10) (11) Urban Work Force Participation Rate Urban Retiree Participation Rate Work Force under Pillar 1-2 (mn) Retiree under Pillar 1-2 (mn) Avg Benefit to Retiree (RMB pa) Avg Contribution by Work Force (RMB pa) Retirement Benefit Grow th Average Contribution Grow th 38% 40% 41% 42% 44% 45% 47% 50% 52% 54% 56% 58% 60% 62% 64% 66% 68% 70% 72% 74% 61% 60% 60% 60% 61% 62% 67% 73% 74% 75% 76% 77% 78% 79% 80% 81% 82% 83% 84% 85% (8,535) (9,251) (10,565) (12,041) (13,933) (15,316) (16,741) (18,701) (20,900) (22,970) (25,496) (28,301) (31,414) (34,870) (38,705) (42,963) (47,689) (52,935) (58,758) (65,221) 2,927 3,287 3,690 4,277 4,833 5,373 5,726 6,472 7,165 7,707 8,463 9,271 10,133 11,050 12,022 13,050 14,134 15,271 16,462 17, % 8.4% 14.2% 14.0% 15.7% 9.9% 9.3% 11.7% 11.8% 9.9% 11.0% 11.0% 11.0% 11.0% 11.0% 11.0% 11.0% 11.0% 11.0% 11.0% 12.0% 12.3% 12.3% 15.9% 13.0% 11.2% 6.6% 13.0% 10.7% 7.6% 9.8% 9.6% 9.3% 9.1% 8.8% 8.6% 8.3% 8.1% 7.8% 7.6% (12) Opening AUM ,253 1,537 1,950 2,394 2,815 3,200 3,515 3,730 3,841 3,809 3,589 3,082 2, (13) = (6)*(9) /1000 Contribution by Work Force (RMB bn) ,111 1,396 1,647 1,863 2,263 2,613 3,005 3,445 3,932 4,469 5,053 5,694 6,395 7,158 (14) Govt Subsidy (RMB bn) (15) = (13)+(14) Fund Income (RMB bn) ,118 1,306 1,623 1,912 2,165 2,565 2,915 3,307 3,747 4,234 4,771 5,355 5,996 6,697 7,460 (16) = (7)*(8) /1000 (17) = (15)+(16) Fund Outgo (RMB bn) (350) (404) (490) (597) (739) (889) (1,056) (1,277) (1,556) (1,847) (2,287) (2,722) (3,225) (3,778) (4,412) (5,136) (5,998) (6,984) (8,128) (9,456) Net Cash-flow (RMB bn) Note: Shaded represents assumptions that are varied between the two scenarios. Source: Global Demographics, MoHRSS, Macquarie Research, June (31) (178) (365) (643) (987) (1,431) (1,995) (18) Investment Yield (%) 2.7% 4.4% 3.1% 3.3% 3.9% 3.1% 2.8% 4.3% 4.5% 4.3% 3.8% 3.8% 3.8% 3.8% 3.8% 3.8% 3.8% 3.8% 3.8% 3.8% (19) (20) = (12)+(17)+(19) Investment Return (RMB bn) Closing AUM (RMB bn) ,253 1,537 1,950 2,394 2,815 3,200 3,515 3,730 3,841 3,809 3,589 3,082 2, (1,097) AUM Growth 36% 36% 35% 34% 26% 23% 27% 23% 18% 14% 10% 6% 3% -1% -6% -14% -28% -61% -227%

50 17 June Fig 60 Urban Basic Pension assets (Pillar 1-2): Macquarie projection of Reforms scenario Reforms Scenario E 2015E 2016E 2017E 2018E 2019E 2020E 2021E 2022E 2023E (1) Work Force (mn) (2) Retiree (mn) (3) Urban Population % 42% 43% 44% 46% 47% 48% 50% 51% 53% 56% 57% 58% 59% 60% 61% 62% 63% 64% 65% 66% (4) (5) (6) = (1)*(3)*(4) (7) = (2)*(3)*(5) (8) (9) (10) (11) Urban Work Force Participation Rate Urban Retiree Participation Rate Work Force under Pillar 1-2 (mn) Retiree under Pillar 1-2 (mn) Avg Benefit to Retiree (RMB pa) Avg Contribution by Work Force (RMB pa) Retirement Benefit Grow th Average Contribution Grow th 38% 40% 41% 42% 44% 45% 47% 50% 52% 54% 56% 58% 60% 62% 64% 66% 68% 70% 72% 74% 61% 60% 60% 60% 61% 62% 67% 73% 74% 75% 76% 77% 78% 79% 80% 81% 82% 83% 84% 85% (8,535) (9,251) (10,565) (12,041) (13,933) (15,316) (16,741) (18,701) (20,900) (22,970) (25,496) (28,250) (31,245) (34,494) (38,012) (41,814) (45,911) (50,319) (55,049) (60,113) 2,927 3,287 3,690 4,277 4,833 5,373 5,726 6,472 7,165 7,707 8,463 9,284 10,175 11,141 12,189 13,322 14,548 15,872 17,300 18, % 8.4% 14.2% 14.0% 15.7% 9.9% 9.3% 11.7% 11.8% 9.9% 11.0% 10.8% 10.6% 10.4% 10.2% 10.0% 9.8% 9.6% 9.4% 9.2% 12.0% 12.3% 12.3% 15.9% 13.0% 11.2% 6.6% 13.0% 10.7% 7.6% 9.8% 9.7% 9.6% 9.5% 9.4% 9.3% 9.2% 9.1% 9.0% 8.9% (12) Opening AUM ,253 1,537 1,950 2,394 2,815 3,200 3,523 4,055 4,567 5,051 5,494 5,859 6,128 6,273 (13) = (6)*(9) /1000 Contribution by Work Force (RMB bn) ,111 1,396 1,647 1,863 2,263 2,617 3,074 3,538 4,058 4,641 5,289 6,025 6,848 7,769 (14) Govt Subsidy (RMB bn) (15) = (13)+(14) (16) = (7)*(8) /1000 (17) = (15)+(16) Fund Income (RMB bn) ,118 1,306 1,623 1,912 2,165 2,565 2,919 3,376 3,840 4,360 4,943 5,591 6,326 7,150 8,071 Fund Outgo (RMB bn) (350) (404) (490) (597) (739) (889) (1,056) (1,277) (1,556) (1,847) (2,287) (2,717) (2,979) (3,481) (4,050) (4,692) (5,436) (6,280) (7,238) (8,325) Net Cash-flow (RMB bn) (88) (254) (18) Investment Yield (%) 2.7% 4.4% 3.1% 3.3% 3.9% 3.1% 2.8% 4.3% 4.5% 4.3% 3.8% 3.8% 3.8% 3.8% 3.8% 3.8% 3.8% 3.8% 3.8% 3.8% (19) Investment Return (RMB bn) (20) = Closing AUM (RMB (12)+(17)+(19) bn) ,253 1,537 1,950 2,394 2,815 3,200 3,523 4,055 4,567 5,051 5,494 5,859 6,128 6,273 6,258 AUM Growth 36% 36% 35% 34% 26% 23% 27% 23% 18% 14% 10% 15% 13% 11% 9% 7% 5% 2% 0% Note: Shaded represents assumptions that are varied between the two scenarios. Source: Global Demographics, MoHRSS, Macquarie Research, June 2014

51 17 June Fig 61 NRPS assets (Pillar 1-3): Macquarie projection of Status quo scenario Status quo Scenario E 2015E 2016E 2017E 2018E 2019E 2020E 2021E 2022E 2023E (1) % Rural Population Covered 15% 51% 75% 78% 78% 78% 78% 78% 78% 78% 78% 78% 78% 78% (2) % Retiree Participants 28% 26% 27% 27% 28% 28% 29% 29% 30% 30% 30% 30% 30% 30% (3) Urban Population % 50% 51% 53% 56% 57% 58% 59% 60% 61% 62% 63% 64% 65% 66% (4) = 1 - (3) Rural Population % 50% 49% 47% 44% 43% 42% 41% 40% 39% 38% 37% 36% 35% 34% (5) Total Population (mn) 1,341 1,347 1,352 1,357 1,364 1,371 1,378 1,385 1,391 1,395 1,399 1,403 1,408 1,412 (6) = (4)*(5) Rural Population (mn) (7) = (1)*(6) Number of Participants (mn) (8) = (7)*(2) Number of Retirees (mn) (9) = (7)-(8) Number of Non-retirees (mn) (10) Opening AUM (RMB bn) ,056 1,197 1,343 1,496 (11) = (12)+(14) Income (RMB bn) (12) Growth of Avg Contribution (%) -43% -2% 5% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% (13) Avg Individual Contribution (RMB) (14) = (13)*(9) Individual Contribution (RMB bn) (15) Inflation Factor (16) Govt Subsidy (RMB bn) (14) = (16)*(8) Outgo (RMB bn) (20) (60) (115) (135) (101) (102) (106) (106) (109) (110) (110) (110) (110) (110) (15) Growth of Avg Retirement Benefit (%) -2% 29% 11% 2.5% 2.5% 2.5% 2.5% 2.5% 2.5% 2.5% 2.5% 2.5% 2.5% (16) Avg Retirement Benefit (RMB) (699) (684) (880) (979) (1,004) (1,029) (1,054) (1,081) (1,108) (1,135) (1,164) (1,193) (1,223) (1,253) (17) = (11)-(14) Net Cash-flow (RMB bn) (18) Investment Return & Others (RMB bn) (19) Assumed Investment Yield (%) 3.0% 3.0% 3.0% 3.0% 3.0% 3.0% 3.0% 3.0% 3.0% 3.0% 3.0% (20) = (10)+(17)+(18) Closing AUM (RMB bn) ,056 1,197 1,343 1,496 1,655 AUM Growth 191% 87% 34% 38% 28% 22% 19% 16% 15% 13% 12% 11% 11% Note: Shaded represents assumptions that are varied between the two scenarios. Source: Global Demographics, MoHRSS, Macquarie Research, June 2014

52 17 June Fig 62 NRPS assets (Pillar 1-3): Macquarie projection of Reforms scenario Reforms Scenario Note: Shaded represents assumptions that are varied between the two scenarios. Source: Global Demographics, MoHRSS, Macquarie Research, June E 2015E 2016E 2017E 2018E 2019E 2020E 2021E 2022E 2023E (1) % Rural Population Covered 15% 51% 75% 78% 78% 78% 78% 78% 78% 78% 78% 78% 78% 78% (2) % Retiree Participants 28% 26% 27% 27% 28% 28% 29% 29% 30% 30% 30% 30% 30% 30% (3) Urban Population % 50% 51% 53% 56% 57% 58% 59% 60% 61% 62% 63% 64% 65% 66% (4) = 1 - (3) Rural Population % 50% 49% 47% 44% 43% 42% 41% 40% 39% 38% 37% 36% 35% 34% (5) Total Population (mn) 1,341 1,347 1,352 1,357 1,364 1,371 1,378 1,385 1,391 1,395 1,399 1,403 1,408 1,412 (6) = (4)*(5) Rural Population (mn) (7) = (1)*(6) Number of Participants (mn) (8) = (7)*(2) Number of Retirees (mn) (9) = (7)-(8) Number of Non-retirees (mn) (10) Opening AUM (RMB bn) ,151 1,326 1,515 1,718 (11) = (12)+(14) Income (RMB bn) (12) Growth of Avg Contribution (%) -43% -2% 5% 10.0% 10.0% 10.0% 10.0% 10.0% 10.0% 10.0% 10.0% 10.0% 10.0% (13) Avg Individual Contribution (RMB) (14) = (13)*(9) Individual Contribution (RMB bn) (15) Inflation Factor (16) Govt Subsidy (RMB bn) (14) = (16)*(8) Outgo (RMB bn) (20) (60) (115) (135) (104) (107) (113) (117) (123) (127) (130) (133) (136) (140) (15) Growth of Avg Retirement Benefit (%) -2% 29% 11% 5.0% 5.0% 5.0% 5.0% 5.0% 5.0% 5.0% 5.0% 5.0% 5.0% (16) Avg Retirement Benefit (RMB) (699) (684) (880) (979) (1,028) (1,079) (1,133) (1,190) (1,250) (1,312) (1,378) (1,447) (1,519) (1,595) (17) = (11)-(14) Net Cash-flow (RMB bn) (18) Investment Return & Others (RMB bn) (19) Assumed Investment Yield (%) 3.0% 3.0% 3.0% 3.0% 3.0% 3.0% 3.0% 3.0% 3.0% 3.0% 3.0% (20) = (10)+(17)+(18) Closing AUM (RMB bn) ,151 1,326 1,515 1,718 1,936 AUM Growth 191% 87% 34% 39% 30% 24% 21% 18% 17% 15% 14% 13% 13%

53 17 June Fig 63 NSSF assets: Macquarie projection Status quo/refroms Scenario E 2014E 2015E 2016E 2017E 2018E 2019E 2020E 2021E 2022E 2023E Opening AUM (RMB bn) ,106 1,277 1,475 1,704 1,968 2,273 2,626 3,033 3,503 4,046 4,673 Investment Income (RMB bn) Investment Yield (%) 3.3% 3.1% 9.3% 38.9% -6.8% 16.1% 4.2% 0.8% 7.0% 5.5% 5.5% 5.5% 5.5% 5.5% 5.5% 5.5% 5.5% 5.5% 5.5% 5.5% Other Income (RMB bn) Other Income % of AUM 25.8% 20.6% 24.2% 16.6% 34.7% 22.0% 6.1% 0.6% 20.3% 10.0% 10.0% 10.0% 10.0% 10.0% 10.0% 10.0% 10.0% 10.0% 10.0% 10.0% Closing AUM (RMB bn) ,106 1,277 1,475 1,704 1,968 2,273 2,626 3,033 3,503 4,046 4,673 5,397 AUM Growth 24% 34% 55% 28% 38% 10% 1% 27% 16% 16% 16% 16% 16% 16% 16% 16% 16% 16% 16% Note: Includes overlapping assets with other pillars (ie. before consolidation). We did not conduct a separate Reforms scenario for NSSF. Source: Global Demographics, SSF, Macquarie Research, June 2014

54 17 June Fig 64 Employers Annuities assets (Pillar 2): Macquarie projection of Status quo scenario Status quo Scenario E 2015E 2016E 2017E 2018E 2019E 2020E 2021E 2022E 2023E Number of China SOE Employees (mn) Growth of SOE Employees (%) -0.1% 0.4% -0.4% 1.5% 2.9% 2.0% 1.0% 1.0% 1.0% 1.0% 1.0% 1.0% 1.0% 1.0% 1.0% 1.0% 1.0% % EA Participation 15.0% 14.5% 16.1% 18.4% 20.5% 23.5% 27.0% 29.8% 32.3% 34.8% 37.3% 39.8% 42.3% 44.8% 47.3% 49.8% 52.3% 54.8% Number of Multi-national Employees in Chin Growth of Multi-national Employees (%) 12.5% 2.5% 4.7% 7.3% 17.9% 3.1% 4.0% 4.0% 4.0% 4.0% 4.0% 4.0% 4.0% 4.0% 4.0% 4.0% 4.0% % EA Participation 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 2.5% 5.0% 7.5% 10.0% 12.5% 15.0% 17.5% 20.0% 22.5% 25.0% Total Number of EA Participating Employee AUM pp (RMB) 9,440 16,351 18,410 21,484 21,041 22,638 26,102 29,353 31,408 33,606 35,959 38,476 41,169 44,051 47,135 50,434 53,965 57,742 AUM pp Growth (%) 73% 13% 17% -2% 8% 15% 12% 7.0% 7.0% 7.0% 7.0% 7.0% 7.0% 7.0% 7.0% 7.0% 7.0% Pillar 2 AUM (RMB bn) ,024 1,203 1,407 1,639 1,900 2,195 2,529 2,905 AUM Growth 67% 26% 33% 11% 27% 35% 25% 20% 19% 18% 18% 17% 16% 16% 16% 15% 15% Source: Global Demographics, MoHRSS, Macquarie Research, June 2014 Fig 65 Employers Annuities assets (Pillar 2): Macquarie projection of Reforms scenario Reforms Scenario E 2015E 2016E 2017E 2018E 2019E 2020E 2021E 2022E 2023E Number of China SOE Employees (mn) Growth of SOE Employees (%) -0.1% 0.4% -0.4% 1.5% 2.9% 2.0% 1.0% 1.0% 1.0% 1.0% 1.0% 1.0% 1.0% 1.0% 1.0% 1.0% 1.0% % EA Participation 15.0% 14.5% 16.1% 18.4% 20.5% 23.5% 27.0% 29.8% 37.3% 44.8% 52.3% 59.8% 67.3% 74.8% 82.3% 89.8% 100.0% 100.0% Number of Multi-national Employees in Chin Growth of Multi-national Employees (%) 12.5% 2.5% 4.7% 7.3% 17.9% 3.1% 4.0% 4.0% 4.0% 4.0% 4.0% 4.0% 4.0% 4.0% 4.0% 4.0% 4.0% % EA Participation 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 5.0% 10.0% 15.0% 20.0% 25.0% 30.0% 35.0% 40.0% 45.0% 50.0% Total Number of EA Participating Employee AUM pp (RMB) 9,440 16,351 18,410 21,484 21,041 22,638 26,102 29,353 31,995 34,874 38,013 41,434 45,163 49,228 53,659 58,488 63,752 69,489 AUM pp Growth (%) 73% 13% 17% -2% 8% 15% 12% 9.0% 9.0% 9.0% 9.0% 9.0% 9.0% 9.0% 9.0% 9.0% 9.0% Pillar 2 AUM (RMB bn) ,187 1,562 2,003 2,522 3,129 3,838 4,665 5,757 6,487 AUM Growth 67% 26% 33% 11% 27% 35% 25% 44% 36% 32% 28% 26% 24% 23% 22% 23% 13% Source: Global Demographics, MoHRSS, Macquarie Research, June 2014

55 17 June Fig 66 Private Pension assets (Pillar 3): Macquarie projection of Status quo scenario Status quo Scenario E 2015E 2016E 2017E 2018E 2019E 2020E 2021E 2022E 2023E Opening AUM (RMB bn) ,090 1,250 1,414 1,581 1,750 1,920 2,088 Premium Income (RMB bn) Premium Growth Rate (%) -57% 23% 87% 99% 26% 43% 24% -1% 3% 30% 5% 5% 5% 5% 5% 5% 5% 5% 5% 5% Benefit Outgo (RMB bn) (6) (12) (19) (27) (38) (49) (63) (79) (96) (115) % of AUM 1.0% 1.5% 2.0% 2.5% 3.0% 3.5% 4.0% 4.5% 5.0% 5.5% Investment Income (RMB bn) Investment Yield (%) 2.9% 3.6% 5.8% 12.2% 1.9% 6.4% 4.8% 3.5% 3.4% 5.0% 5.0% 5.0% 5.0% 5.0% 5.0% 5.0% 5.0% 5.0% 5.0% 5.0% Closing AUM (RMB bn) ,090 1,250 1,414 1,581 1,750 1,920 2,088 2,255 AUM Growth 40% 54% 75% 47% 50% 41% 29% 24% 26% 22% 19% 16% 15% 13% 12% 11% 10% 9% 8% Source: Global Demographics, Company Data, Macquarie Research, June 2014 Fig 67 Private Pension assets (Pillar 3): Macquarie projection of Reforms scenario Reforms Scenario E 2015E 2016E 2017E 2018E 2019E 2020E 2021E 2022E 2023E Opening AUM (RMB bn) ,036 1,334 1,755 2,353 3,203 4,417 6,154 8,639 Premium Income (RMB bn) ,182 1,714 2,486 3,604 Premium Growth Rate (%) -57% 23% 87% 99% 26% 43% 24% -1% 3% 30% 30% 35% 40% 45% 45% 45% 45% 45% 45% 45% Benefit Outgo (RMB bn) (6) (12) (21) (33) (53) (82) (128) (199) (308) (475) % of AUM 1.0% 1.5% 2.0% 2.5% 3.0% 3.5% 4.0% 4.5% 5.0% 5.5% Investment Income (RMB bn) Investment Yield (%) 2.9% 3.6% 5.8% 12.2% 1.9% 6.4% 4.8% 3.5% 3.4% 5.0% 5.0% 5.0% 5.0% 5.0% 5.0% 5.0% 5.0% 5.0% 5.0% 5.0% Closing AUM (RMB bn) ,036 1,334 1,755 2,353 3,203 4,417 6,154 8,639 12,200 AUM Growth 40% 54% 75% 47% 50% 41% 29% 24% 26% 26% 27% 29% 32% 34% 36% 38% 39% 40% 41% Source: Global Demographics, Company Data, Macquarie Research, June 2014

56 Glossary Accountable Salary = personal average monthly salary of last year subject to a maximum of 300% of regional average income and a minimum of 60% of regional average income Assets per participant = Assets / population of participants (e.g. work force, retirees, unemployed, policyholders) CASS = Chinese Academy of Social Sciences, the most authoritative research and academic institution in China. The Government often relies on their research to make decisions. Collection Rate = proportion of population contributing monthly payments within total covered population Defined Benefit (DB) = a scheme whereby the employer/sponsor promises a specified monthly benefit on retirement that is predetermined by a formula based on the employee's earnings history, tenure of service and age, rather than depending directly on individual investment returns Defined Contribution (DC) = a scheme whereby the employer or employee (or both) make contributions on a regular basis, future benefits fluctuate on the basis of investment earning Dependency Ratio = average retiree benefit / average work force contributions. Individual Account = an account that collects & accumulates individual s personal contributions in a segregated fund to fulfil pension benefit obligations once the individual retires. Insurance density = premium income per capita Insurance depth = premium income / GDP MoHRSS = Ministry of Human Resources and Social Security NRPS = New Rural Pension System NSSF = National Social Security Fund Pay-as-you-go (PAYG) = a pension operating scheme such that the benefit obligations in each year are fulfilled using the income during the same year, regardless of matching of benefit and contribution by the same individual participant Replacement Rate = compensation after retirement under pension program / income before retirement Retirement age: we use 60 throughout the report in all analysis/projections for simplicity and consistency; however, such a reader should be acknowledged that currently China impose different retirement ages upon different groups of people (by sex, occupation level). Particularly, retirement ages are set at 60 for male, 55 for female who works at management level, and 50 for normal female workers. Social Planning = a pension fund pooling system that collect/allocate/pay out pension funds on an aggregate basis SOE = State Owned Enterprise SSF = National Council for Social Security Fund, PRC. 17 June

57 Companies mentioned: China Life Insurance (2628 HK, HK$21.60, Outperform, TP: HK$27.50) China Pacific Insurance (2601 HK, HK$28.30, Outperform, TP: HK$33.00) China Taiping Insurance (966 HK, HK$14.04, Outperform, TP: HK$18.00) New China Life Insurance (1336 HK, HK$24.70, Outperform, TP: HK$30.00) PICC Group (1339 HK, HK$3.14, Underperform, TP: HK$2.70) Ping An Insurance (2318 HK, HK$61.95, Outperform, TP: HK$70.00) 17 June

58 Important disclosures: Recommendation definitions Macquarie - Australia/New Zealand Outperform return >3% in excess of benchmark return Neutral return within 3% of benchmark return Underperform return >3% below benchmark return Benchmark return is determined by long term nominal GDP growth plus 12 month forward market dividend yield Macquarie Asia/Europe Outperform expected return >+10% Neutral expected return from -10% to +10% Underperform expected return <-10% Macquarie First South - South Africa Outperform expected return >+10% Neutral expected return from -10% to +10% Underperform expected return <-10% Macquarie - Canada Outperform return >5% in excess of benchmark return Neutral return within 5% of benchmark return Underperform return >5% below benchmark return Macquarie - USA Outperform (Buy) return >5% in excess of Russell 3000 index return Neutral (Hold) return within 5% of Russell 3000 index return Underperform (Sell) return >5% below Russell 3000 index return Volatility index definition* This is calculated from the volatility of historical price movements. Very high highest risk Stock should be expected to move up or down % in a year investors should be aware this stock is highly speculative. High stock should be expected to move up or down at least 40 60% in a year investors should be aware this stock could be speculative. Medium stock should be expected to move up or down at least 30 40% in a year. Low medium stock should be expected to move up or down at least 25 30% in a year. Low stock should be expected to move up or down at least 15 25% in a year. * Applicable to Asia/Australian/NZ/Canada stocks only Recommendations 12 months Note: Quant recommendations may differ from Fundamental Analyst recommendations Financial definitions All "Adjusted" data items have had the following adjustments made: Added back: goodwill amortisation, provision for catastrophe reserves, IFRS derivatives & hedging, IFRS impairments & IFRS interest expense Excluded: non recurring items, asset revals, property revals, appraisal value uplift, preference dividends & minority interests EPS = adjusted net profit / efpowa* ROA = adjusted ebit / average total assets ROA Banks/Insurance = adjusted net profit /average total assets ROE = adjusted net profit / average shareholders funds Gross cashflow = adjusted net profit + depreciation *equivalent fully paid ordinary weighted average number of shares All Reported numbers for Australian/NZ listed stocks are modelled under IFRS (International Financial Reporting Standards). 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