China’s demographic change has become one of the biggest challenges for Beijing, as policymakers try to avert the unwelcome prophecy of the country ‘getting old, before getting rich’. A dramatic drop in China’s birth rate over the past five years has added urgency to the requirement to establish a sustainable and sufficiently well-funded pension system to ensure that the benefits from the ‘youth dividend’ – which has fuelled China’s economic miracle over the last four decades – can be enjoyed by current and future retirees. 

Private pension schemes have long been seen as a major element of this reform and have received a new push following the opening-up of China’s financial services industry. On 21 April 2022, the State Council published a new reform proposal to establish private pension investment plans – similar to the American 401(k) accounts – which would allow Chinese employees to have their own individual pension portfolios. 

Yet the Chinese government’s wooing of foreign insurance companies and financial institutions to help set up a functioning market for pension funds also provides a good example of the challenges and complexities China faces in the age of ‘Common Prosperity’ and slowing economic growth.

Background 

Following China’s departure from a Soviet-style planned economy and the rapid downsizing of the country’s vast state-owned enterprise sector in the late 1990s, Chinese reformers faced the daunting challenge of creating a new social welfare net which could replace the traditional ‘iron rice bowl’ (the cradle-to-grave coverage provided by one’s work unit). Additionally, the return of Hong Kong in 1997 posed the – albeit long-term – question of how to integrate the city’s developed pension system into a nationwide structure. 

The 1997 State Council Document No. 26 outlined the main idea of China’s pension reform, namely the creation of a multi-pillar system for China’s entire urban population. The plan was elaborated further, and in 2000, the State Council published Document No. 42, which designated Liaoning Province and its neighbours as reform pilot areas. At that time, the three Manchurian regions were not only the most industrialised but also the hardest hit by Zhu Rongji’s radical downsizing of China’s state-owned enterprises, with millions of employees losing their jobs virtually overnight. 

Yet the initial reform produced only partial results. A key problem – not only for retirement policy – remains the decentralised and highly fragmented nature of China’s administration. Like nearly all social services, pension policies are set at the municipal or township level, thus leaving it up to each local government to set its own rules. Given such budgetary constraints, successful implementation thus often depended on subsidies and support from the central government and international organisations, such as the Asian Development Bank. As Zhu Xufeng from the School of Public Policy and Management at Tsinghua University and Zhao Hui from Beijing’s Capital Normal University have noted in a recent paper, early pension reforms without government support – such as those initiated in Zhejiang province – failed to get off the ground. 

Since 2000, several reforms have therefore aimed to both harmonise pension rules across China and open up new financing channels. Below are some of the milestones of China’s pension reform:

• 1997: Outline of a Three Pillar Model (Document No. 26) for urban employees
  2000: Launch of pilot pension reforms in Liaoning and other provinces
  2006: Plan to extend pensions to all employees in both urban and rural areas by 2020
  2009: Creation of New Rural Social Pension Scheme, including for unemployed urban residents
  2010: A new Social Insurance Law sets a maximum contribution for all Chinese employees (<20%) and employers (<8%)
  2014: Merger of Urban and Rural Basic Pension Scheme
  2015: Inclusion of SOE employees and civil servants in a National Basic Pension Scheme
  2018: Pilot Project in Shanghai for tax deferral for pension contributions and Nationwide Transfer Mechanism for local pension funds
  2022: State Council proposes an individual retirement savings and investing plan (e.g. 401(k)) for Chinese employees

The timeline of China’s pension reform is very much in line with its usual reform development, starting with local pilot projects which are then incrementally merged into a nationwide framework. Yet until the late 2010s, most of these steps targeted just the statutory part (Pillar I) of China’s pension system. It was only in 2018 that the two other pillars – enterprise annuities (Pillar II) and private pension plans (Pillar III) received greater attention from Chinese policymakers.

In February 2018, new regulations for enterprise annuities made is easier for companies to set up their own pension plan. The Chinese government also launched a new pilot project in Shanghai which would allow employees to defer taxes on pension contributions in an effort to make these plans more attractive. 

As a result, the performance of enterprise annuities has improved markedly, with the annualised rate of return increasing from 3.01% in 2018 to 10.3% in 2020, according to Bo Sun, a Chinese pension expert. A recent report by EY also saw strong growth in this pillar, with a 43% year-on-year increase in 2020 alone.

Yet the most promising – from a private insurers’ perspective – third pillar has so far received relatively little support. According to data collected by EY, private pension plans still only account for a relatively small fraction of overall pension funds. As of the first half of 2021, only RMB75.6 billion (£9 billion) was invested in private pension plans versus RMB3.5 trillion in enterprise and occupational annuities, and RMB2.9 trillion in government pension funds.

The Third Pillar is taking shape 

It is, however, private pensions which promise the biggest growth opportunity in the coming years. According to EY data, the total value of private pensions funds in 2018 was just RMB4 billion. Two years later, the value had increased to RMB57.6 billion – a 1,340% growth. Independent consultancies quoted by Reuters estimate that the value of China’s pension funds could rise to at least RMB1.7 trillion by 2025. 

Yet it wasn’t until this year that the Chinese government started taking steps to create a legal framework for private pension investment plans. Inspired by the US model of 401(k) pension plans, China’s General Office of the State Council – an institution similar to the UK’s Cabinet Office – released a document outlining the basis for a Chinese variant of such investment plans.

The document – simply called Guobanfa [2022] No. 7 – tasked the Ministry of Human Resources and Social Security and the Ministry of Finance to create the regulatory framework for personal pension funds (in Chinese: geren laoyangjin/个人养老金). While the document does not spell out the details, it lays down a few cornerstones:

• Payees need to be enrolled in a basic urban or rural pension scheme;
• Individuals may contribute up to RMB12,000 (£1,400) per year;
• Contributions and risks are borne by the individual (no employer contribution);
• Funds can only be withdrawn after reaching retirement age, or in exceptional circumstances (e.g. invalidity, emigration);
• Contributions will benefit from preferential tax policies;
• Repayment method can be stipulated by payee as monthly, in fixed tranches or as a lump-sum payment, but once set, cannot be changed;
• Personal Pension Plan Accounts have to be set up through an official Personal Pension Information Management Service Platform (managed by the Ministry of Social Security).

The document provides few details on the investible funds and states only that they may include management products, savings deposits, commercial pension insurance, and public funds, as well as being ‘safe, mature and stable, standardised, and focused on long-term benefits’. A list of eligible investment products is set to be drafted by Chinese financial regulators and published on the Personal Pension Information Management Service Platform.

What are the next steps?

Document No. 7 is an important milestone as it is the first nationwide policy guidance that calls for concrete steps to set up a government-led private pension fund platform. As such, it sends a strong signal of government support for private pension funds and will almost certainly boost growth in this industry. Nonetheless, the document’s paucity of details means that several key elements of Pillar 3 have yet to be decided.

First and foremost, it is up to Chinese regulators to decide which financial service providers are allowed to list their products on the new information platform. They will probably include big Chinese insurers and investment giants such as Ping An or CITIC. But foreign insurers also have a good chance of being part of the mix, as Chinese authorities have repeatedly signalled that they would welcome foreign financial institutions. Thus, vice-chairman of China’s Banking and Insurance Regulatory Commission (CBIRC) Zhou Liang reiterated this position in a recent call with CBBC members.

Secondly, Chinese regulators need to define the criteria of included financial products and fund managers. This would not only relate to financial risk management but also set a minimum return-on-investment as is common for many Western pension funds. In his talk with CBBC, Liang indicated that defining such a threshold remains one of the thorniest issues of the reform. Setting it too low could hamper the overall attractiveness of private pension plans, while too high a threshold could increase financial risk, create a moral hazard and exclude more prudent investors. 

Finally, Chinese tax authorities need to work out an effective tax policy which incentivises investment in such funds. As researchers at EY pointed out in their recent report on China’s pension reform, fragmentary and unclear tax policies remain one of the biggest obstacles to a healthy private pension market. Creating a uniform and nationwide system of tax benefits for private pensions would clearly help.

China’s decade-long pension reform offers attractive new opportunities for UK insurers and financial institutions as plans to establish a market for individual pensions speed up the volume of assets under management by private pension funds

What challenges remain? 

Besides these regulatory requirements, there are also a few other challenges to creating a successful private pension system. 

Firstly, pension funds will have to compete with a range of alternative investment options for Chinese people. Although real estate – China’s most popular old-age-insurance – has recently lost some of its lustre due to a struggling property sector, it still ties up a considerable amount of private savings. Other alternatives, such as wealth management products (WMP), have long attracted private investment and often offer higher returns than long-term pension funds. In a high-growth economic environment, such types of investment are likely to receive a larger share of private savings than less liquid long-term investment plans. Most challengingly, changing this will not only require new policy incentives, but also more sober communication by the Chinese government about the country’s slowing economy. 

Capital controls are another big challenge. In order to create a high-quality private pension market, sooner or later, Chinese regulators will need to allow pension funds to invest in assets in other, more advanced financial markets, most notably in the US and Europe. Local fund managers will also need a better understanding of international financial markets to ensure that pension funds are managed properly. Stuart Leckie, the founder of the Hong Kong Retirement Schemes Association and a long-term observer of Chinese pension reforms, suggests that an incremental increase of foreign asset allocations in Chinese private pension funds over several years could help local authorities to familiarise themselves with global best practices and slowly lift the quality of China’s own financial services industry. 

The biggest issue, however, remains China’s own institutional and socioeconomic fragmentation. Despite past reforms and improved standardisation, pensions are still managed by the local governments and contributions and tax incentives thus vary wildly.

While China’s richer parts in the east and south will set up the necessary infrastructure fairly quickly – and probably also account for the majority of investors – some poorer regions might struggle to attract both investors and high-quality funds. Recent research by Yang Yujeong of the State University of New York College at Cortland shows that areas with a level of out-migration generally rely more on government pension schemes than booming regions with net immigration. Given these discrepancies, a standardised and uniform offer for private pension funds across China might be more useful than sign-up platforms run by local bureaux which would risk a deepening of existing social divisions.

The CBBC View 

China’s decade-long pension reform offers attractive new opportunities for UK insurers and financial institutions. The Chinese government’s latest reform proposals to establish a market for individual pension plans will probably speed up the volume of assets under management by private pension funds and help establish the Third Pillar in China’s pension system. 

The reform could also accelerate a broader opening-up of China’s financial system as more private investment by pension funds paired with a slowing economy could force Chinese regulators to allow Chinese funds to put their money into foreign assets. Seen from this perspective, the positive effects of China’s pension reform could go far beyond the stabilisation of strained pension funds. 

Yet much remains to be done and further reforms are needed to implement the latest initiatives fully. Chinese authorities will most likely apply the well-worn practice of letting local authorities – especially those in the rich coastal regions – come up with solutions which are then applied to the rest of the country. But as past social policy reforms have shown, central coordination and standardisation remains indispensable if the government wants to create a modern and sustainable pension system.

Call +44 (0)20 7802 2000 or email enquiries@cbbc.org now to find out how CBBC’s market research services can help you build knowledge and understanding of the Chinese market prior to investment.

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China’s rapidly ageing population brings about plenty of challenges and opportunities. As our report on elderly care shows there is a lot of scope for companies to help in the care sector and make the most of the gradual welfare reforms that will benefit the older generations.

This article also explores how pensions are being reformed to address the shrinking number of working adults that are contributing to the social security system. Whilst there are steps being taken in the right direction there is no denying that in 1993, there were five adults contributing for every one elderly person withdrawing from it, whilst projections suggest that there may be just 1.3 contributors for every elderly person by 2050.

The population is expected to peak at 1.44 billion in 2029 before shrinking to 1.36 billion in 2050, when four in 10 Chinese people will be over 60; whilst automation and the growth of AI will also contribute to a shrinking work force. All of this is forcing China to strategically reconsider its vocational, education and training (VET) system.

Although China’s major cities have some of the best academic education systems in the world, the growing shortage of workers has seen a growth in the promotion of vocational training. The number of university graduates has risen from 6 million in 2008 to over 20 million in 2018 but VET has traditionally been seen as a lower status qualification than a university degree. There are still few organised national programmes available to those looking to train in an industry, and few national standards that are recognised from province to province. There is a marked divide between academic education and vocational training, and the links that allow students to enter into industry after VET graduation are often lacking.

There are still few organised national programmes available to those looking to train in an industry, and few national standards that are recognised from province to province

Aware of these challenges, China is hosting the WorldSkills Shanghai event in 2021 which Vice Premier Hu Chunhau has said should emphasise the sharing of professional skills, particularly amongst China’s young people. The country has also been working to create better links with international partners – including those in the UK – to try to raise standards and bring certification into line.

The University of Salford is a fine example of a UK-China partnership that trains students for the workplace. As this article shows both the curriculum and visits from Salford’s fashion department staff help students in China, who then have advantages when they go on to work in China’s fashion industry. The relationship is, of course, mutually beneficial; it also provides UK students with access, network development opportunities and solid experience in China.

In a similar fashion, through its partnership with Youjiang Medical University, the New College Lanarkshire in Scotland is providing dental nursing certification and education programmes to Chinese students, creating much needed dental nurses in a sector where previously there was very little standardised certification.

In the short to mid-term, the nature of work around the globe is likely to see significant change. Whilst also true in China, local factors such as the dramatically ageing population and the opening up of previously closed areas will see a number of uniquely Chinese opportunities present themselves.

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Although this is good news for businesses, China is nonetheless facing increasing pressure to reform its pension system. With an aging population, local governments are confronted with rising costs for its senior citizens at the same time as the working-age population is shrinking.

This has put considerable stress on provincial pension funds, with some provinces, such as Heilongjiang, already spending more than they receive from contributions. According to a study conducted by the Chinese Academy of Social Sciences, on the national level, pension funds could be fully depleted by 2035.

In order to help provinces with a disproportionate number of older people, China established a national transfer mechanism in July 2018. The mechanism would take surplus income from richer provinces and redirect it towards provinces with deficits. In early April 2019, China’s Ministry of Finance published4 its first budget for the transfer mechanism. The figures reveal stark inequalities between provinces.

However, the numbers also offer a useful insight into the shifting demographic situation in China and could be a precursor for future reform initiatives.

China’s march towards a universal pension system

China’s pension system dates back to 1955. However, it only covered civil servants and urban workers in the state sector. Under this system, each company managed its own pension fund and contributions and payments were handled on a pay-as-you-go (PAYGO)-basis. As the economy began to liberalise in the 1980s, this system become unsustainable and in 1991 the government created a regional fund which would cover all enterprises.

The new system rested on two pillars. The first one is an earnings-based pension following the PAYGOprinciple with defined benefits for retirees. The second pillar consists of forced savings into an individual pension account. Both relied on mandatary contributions from both employees (8 percent) and employers (20 percent). Although this reform vastly expanded the safety-net, it still covered only around 30 percent of urban residents5 in 2005. Rural workers remained excluded.

After a failed experiment with voluntary contributions, it was not until 2009 that the Chinese government managed to set up a universal non-contributory pension system for rural residents. Two years later, this basic insurance scheme was extended to non-working urban residents.

In 2014, both systems were finally unified into one single basic pension scheme, and in 2015, the State Council abolished the separate system for SOE employees and civil servants and merged their accounts with the general system.

Geographical disparities

Despite the continued expansion of China’s minimum pension insurance, considerable inequalities between regions remain, especially with regard to pension funds that rely on contributions by employees and companies (1st pillar).

The published budget for the transfer mechanism testifies to the considerable problems faced by many provincial pension funds. In total, the mechanism will reallocate £13,96 billion. However, only seven provinces are net-contributors, with almost 40 percent borne by Guangdong alone. The other net payers are Beijing, Shanghai, and the coastal provinces of Shandong, Jiangsu, Zhejiang, and Fujian. Three provinces, Guizhou, Yunnan, and Tibet are spending as much as they earn, whereas the remaining 21 provinces are all net-recipients. The biggest beneficiaries are Liaoning, Heilongjiang, Sichuan, Jilin, and Hubei, which, taken together, receive 63 percent of the funds.

Continuing problems and outlook

While the transfer mechanism might help to stabilize some of the struggling pension funds, it raises serious questions about the sustainability of the scheme. Given China’s overall demographic trends, it is likely that the amount required will further increase at the same time as the number of net-contributors shrinks.

What’s more, since 2012 the number of eligible recipients has grown faster than that of new contributors. Although the share of the participating working population has increased over the years from 23 percent in 2009 to over 36 percent in 2017, the number of retirees has grown even faster. In 2010 the number of contributors increased by 9.4 percent against a rise of 8.6 percent for recipients, whereas since 2012 the latter was consistently higher than the former. In 2015, the growth of the number of eligible pensioners was even more than double the increase in contributions, pushing down the dependency ratio from 3.16 in 2011 to 2.65 in 2017.

The impact of China pension problem on reforms

The woes of China’s pension funds have considerable ramifications on China’s reform efforts. First, the need for additional capital has likely stalled the long-awaited reform of state-owned enterprises (SOEs), as their assets have been used to plug the funds’ holes. This has made any privatization politically costly and has increased the government’s efforts to buttress the ailing state-sector despite low productivity and misallocation.

Second, the low level of state pensions and the lack of private alternatives have prompted many Chinese to invest in real estate and the stock market, thus fueling bubbles and encouraging rent-seeking. This has led to repeated government intervention in order to stabilise prices far beyond market rates.

Building a third pillar

In order to alleviate these problems, the Chinese government has made several efforts to add another pillar to the pension system. It has thus encouraged Chinese employees and pensioners to invest in private pension schemes, which could help raise the general pension level and ease pressure on public funds. Unfortunately, poor regulatory oversight, lack of professional risk management and low financial literacy rates have created a breeding ground for fraud and greed. In April, the Chinese journal Caixin reported of the real estate company Zhongan Minsheng Pension Service Co., Ltd. having convinced retirees to invest in apartments in Beijing’s high-end Haidian district. The investors would then receive an annual return of 4 percent- 6 percent, paid as monthly supplement to the state pension. However, in February 2019, the company stopped making payments and shortly after ceased operations completely, leaving one investor with a private debt of £340,000.

To avoid such scandals in the future, China’s government is pushing for further reforms. On 29 March 2019, the State Council published a document which called for further reforms to broaden investment channels for retirees. These include the promotion of financial pension services, an expansion of corporate bond issuance in the old-age care sector, and, most importantly, better access for foreign financial pension fund providers.

Although it might not solve the underlying structural problems, an effective opening up to international investors with a global portfolio could at least provide Chinese pensioners with a viable and comparatively safe alternative, especially given the vulnerability and fragility of China’s own financial and real estate markets.

Lessons for UK companies

Although China’s pension crisis might raise costs for businesses in China, it also offers new opportunities for UK financial institutions and Fintech companies. According to a 2017 research report9 by KPMG, China’s private pension insurance volume could reach GBP 1.3 trillion by 2025.

As pressures grows on the government to provide reliable and well-managed investment opportunities for an aging workforce and growing number of middle-class retirees, an accelerated liberalization of China’s financial markets, especially in the insurance and retirement fund sectors, looks more and more likely.

However, an effective operation in China for UK fund managers and investment companies will also require additional reforms in China’s domestic capital markets and reduced capital controls, without which foreign institutions might face the same risks as domestic investors.

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During the 21^st century, measures to reduce poverty whilst improving healthcare, pensions and social services (including education and housing) have all moved up the policy agenda of the Chinese state. The Chinese Communist Party has shifted its goals from economic growth to ‘economic and social development’ – no longer are they focussed just on raising incomes, but now want to also provide services and safety nets.

The Party’s shift appears to be aimed at enhancing its legitimacy by realising ‘a moderately prosperous society’, and at reducing the protest and dissatisfaction that might threaten ‘social stability’. As China’s economic growth rates slow, attention has turned to quality of life along with concerns about the problems China will face as its society ages. There is also a commitment to China’s national development and a view that improving China’s economic and social health enhances its global status and influence.

The evolution of social policy since the 1990s

During the 1990s the Chinese party-state focussed on economic growth and state enterprise reform and, as part of this, reformed health insurance and pensions for urban workers – primarily the state sector. It also introduced means-tested income support and programmes for laid-off state enterprise workers to prevent urban protest (a particular concern in the years following the Tiananmen demonstrations of 1989).

But following the Asian Financial Crisis of 1997 and China’s entry into the World Trade Organisation in 2001, the focus began to turn to rural areas and the non-working urban population – now seen as a source of untapped domestic consumption and demand. The party-state introduced rural income support and pensions as well as cooperative medical schemes to help rural residents with their healthcare costs. It also introduced basic health insurance for the urban non-working population, made a commitment to a minimum of nine years of free education for all children, and announced major health care reforms.

Impressive achievements

China has seen huge reductions in extreme poverty, introduced universal entitlements to health insurance and pensions, and ensured steadily rising social services expenditure. Now categorised as an ‘upper middle income’ country by the World Bank, only 1.4 percent of the population lives on the international poverty line of $1.90 per day (2011 Purchasing Power Parity), a fall from 67 percent of the population in 1990. By 2010, China had extended health insurance and pensions across the entire population – for the first time establishing entitlements for rural residents. According to the OECD, public social spending in China has risen from 6 percent of GDP in 2007 to 9 percent in 2012. China’s government spending on health, education and social safety nets also increased in both real terms and as a share of total government spending over the decade to 2017.

Only 1.4 percent of the population live on the international poverty line, a fall from 67 percent of the population in 1990

Substantial problems remain

Despite the progress, China’s social problems are still enormous and social services remain problem-ridden. According to the latest World Bank data, from 2015, on the upper middle-income poverty line of $5.50 per day, 31.5 percent of the population remains in poverty – 430 million people. The quality of health care, education and housing varies enormously both within and between rural and urban areas – largely the result of fiscal decentralisation and policies that benefit the middle classes.

The quality of health care, education and housing varies enormously both within and between rural and urban areas

Public spending on health insurance and pensions, meanwhile, remains highly regressive, meaning that the most generous insurance schemes provide for the well off, and the least generous for the poorest in society. For example, from 1999 to 2006, although the number of people participating in publicly financed health insurance (mainly for employees in government and public institutions) was falling, this scheme still accounted for about 40 percent of the total government health budget. Meanwhile, overall public social spending remains considerably lower than the OECD average of 22 percent of GDP.

China has also set the goal of reaching rich country levels on indicators for infant mortality, maternal mortality and life expectancy by 2030

Ever more ambitious goals

Under Xi Jinping, the Party has continued to set ambitious goals. It aims to eli­­­minate absolute poverty by 2020 (using the national poverty line of 2,300 RMB per annum, or about a dollar a day). It has also set the goal – by 2030 – of reaching rich country levels on indicators for infant mortality, maternal mortality and life expectancy. It is pressing forward with primary care reforms in health and is introducing IT in education and has recommitted itself to increasing the quantity of affordable housing – something that has been promised for over a decade but not yet delivered on. It has also begun to tackle the very difficult problem of merging locally administered health insurance and pension schemes to reduce the divisions between urban and rural and increase mobility.

Achieving these ambitious goals and pushing through next-stage reforms will not be easy. The Party is mobilising both public and private sector firms as well as local governments to eliminate absolute poverty, and this goal looks achievable. But other initiatives will require substantial public investment and effort if vested interests are to be overcome. This is particularly evident in the health and real estate sectors, where local governments’ revenues tie them to such interests, making reform particularly difficult. Since Xi Jinping’s supporters argue that he has amassed power precisely so that he can tackle vested interests, social services may be an important test of the leadership’s commitment and ability to use their new powers for the public good.

Professor Jane Duckett is Edward Caird Chair of Politics at the University of Glasgow and Director of the Scottish Centre for China Research. Follow her on Twitter: @j_duckett.

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