China’s pension policy has made great progress over the past two decades, evolving from an iron rice bowl/informal family social safety net to a largely unfunded pay-as-you-go system to more recently a partly funded multi-pillar system with both mandatory and voluntary schemes. China’s policymakers have an important role in implementing regulations that encourage prudent management of pension fund assets, greater transparency and governance and strong risk controls. All of these factors can lead to the development of a national, sustainable and fully funded pension system that can meet the burgeoning retirement needs of its ageing population.
The large-scale restructuring efforts implemented at SOEs between 1997 and 2005 resulted in an estimated one-third reduction (35 million workers) in SOE employment, and thereby putting more strain on the existing pension system over a relatively short period of time.
More than half of China’s population lives in rural areas, and as a legacy of past economic and pension policies, there is great disparity in both economic development and pension coverage between the urban (eastern coastal areas) and rural populations (mainly the western provinces); the urban population is generally better covered while the rural and migrant populations sit outside the scope of any pension coverage. Indeed the pension system and reform process have thus far largely ignored the rural sector and migrant worker population but policy makers understand the importance of including these groups more effectively going forward. According to MOHRSS, China’s pension system covered just 15% of the population as of March 2008. Hence, much work needs to be done to provide universal coverage for the greater population. Given China’s population demographics, a national pension system would by necessity become the largest such system in the world.
The decentralized nature of pension policy makes it difficult for the central government to effectively implement coherent national pension policy changes. Provincial and municipal authorities have large degrees of authority and discretion over pension plan administration. Indeed, cooperation between the central and provincial and municipal governments is generally lacking. Furthermore, the many regulatory bodies involved - MOHRSS, MOF, CIRC, etc. - make coordination of the overall pension plan administration more difficult.
China’s policy makers also need to deal with the legacy costs from previous pension plans and the growing obligations from current pension plans. These large unfunded pension liabilities are largely related to the pension plans in place before the revised plans introduced in 1997; pension entitlements under the pre-1997 plans were more generous than subsequent ones but were largely unfunded.
There have been a number of corruption scandals involving the misuse of pension funds by government officials in China. Among the most prominent cases was the discovery in 2006 of the misuse of funds from the Shanghai Social Security Fund for speculative real estate projects. As a result of such scandals, the public’s trust in the pension system has been adversely affected.
The Way Forward for China’s Pension System
China’s policy makers have introduced a number of important new laws and regulations relevant to its pension reform drive; they have targeted the establishment of a comprehensive national pension system covering the entire population - urban, rural and migrant - by 2020. The 11th Five-year Plan in 2006 called for the formation of a rural pension system. The Urban and Rural Planning Law was enacted in 2008 to better balance the economic development of the urban and rural populations. In December 2008, the standing committee of the National People’s Congress released a draft of a national social insurance law; this draft calls for the pooling of Pillar I at the provincial level by the end of this year and at the national level by 2012. Hence, China is making progress in improving its regulatory and legal framework and creating a national social security law. Such a law would provide the legal foundation for the creation of a national pension plan and incentivize greater participation by employers and employees alike.
Many industry practitioners are arguing for a new, centralized national pension system to be established independently of existing government bodies. One school of thought argues that this system should be placed under the directive of the State Council, which is the chief administrative authority in the Chinese government. In this way, the State Council can be directly involved in the implementation of a new coherent national pension system and ensure that regulators and the central and local governments are effectively implementing a coherent national pension policy.
The Chinese pension system is increasingly moving from the QAR to the Prudent Person Rule (PPR) regulatory approach. MOHRSS is currently reviewing the investment limits on pension plans with an open view to easing investment restrictions towards a PPR approach. Investments in more asset classes and in overseas markets (which is currently permitted under the Qualified Domestic Institutional Investor (QDII) scheme ) are gradually opening up. Five domestic and joint venture firms were selected to manage NSSF assets in 2005, and the NSSF has invested overseas since 2006 via investment mandates to foreign asset managers. However, restrictions on overseas investments by EA plans still exist.
The development of China’s capital markets - equities, debt, derivatives - will play an important role in the development of the pension system since investments will increasingly be made in more sophisticated securities products in the search for higher returns. Relative to more developed markets, China’s capital markets are nascent, with shorter trading histories, less liquidity, less foreign investor participation and a smaller institutional investor base.
Policy makers also realize that China needs a strong, well-capitalized financial sector - banking, securities and insurance - to support the development of its pension system; a robust banking system would provide credit, encourages savings and facilitates the efficient operation and stability of the capital markets.
Policy makers are encouraging private enterprises to establish more EA plans. Pension plans under the EA scheme shift the oversight responsibility from the government to the members of the scheme. However, industry practitioners are arguing for greater guidelines on tax exemptions for corporates in order to incentivize them to set up more EA plans. In fact, in April 2009 the Shanghai government announced a tax break plan to encourage such plans.
A potential long-term threat to the stability of the national pension system is the lack of employment opportunities for the nation’s large supply of labor in the midst of the global financial crisis. New college graduates are entering the workforce in large numbers but are unable to find jobs. Migrant workers are returning to their home villages because of lack of employment opportunities in the urban areas. The implication is that the economically inactive population is growing at a high rate and without employment opportunities, they cannot meaningfully contribute to the development of the national pension system.
Greater education about the benefits of a pension system for all the key players in China’s pension policy is needed - policy makers, trustees, administrators, investment managers and custodians. These players have fiduciary duties to become more knowledgeable and experienced in terms of financial literacy and investment know-how. Indeed, a strong pension fund governance structure calls for the establishment of well-defined plan objectives, proper internal controls, transparency and regular monitoring and assessment of performance. The general working population, as participants and ultimately the beneficiaries of the pension system, also need to be educated about the benefits of a well-defined pension system. These participants will also need disclosure of relevant information about fund performance on a regular basis.
James Lee is a member of the Asia Pacific office of the CFA Institute Centre for Financial Market Integrity. The CFA Institute provides training in best practices has formulated a Code of Conduct for Members of a Pension Scheme Governing Body, an Asset Manager Code of Professional Conduct and the Global Investment Performance Standards.
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