Lessons from China s Pension Reform Experiences Mark C. Dorfman World Bank Pensions Core Course November 13, 2009 1
Organization 1. Background - History 2. Overall Structure, Challenges 3. Urban Enterprise Scheme History Structure Demographics, Coverage and Financial flows Challenges 4. Public Sector Units and Civil Servants History, Benefits, Challenges 5. Rural Pension Systems Structure Challenges Reforms taken and being implemented 6. Treatment of Migrants 7. Voluntary Savings Arrangements 8. Conclusions 2
Overall Structure: Coverage 21.5% Urban Enterprise Contributors Rural Contributors PSUs 55.2% 6.7% 3.7% 1.5% 2.4% Civil Servants Migrants Urban Uncovered Rural Uncovered 9.0% Source: National Bureau of Statistics, Labor Statistical Digest, various issues.
Overall Structure: Urban Provisions
Overall Challenges Aging Economic Adjustment Coverage Fragmentation Lack of portability Legacy burden and financing strategy Decentralized fiscal and administrative structure
Aging Population (1) One Chile Policy and the 1-2-4 Family structure Increases in life expectancy Changes in the family structure China: Female and Male Age Groups, 1995 China: Female and Male Age Groups, 2030 5-year age groups: 0-75+ 5-year age groups: 0-75+ 80000 60000 40000 20000 0 20000 40000 60000 80000 Females and Males, in '000s 80000 60000 40000 20000 0 20000 40000 60000 80000 Females and Males, in '000s Source, Sin, 2005.
Aging Population (2) China s Population Will Age Rapidly After 2010 Million 1200 1000 800 600 400 200 35 30 25 20 % 15 10 5 0 1990 1995 2000 2010 2020 2030 2050 Year 0 1. Population in age group: 15-64(in millions) 2. Population in age group 65 and above (in millions) 3. Dependency ratio(%) (2)/(1) Source: Sin, 2005
Urban Enterprise Pensions History (1) 1951 Est. enterprise-based pay-as-you-go defined-benefit mandatory public pensions. Iron Rice Bowl - pensions, health, employment, housing, maternity, work injury, basic living support 1960 s Devolution of pension management to enterprise (SOE) level 1986 Beg. pilot programs in municipal pooling 1992 Beg. pilot programs in individual accounts 1995 National mandate for choice of individual accounts and defined benefits 11/19/2009 8
Background Urban History (2) 1997 National mandate and parameters for threetiered benefit structure - basic benefit, individual account, supplementary pension and transition arrangements 1999 Coverage extension to non-soe enterprises; central sector funds decentralized 2001 Liaoning Pilot Program, 2001 Est. National Social Security (Reserve) Fund 2004 Initiation of Enterprise Annuity Occupational Pension Scheme 2005 Parametric adjustments to Urban Enterprise Scheme 2009 Issuance of Draft Social Insurance Law for Comment 11/19/2009 9
Urban Enterprise Scheme Current Structure (1) Benefits (Phased in from 1996 to 2035 with different benefit formula for old men, middle men and young men ): Pillar 1a 20% of ½ individual and ½ regional average wage (changed to 1% accrual rate for most provinces -2005) Pillar 1b Monthly Lifetime Annuity = Individual Account Accumulation / Annuity Factor Transition Benefit - Defined Benefit accrual rate 1-1.4%/year for service prior to 1996 11/19/2009 10
Urban Enterprise Scheme Current Structure (2) Qualifying Conditions Retirement Age: 50 for women workers 55 for women managers 60 for men 5 years early retirement for enterprises in transition + hazardous professions life expectancy at est. women retirement age of 50: 77; men est. retirement age of 56 for men: Age 76 Vesting: 15 years 11/19/2009 11
Contribution Rates: Urban Enterprise Scheme Current Structure (3) Vary by Province and city - Employer contributions 20-23% of covered wages Employee contributions generally 8% Total pension contribution rates: 28-31% Wages subject to contributions: 60%-300% of regional average covered wage. Account Administration: At the county and city level (having migrated from the enterprise level in most venues) In select cities, with horizontal links to health, unemployment insurance, maternity and work injury 11/19/2009 12
Recent Demographics of the Urban Enterprise Scheme 180.00 160.00 140.00 120.00 Millions 100.00 80.00 60.00 40.00 20.00 0.00 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 Contributors Pensioners System Dependency Ratio Sources: National Bureau of Statistics, Labor Statistical Digest 11/19/2009 13
Urban Enterprise Scheme Coverage Coverage low but increasing (with growth and changes in economic composition.) 350,000,000 300,000,000 250,000,000 200,000,000 150,000,000 100,000,000 50,000,000-1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 Covered Employees Urban Labor Force Retirees Sources: National Bureau of Statistics, Labor Statistical Digest 11/19/2009 14
Pension System Coverage Relationship between Coverage and Income per Capita Coverage (active members / labor force ) 100.0% 90.0% 80.0% 70.0% 60.0% 50.0% 40.0% 30.0% 20.0% 10.0% Moldova Vietnam India Ukraine Armenia Brazil Romania Albania Serbia Macedonia Kyrgyz Rep. Bosnia Mexico Kazakhstan Georgia China Russia Poland Hungary Latvia Estonia Croatia Czech Rep. Slovak Rep. Lithuania Japan Germany y = 0.2466ln(x) - 1.7331 R² = 0.7764 0.0% - 10,000 20,000 30,000 40,000 50,000 60,000 Income per Capita (PPP) Source: World Economic Indicators. 15
Urban Enterprise Scheme Recent Financial Flows (% GDP) Although system revenues have been greater than disbursements, there are substantial regional differences and many individual accounts have been empty. 3.50% 3.00% Percent of GDP 2.50% 2.00% 1.50% 1.00% 0.50% 0.00% 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 Revenues Disbursements Reserves Sources: National Bureau of Statistics, Labor Statistical Digest 11/19/2009 16
Urban Enterprise Scheme Recent Growth in Subsidies 1400 1200 1000 800 Million Yuan/Year 600 Provincial/Local Government Central Government 400 200 0 2003 2004 2005 2006 2007 Source: Sin, 2008. 11/19/2009 17
Urban Enterprise Scheme Individual Account Rate of Interest vs. Wages Income replacement from individual accounts has dwindled as returns have been dwarfed in comparison to wage growth. Marginal replacement rate decreased from target of 58%. 1400 Index (1990 = 100) 1200 1000 800 600 400 200 0 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 Inflation Wage Growth Growth of 1-Year Term Deposits Source: Sin, 2008. 11/19/2009 18
Urban Enterprise Scheme - Challenges Financing approach. A rapidly aging process stresses system finances and makes the existing scheme unsustainable. Legacy costs largely financed through pension contributions hinder competitiveness, support incentives for non-compliance and limit coverage. Lack of portability hinders labor market efficiency. Lack of design uniformity and fragmented/decentralized administration adversely impacts competitiveness. Lack of risk-pooling and inter-urban resource transfers across communities materially limits the potential benefits from insurance. Parametric weaknesses (inc. low ret. age, high minimum covered wage, vesting requirements) adversely affect incentives, benefits and sustainability. Limited coverage and benefit uncertainty contributes to precautionary savings behavior. Individual account accumulations and replacement rates have been less than anticipated. Decentralized management has contributed to poor portability and other difficulties. 11/19/2009 19
Urban Enterprise Scheme Lessons for Other Countries The authorities enacted pro-active design reforms in the early 1990s aimed at remedying many of the weaknesses of the earlier definedbenefit, enterprise-centered approach. Wage growth has dwarfed returns on individual accounts due to special circumstances of labor and financial markets. The authorities were attentive to performance weaknesses, enacting parametric refinements in 2001 and 2005. The pension system has been able to support the economic restructuring of the 1990s but financing legacy costs have been a burden to enterprises and workers alike, contributing to informality. The central Government adopted a prudent financing strategy increasing Government subsidies in accordance with fiscal capacity. The authorities have adopted a long-term perspective through the establishment of the National Social Security Fund to pre-fund future pension liabilities. 11/19/2009 20
Civil Servants and Public Sector Units Pensions - History 1992 Local governments encouraged to experiment different schemes. Pilots in 6 provinces 1997 Experiments by 1,700 county governments in 28 provinces + 19 provincial governments. Some employees in fully self-funded PSUs required to join the urban enterprise system. Employee would contribute 2% to 4% of wages to individual accounts. Pension payments remained the responsibility of each PSU. 2008 New PSU trials introduced - objective to bring the PSU pension system more in line with the current urban enterprise pension system. 2009 February 2009 five provinces selected by the government to implement the pilot. 21
Civil Servants and Public Sector Units Pensions Replacement Rates Defined-benefit schemes based on the final salary and length of service. Accrual rate is front-loaded Retirement age. 60 for men and 55 for women. Replacement Rates Civil service PSU Years % 10 40 50 > 10 and 20 60 70 > 20 and 30 75 80 >30 and 35 82 85 >35 and 40 88 90 22
Civil Servants and Public Sector Unit Pensions Average pension relative to average earnings: government and non-government employees 110 100 90 80 70 60 50 40 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 government replacement enterprise replacement Source: Hu, Yu Wei, 2009. 23
Civil Servants and Public Sector Unit Pensions Cost of civil service and PSU pensions 30 1.2 25 relative to wage bill 1.0 20 0.8 15 relative to GDP 0.6 10 0.4 5 0.2 0 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 0.0 Source: Hu, Yu Wei, 2009. 24
Civil Servants and Public Sector Unit Pensions - Challenges Portability and labor mobility. Lack of portability of rights to the urban enterprise scheme forces individuals into suboptimal labor market decisions and impacts productivity. Generosity and modality for promised income replacement. Replacement rates much higher than for the urban scheme suggesting that integration with the urban enterprise scheme requires establishment of a top-up benefit as through an supplemental occupational annuity plan. Financing. Efforts to integrate PSUs with the urban enterprise scheme are limited by very limited historic contributions. 25
Rural Pensions (1) History 1986 Ministry of Civil Affairs (MOCA) Pilots in Beijing and Shanxi 1991 MOCA est. as lead for rural pensions 1992 MOCA Basic Scheme for Rural Pensions at County Level (+1995 Policy Document) 1998 Rural Pensions in 31 Provinces 80 million participants 1999 State Council Change in Policy leading in sharp decline in coverage (60 million 2001, 55 million in 1900 counties by 2007) 2003 Renewal Phase initiated social pooling +IA; flat benefit + IA; IA only; various incentives 2009 Est. of Rural Pension Pilot Program 11/19/2009 26
Rural Pensions (2) Coverage 18.0 16.0 14.0 12.0 10.0 Percent of Rural Labor Force 8.0 6.0 4.0 Rural pension converage (%) 2.0 0.0 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 Sources: National Bureau of Statistics, Labor Statistical Digest 11/19/2009 27
Rural Pensions (3) Contributions: State Council Document 32 June 2009 Contribution at 5 levels (100-500 Yuan/month) Minimum match of 35 Yuan/month (locally financed) Accumulations Based on 1 year time deposit rate Fund management Benefit: Annuitized benefit from account accumulation at age 60 (+ application of annuity factor) Flat benefit centrally financed of 55/month Yuan in 2009 terms Qualifying conditions and transition provisions Age 60 (men and women) 15 years of service Those with less than 15 years subject to Family Binding requirement Target Coverage: 10% of counties in 1 st stage; 100% by 2020. 11/19/2009 28
Rural Pensions (4) Aging Coverage Challenges Precautionary savings (reducing current consumption) Elderly poverty prevalence Mobility and lack of portability Fragmentation lack of integration of existing schemes (including lack of support to migrants) 11/19/2009 29
Rural Pensions (5) Lessons Design experience and results. Chinese have experimented with rural pensions savings vehicles and flat defined-benefit provisions since 1992. Although credibility may have been affected by promotion followed by removal and reintroduction, the experience informed the latest policy design. Financing. The authorities have experimented with different subsidy mechanisms, ex-ante and ex-post and have collective experience on the effects of different approaches adopted. Experience with financing from different levels (national, provincial, municipal) also instructive. Impressive coverage of rural areas. Overall coverage levels achieved in the 1990s were substantial when compared to rural coverage benchmarks in other developing countries. The modalities designed to motivating rural residents to contribute towards retirement are also noteworthy. 11/19/2009 30
Migrants Pensions (1) Modalities and Coverage Hukou system had deterred migration. Growing number of migrants in mid-2000s, est. 130 150 million workers (of an Econ Active Population of 786 million) Varying migration duration and patterns (ruralrural, rural-urban) Urban Ent. Scheme costly for migrants (28-31% cont. rate, min. wage subject to contributions: 60% of the regional average wage) Urban Ent. Benefit accruals not portable. Est. 24 million migrant workers participating in urban enterprise schemes (2008). 11/19/2009 31
Migrants (2) 160,000,000 140,000,000 120,000,000 100,000,000 80,000,000 60,000,000 40,000,000 20,000,000-2006 2007 2008 Contributors Est. Total Sources: National Bureau of Statistics, Labor Statistical Digest 11/19/2009 32
Migrants (3) Pilot Reform Program - Policy Blueprint - 2009 Objective to achieve large coverage, transferability, portability and low contributions. Uses existing urban enterprise architecture (social pooling + ind. Accounts) Yet lower contribution rates (enterprises 12%, individuals 4-8%). 15 year vesting (as urban scheme) Target for local management but national information system 11/19/2009 33
Voluntary Savings Arrangements (1) History Individual long-term savings products limited use and low returns. 1997 Urban enterprise reform anticipated voluntary savings - but high urban contribution rates (28-31%) and returns lower than wage growth discouraged voluntary pension savings 2004 introduction of the Enterprise Annuity a framework for employer sponsored voluntary pension savings arrangements. 11/19/2009 34
Voluntary Savings Arrangements (2) Enterprise Annuity Program Fully funded, defined-contribution design. Maximum contributions limited to 1/12 of previous year s wage from each of employer and employee Tax exemption on contributions and benefits determined by provincial governments (most around 4-8% of wages); no exemption provided for individuals Benefit form. Lump sum or monthly benefit at ret. age Termination benefit: accumulation transfer to new enterprise or remain in previous enterprise Permissible investments subject to prescribed limits Management structure spelled out in regulations. 11/19/2009 35
Voluntary Savings Arrangements (3) Challenges Enterprise Annuity Scheme design is limited to a relatively narrow group of potential participants formal sector workers while the need for voluntary contractual savings vehicles is vast in the informal sector. Regulatory framework (custodian, trustee, administrator, investment manager) needs revision and strengthening. Legal framework ill suited for small and medium-sized enterprises. Tax treatment provides poor incentives for individual participation. Supervisory institutions, capacity and accountability needs to be developed. 11/19/2009 36
Conclusions In the face of strong headwinds of aging, and economic adjustment, the Authorities have been proactive in enacting constructive pension reforms since the 1990s. They have also been receptive to parametric modification as conditions and needs change and experience suggests. Experience with rural pensions savings and subsidy schemes provide useful insights into current designs being considered. The principles guiding reform articulated by the authorities (broad coverage, protect at a basic level, multilayered (diversified), sustainable and flexible (for rural pensions) are highly consistent with the Bank s thinking of the guiding principles for pension reform in China. For the future, the imperative of an integrated pension framework across professions, regions and linking work in urban and rural areas is essential to long-term growth, competitiveness and old age income protection. Such a system should satisfy the principles indicated by providing multiple instruments supporting the core objective. 11/19/2009 37