Crowding out enterprise annuity pensions

Since China introduced enterprise annuities in 2004, the annual contributions towards the voluntary private retirement programme have been increasing rapidly. According to the latest statistics from the ministry of labour and social security (MoLSS), annual contributions reached almost $8.8bn (€6.6bn) and $11.6bn at the end of 2005 and 2006 respectively.

While these figures may seem impressive at first, the participation among private enterprises remains low. At the end of 2005, a total of 24,000 enterprises all over China had set up enterprise annuities, with 9.24m employees participating. This is still far below the 174.87m covered under China's mandatory social insurance programme for urban workers.

Putting this in perspective, the total annual contribution towards the retirement schemes in Hong Kong and Singapore was around $5.5bn and $2.5bn in 2006, covering participants of 3m and 3.1m respectively.While different retirement systems cannot be compared directly (for example, Hong Kong and Singapore do not have comprehensive social insurance as in China), the number of participants and amount of contributions towards the private savings pillar in China remain very low in comparison.

China's rapidly ageing population and the severity of the funding shortfall in its public pension system put tremendous pressure on its social and private savings structure, and eventually its economy.

China's pension system dates back to the 1950s, when it was an urban and SOE-based pay-as-you-go system. The system provides relatively generous benefits to pensioners, which ultimately proved to be unsustainable, and began its reform in the late 1980s. After a series of adjustments, China established a multi-level old-age insurance system that consists of three pillars: the basic pension, enterprise annuity and personal savings insurance.

The basic pension aimed to guarantee the basic living standards of the retirees, especially the low-income earners, is a mandatory national-wide system of social pooling and individual accounts. The basic pension, mainly implemented in cities, is financed by the enterprise and the employee, subject to 20% and 8% of the wages respectively.

As with most social pensions around the world, the funding put towards the basic pension system is inadequate. For historical reasons, the liabilities of the old system were transferred to the new system but the current contributions cannot finance the massive unfunded pension obligations.

ven without the legacy problem, the current pension system is difficult to sustain because of the growing number of retirees. Men in China normally retire at 60 and women at 50 or 55 (for those in managerial positions). Due to the low retirement age and improving health in China, it is expected that the higher growth rate of pension expenditures will exceed contributions and consequently bankrupt the system.

The government recognises this is a major problem and has been exploring options to sustain this programme. Obvious solutions would be to increase the retirement age, reduce benefit levels, increase contribution rates and sell state assets. However, as with other major industrial countries, these solutions face tremendous resistance from the population.

Unlike the basic pension pillar, an enterprise annuity is a fully funded arrangement without any social transfer issues. Although enterprise annuities cannot resolve the immediate issues of the basic pension system, they can reduce the financing pressure from the social system when sufficient assets are accumulated over time.

The government can scale back some of the social benefits when sufficient private savings are in place and reduce the funding pressure from the current system and redirect the funding towards those who need them. Thus the government should have a vested interest in encouraging the expansion of the enterprise annuity programme.

urrent participation in the enterprise annuity is still far from sufficient. There could be many factors contributing to the low participation in the programme. Companies are already funding 20% of payroll towards the basic pension.

While company contributions are tax deductible, companies do not have any further incentives to voluntarily provide additional retirement benefits to their employees due to the high contribution towards social programmes. Employees are not encouraged to save under this programme either, as their contributions have not been tax deductible. The maximum 4% contribution rate is also far from sufficient to secure meaningful retirement income for the participants.

It may be inevitable that the Chinese government will need to scale back basic pension benefits or to increase contribution rates in the near future. Should this happen, enterprises will be encouraged to cut back or even terminate their participation in the enterprise annuity programme, and ultimately the government will crowd out private retirement savings and need to support the entire system on its own.