New Chinese rules introducing tax deferrals on certain pension insurance products are set to boost revenues from domestic life insurers’ annuity business, but will also create greater asset-and-liability management challenges, said industry experts.

They were speaking to AsianInvestor as guidelines were issued this week providing details of how the new scheme will work, after the tax-deferral regulations came into force on May 1.

The regulatory change is aimed at boosting demand for pension schemes in China and will likely lead to more investment assets for insurance companies. It will also create more product diversification for life insurers and, to a lesser extent, increase revenue and profit for their annuity businesses, noted Zhu Qian, senior credit officer at rating agency Moody’s.

But it will also mean lifers will face the investment and longevity risks associated with annuity products, as the China Banking and Insurance Regulatory Commission has noted.

Hence the scheme is expected to bring about some adjustments to the overall asset allocation of insurers, although as yet they are still seen to be under consideration.

One large local insurer is currently thinking about product development rather than asset allocation tweaks, given that the rules have only just been introduced, a spokeswoman for the firm’s fund management arm told AsianInvestor.

Most insurers will be well positioned to manage the risks involved, said Wu Haichuan, head of retirement business for Greater China at Willis Towers Watson. Most of the products/annuities designed are quite conservative, he told AsianInvestor, and the authorities have been careful to ensure that protection-type products serve their purposes.

Reinvestment risk is the risk that interest income is reinvested at a lower rate than the original investment. Typically, the guaranteed rate of return on annuity products is deemed the best estimate of the rate at which interest income is re-invested.

Since annuity payouts are spread over a period of time, stable income streams from long-term assets are required. However, these income streams can be affected by an unexpected decline in interest rates.

Longevity risk is the risk attached to the increasing life expectancy of policyholders, which can eventually result in higher payout ratios than expected.

HOW THE SCHEME WILL OPERATE

Under a one-year pilot scheme starting on May 1, policyholders to pension insurance products will not pay tax on their contributions until they start withdrawing funds after retirement, subject to a cap of Rmb1,000 ($157) or 6% of their monthly taxable income, whichever is lower. 

Capital gains will also not be taxed during the contribution period. When withdrawals start after retirement, 25% of the withdrawn amount will be tax-deductible, with the rest taxed at a flat rate of 10%.

Once the contribution period ends, insurers must offer a fixed/guaranteed income to retirees as long as the policyholder is alive or for a minimum of 15 years.

Policyholders cannot withdraw money from the new tax-deferred annuity schemes before they retire, unless the individual is seriously disabled or if the policyholder dies and the beneficiary has to receive a payout.

Tax-deferred annuity schemes will form part of the third pillar of China’s pension system, which will be based on voluntary savings from individuals. Authorities are also promoting fund-of-fund (FoF) pension products to help build this pillar.

The three product categories that benefit from tax deferrals are those with guaranteed returns, principal-guaranteed products and products that offer returns based purely on investment performance (unit-linked plans).

The proposed tax incentives will translate into an immediate saving of up to Rmb450 per month on average over the contribution period, said Zhu Qian, senior credit officer at rating agency Moody’s.

The initial scheme will cover Shanghai, Fujian province and Suzhou Industrial Park in Jiangsu province.

These locations chosen are relatively well developed financially and will help to gauge the public's reception to the new measures, said Wu Haichuan, head of retirement business for Greater China at Willis Towers Watson.

*The regulators in question are the Ministry of Finance, the State Administration of Taxation, the Ministry of Human Resources and Social Security, the China Banking Insurance Regulatory Commission and the China Securities Regulatory Commission.