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Impact Investing

IPE special report May 2018

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China: China playing catch-up

Available figures suggest China’s enormous pension market could mean huge potential opportunities for insurers and asset managers, writes Florence Chong 

At a glance 

• There is a dearth of meaningful statistics on China’s pensions system.
• In 1997, the Chinese government overhauled its existing state pension system, replacing it with a part defined benefit and part defined contribution scheme.
• The government also introduced enterprise annuities in 2004.
• It is hard to predict if reform is likely.

Although it is a country with a workforce bigger than that of the combined working population of the developed world, China’s pension market lags behind many others.

There are no meaningful statistics available to indicate the size of China’s pension pool. The trend, however, suggests a shift towards defined contribution (DC) away from the more generous defined benefit (DB) scheme, which applied when China was fully a command economy.

Two sets of figures are available to offer a glimpse of the China market’s size. The first is what is known as Enterprise Annuities (EA), a flexible contribution system to cover private-sector employees, now calculated at somewhere between RMB900bn and RMB1trn (€122bn and €135bn). The second is the published assets for China’s National Social Security Fund (NSSF), which stood at RMB2trn at the end of 2015.

But little information is available about China’s state-run compulsory basic-aged pension scheme. In 1997, the Chinese government overhauled its state pension system, replacing it with a part defined benefit and part defined contribution scheme. It followed up with the introduction of Enterprise Annuities in 2004.

Eleven years later, it rolled out an occupational pension scheme for government employees. This operates as a public sector EA scheme. Both systems are managed by the private sector.

Janet Li, director of investment for Willis Towers Watson Greater China, says the Chinese government has moved in incremental steps to reform the country’s pension system. Implementation of EA and occupational pension systems, are examples of this trend.

janet li

Asked whether more pension reform is likely, Li says this is hard to predict. But given Beijing’s current preoccupation with stabilising its exchange rate, she does not believe reform of the system is a priority.

Li says implementation of both EA and occupational pensions (established in 2015) are steps that have been taken to alleviate problems in the pension and insurance sector. As assets continue to accumulate in the various pension systems, China’s potential is huge. “There is a hidden pot of golden eggs in China’s pension system,” she says.

“Any future move by the government as to how pension assets are going to be managed will have a substantial impact on both the industry and on financial markets.”

Hong Kong-based Stuart Leckie, chairman of Stirling Finance, an investment and pension consultancy, says that when people talk about China’s pension system, they generally refer only to the urban pension systems, which relate to both state and private pension entities.

Leckie has researched the Chinese pension systems for multilateral agencies, including the Asian Development Bank, the International Labour Organization, Organisation for Economic Co-operation and Development (OECD) and World Bank for 20 years.

Kenneth Cai, a Shanghai-based investment consultant with global insurance and risk management consultancy group Aon Hewitt, says three pillars prop up China’s pension system. The first is the state pension system, the second is the corporate pension system (which includes EAs and occupational pensions), and the third, individual top-up pension plans. 

Of these, says Cai, only the state and corporate pension schemes attract tax concessions. At present, he says, individual pension plans are excluded from government support. But it has been mooted for four or five years that the government will extend tax concessions to this market segment.

Leckie points out that China’s state pension system has two parts. The first has employers contributing about 20% of payroll, which is then immediately paid out to retired workers as a pension defined benefit. The second is one where employees contribute 8% of their salary. This accumulates until retirement and is then paid out as a monthly pension.

kenneth cai

From this year, 40m civil sector employees will benefit from a 12% compulsory superannuation contribution to occupational pension schemes. With a 12-year history, EA schemes are comparatively more established. 

Large Chinese corporations – especially those in the high-tech and finance sectors, and multinational companies operating in China – contribute to EA schemes for employees.

A source told IPE that the Chinese EA market grew at about 22% a year between 2011 and 2015. The source said there were more than 75,000 participating enterprises at the end of 2015.

Cai says that, at the end of 2015, the market size of the EA segment was about RMB1trn. In the past three years, EA assets under management have risen by 36%.

Says Leckie: “An employer who wishes to give benefits over and above the state benefit can take out an enterprise annuity plan for his employees, giving an added benefit on retirement.”

Although EA schemes work on Western business models, they are heavily regulated. “There is a trustee, an administrator, a fund manager and a custodian,” Leckie says.  Each of these functions comes under the purview of a government agency, making for a complex and highly-regulated system.

The primary regulatory agency for pensions is the Ministry of Human Resources and Social Security. Other government bodies have responsibility for regulating China’s insurance industry and its trusteeship and funds management sectors.

Leckie says the authorities do not prescribe contribution rates for EA plans, but there are limits. Employers typically pay in the range of 4% to 6% of an employee’s salary towards the plan. Employees may have the flexibility to contribute, and those who do so pay between 2% and 5%.

“Sometimes, instead of paying a percentage of salary, the employer may decide to contribute, say, 10% of the company’s profit,” says Leckie.

Li says her firm estimates that EA today covers about 25m Chinese workers. Fifty-eight licences have been issued to the private sector to manage this pool of savings. Some licence holders have overseas joint-venture partners. Australia’s AMP, for example, has a joint venture with China Life.

AMP acquired a 20% stake in China Life Pension Company in 2014 for AUD240m (€168.8m).

A source that advised AMP on the acquisition said: “One of the attractions to AMP is the ability to participate in the Chinese EA market.” 

Deutsche Asset Management is in joint venture with Hong Kong-based Harvest Fund Management Company, which holds one of the 58 licences.

Li says EA managers invest mostly in cash deposits, guarantee notes and fixed income. “Most of these with guaranteed returns, like term deposits, are due to mature soon,” she says. 

“But it will be a challenge for the managers of these funds to continue to provide the same level of return. They have to look at ways to add value to their investment approach.”

Cai says: “There have been some reforms to the investment options for DC and DB funds. Two or three years ago, most of the money went into bank deposits; the investment return was very low, but safe.” Most managers, he says, achieved a 5-6% annualised return on their fixed-income portfolios and a 6-8% annualised return on equity portfolios, but the latter is more volatile.

Part of the last round of relaxation on EA investment was to allow managers to invest up to 30% in Chinese equities for diversification and better returns.

Leckie remains sceptical. “This is a good thing to do, [but] China is doing it for the wrong reasons – not to improve pension returns, but to bolster the Chinese stock market.”

Where next for China’s social security fund?

China is moving – slowly – to unshackle its underfunded state pension scheme to enable it to meet its liabilities. The Chinese state pension scheme (compulsory basic-aged pension), forms the first of the three pillars that hold up its pension system.

Pillar one remains under government management. Provincial governments run these schemes, and they have “very limited” exposure to investment opportunities in the capital markets, industry sources tell IPE.

As one source at a leading Chinese insurer says: “Since 2006, there have been several rounds of discussions to move the basic pension scheme towards a centrally-managed, professionally invested framework.”

In 2012, the State Council approved the National Commission of Social Security Fund (NCSSF) to take over management of China’s basic pension schemes. The commission manages the National Social Security Fund (NSSF). It had assets of RMB2trn (€270bn) as at the end of 2015.

The Guangdong provincial government has entrusted RBM100bn in assets from its basic pension fund to the NSSF.

Earlier this year, the Shandong provincial government entrusted a further RMB100bn in assets from its basic pension fund to NCSSF to be invested with NSSF.

It is expected that more provincial governments will entrust the government body with management of their basic pension funds. A recent round of manager selection for the basic pension fund by NCSSF is a significant milestone in moving towards a market-oriented, professionally-managed basic pension fund scheme, says an industry source.

In that selection round, 21 institutions, including seven with foreign partners, were selected to broaden the investment options of the basic pension system. Kenneth Cai, a Shanghai-based investment consultant with global insurance and risk management consultancy group, Aon Hewitt, says NSSF has an allocation of only 5% to foreign government bonds.

“In absolute terms, NSSF has RMB13bn invested overseas,” says Cai. But he qualifies this, pointing out that the NSSF does not fall into either the defined contribution (DC) or defined benefits (DB) buckets because it is a reserve fund, set up as a buffer for China’s social pension systems, mainly with contributions from the government.

Some large state-owned enterprises (SOEs) also assign special shares to NSSF when they are listed on stock exchanges, he adds. Stirling Finance chairman, Stuart Leckie, says: “The NSSF is becoming more like a sovereign wealth fund and less like a pension fund. With a pension fund, you know what the benefits are and who will get pensions from it.

“But China has been amazingly quiet on the NSSF. It is said to be for retirement needs and ageing population problems, and to help the provincial governments with their pension liabilities.

“But we have no information as to what the NSSF is ultimately going to be used for.” With rapid ageing of the Chinese population, Leckie says financing of the state system is going to be an immense problem for China.

The number of Chinese aged 60 years and over is expected to grow from 202m in 2016 to 302m by 2050. Leckie says the government’s total unfunded pension liabilities could be as much as 1.5 times China’s GDP, which stood at $11trn in 2015, according to the World Bank.

Despite recent moves, concerns remain that China is moving too slowly in dealing with its pension burden. In a sense, the problem of unfunded pensions is not just China’s. It is a challenge that many governments the world over will face in coming years. 

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