Of the various policies that China's President Xi Jinping has vowed to prioritise in the next five years, pension reform could be among the most significant.

Much like the West, China has an ageing population, so there is a pressing need for pension reform before funding pressures become too great, delegates attending the country's 19th ruling party congress heard over the past few days.

There are many shortfalls in people’s livelihoods, including their pension arrangements, and the government will plan for pension insurance nationally as soon as possible, Xi said last week, as the Communist Party of China’s congress got underway. 

He was followed on Sunday by the country's top pension official, who outlined the government's broad agenda, with more changes likely to follow, covering both the sourcing of capital for pension funds and their investment management.

Yin Weimin, China's minister of human resources and social security said the country faced a fast-growing pensions burden and that the government is working on ensuring a sustainable system of pension provision for its ageing population.

Chinese people aged 60 or more exceeded 230 million as of the end of 2016, accounting for 16.7% of the overall population. That proportion has grown significantly in recent years and is getting bigger; whereas in the 1990s there were five working people in China for every retired person, the ratio is now just 2.8:1, Yin said.

With that ratio set to continue falling the funding pressures on the country's pensions will be huge, Yin said. (A summary of Yin's press conference is available on the ministry’s website). 

Three key areas

To tackle the growing challenge, the Chinese government has outlined three key areas of reform.

First, as Xi indicated the government will plan to ensure sufficient funds are set aside nationally.  China’s public pension funds (PPF) overall have Rmb4 trillion ($603 billion) outstanding, which is sufficient for the nation’s pension payments for 16 months, but payment abilities vary across different provinces.

For example, the northernmost province of Heilongjiang has the biggest payment challenge, with 1.3 working-age people for every retired person, while Guangdong province has the least burden, with the ratio at 9:1. So with an overall planning strategy the central government will be better able to mobilise pension funds between different provinces, Yin said.

The second area of change is in the investment of PPF. In a new scheme started in October last year China allowed the National Council for Social Security Fund to manage the PPFs, which were previously owned by individual provinces, to help improve returns. There have so far been eight provinces that have mandated the NCSSF to help manage their investments, covering more than Rmb400 billion in funds in total, Yin said.

Thirdly, the government will transfer some state-assets to social security funds in future to help enlarge the available pool of capital, he added.

Creating incentives

Increasingly the asset management community in China is openly discussing what can be done to help expand the capital pool and improve the investment returns of the country’s pension assets.

The Asset Management Association of China (Amac) set up a dedicated pension fund committee to help improve China’s retirement system on September 6.

Wang Zhongmin, vice chairman of NCSSF, said at the new committee that the provision of commercial pension insurance -- a key pillar of the Chinese pension system, together with PPF and enterprise annuities -- could be better developed if the government provided account holders with the right incentives. 

That includes tax benefits and greater flexibility when it comes to investing, Wang said.

To help improve investment returns, pension funds themselves should improve their internal management, Xiong Jun, chief economist of Tianhong Asset Management, said at a conference on October 10, following the release of an academic report on the development of Chinese pension provision.

One potential area of reform are the incentives given to managers of asset owners , who are often only appointed for fixed terms and so tend to focus on delivering stable returns with low levels of volatility, which may not be good for the fund in the long run.

So how to incentivise managers so they invest in higher risk assets that help to improve the long-term performance of funds is one important question, Xiong said.

Another problem is that some pension funds adopt a “survival for the best” mechanism for asset managers that run their mandates and eliminate managers that have the worst performances in a year or two. But, as Xiong noted, investment performances are often not consistent. So a manager whose performance is in the top 20% one year could be ranked in a worse category the next year, since the investment returns can be influenced by several factors including asset risk exposures, market conditions, investment styles, and strategies, Xiong said.

So though it’s necessary that pension funds adopt the elimination mechanism, it should not be based solely on investment returns, Xiong said.

For now, though, all eyes are still on the Chinese government and its closing showpiece event. With Xi's commitment to reforming China's pension system still ringing in their ears, delegates at the Communist Party of China's congress are scheduled to choose a new politburo standing committee today (Wednesday). This is the top decision-making body that will determine the progress of a wide range of key economic and financial reforms over the next five years, not just on pensions.