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Seeking harmony from regional differences

How is China dealing with the fragmentation of pension benefits across the country? Carl Redondo reports

In the days of the ‘iron rice bowl' the state was expected to provide a job for life and all the benefits that went with it - including housing, pensions and medical coverage. China has changed - and is still changing - and the iron rice bowl mentality has had to change with it.

The platform for employee benefits in China is still the comprehensive social security system with employer contributions often in the range of 40-50% for the majority of employees. However, as the economy has grown and the ‘war for talent' has locked down in China, the servings from social security's iron rice bowl have become insufficient and many companies now offer a myriad of supplemental benefit programmes.

The supplemental programmes are most prevalent in the first-tier cities, Shanghai, Beijing and Guangzhou; second-tier cities such as Hangzhou and Suzhou are catching up quickly. In contrast, many of the third-tier and developing cities still rely solely on the social security system.

This fragmentation of benefits between cities/regions is driven partly by competitive reasons but also because the underlying social security systems in the various regions are different.

The situation now for many companies in China is that they have growing operations across various provinces with complicated and inconsistent benefit programmes. The underlying social security rules are different and the supplemental programmes that sit on top are also likely to be different.

As the economy matures and stabilises, companies are beginning to think about sorting out some of this confusion; harmonisation is a hot topic amongst human resources professionals in and around China. The question is how to harmonise and many are scratching their heads.

As an example, recent cuts to the social security Housing Fund in Beijing have left many employees worse off. But how should companies react? They could set up a supplemental housing programme but this just adds another benefit programme to an already complicated system. What is more, there is no such change in Shanghai, so should employees there become eligible for any new supplemental programme?

Looking at the bigger picture, one potential solution that companies are starting to look at is the idea of a flexible benefits approach. The principle would be that employees are provided with a benefits account from which the costs of social security and other mandatory programmes (eg supplemental life insurance, medical cover) would be deducted. The remaining account is for employees to spend on the benefits of their choice.

This seems to be where we are heading in the long term but in the short term there are potential hurdles. The first of these is that at ground level many companies operating in China do not have the resources to manage and administer such a plan. Headcounts are still growing rapidly and the idea of rolling out a flexible benefits plan would be just unmanageable.

The second hurdle is the external capabilities to handle such a plan. The idea of ‘flex' in China is still embryonic and very few service providers are set up to offer varying levels of pension contributions, life insurance, dental coverage, medical coverage etc. Similarly, the typical providers of flex administration services are not tested yet in China.

So this leads us back to our head scratching. If we accept that in the long term flex is the solution then in the short term one option may be to pay out the residual benefits account as cash. This sidesteps the need to set up a full flex programme but provides equality between employees and moves in the right direction.

One of the pitfalls here is philosophical - this is supposed to be a benefits programme but we are now (probably) increasing the benefit spend but providing it in the form of a cash supplement. Many companies will not get regional/global approval for additional benefits spending that just results in more cash being paid out to employees. Paying cash is also not particularly attractive for senior employees, who are likely to be subject to a marginal tax rate of 45%.

Companies also like to see a ‘bang for their buck' and in China this usually means a differentiator in the already mentioned ‘war for talent'. Paying out cash is unlikely to provide a differentiator in the way that more innovative benefit programmes could do.

More head scratching. Possible advances on the cash solution might be a deferred cash plan or a stock purchase scheme. Under a deferred cash plan, the benefits would still be paid out as cash but they could be tied to fulfilling certain conditions - usually linked to minimum service periods or minimum age requirements. This gives something back in terms of retention and if branded in the right way could be seen as a differentiator in the market.

One of the downsides is setting up such a plan and in particular how to fund it. The other major downside is income tax to the employee. The payment would be made as a lump sum on leaving and could easily take an employee up to the next income tax bracket, leading to an unnecessarily high tax payment.

The stock purchase scheme has a lot of the advantages of the deferred cash plan - and may even be viewed in higher regard by current and potential employees. It can also overcome the income tax issue, as employees will not be forced to liquidate the stock on leaving employment. The key problem with this approach is that the tax rules around how to treat stock purchase schemes in China are unclear and there would be a certain amount of compliance risk until these are sorted out.

All of which leaves us back where we started but with less hair. Benefits harmonisation is a hot topic in China but there are no clear solutions. A clear first step for a company is to carry out a benefits inventory across its operations in China to understand the scope of the harmonisation project. Then let the head scratching begin.

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