China’s new rules around enterprise annuities (EAs) look unlikely to reach their aim of encouraging individuals and companies to pump more money into the aenemic pension fund system, say market experts.

Enterprise annuities (EA) are a set of ‘second pillar’ pension insurance schemes to supplement the country’s social security fund. Under this pillar, employees and employers contribute voluntarily to personal retirement accounts. The new measures, which come into effect on Thursday (February 1), replace the trial rules, released in January 2004.

So far EAs haven't been very successful. The schemes cover less than 3% of the country's workforce population of about 900 million.

At the end of 2016, there were 76,000 corporates who had EA schemes, with cumulative assets totalling Rmb1.1 trillion ($174.95 billion). The schemes covered 23.25 million employees in China, according to the report on the development of social insurance in China for 2016, published in May 2017.

The new rules seek to "promote the development of EA". They lower the maximum contribution limit, while making the contribution status and entitlements of the employees more specific.

The employers’ contribution has been capped at 8% of an employee’s total salary over the previous year, while the total contribution from employers and employees is capped at 12% Previously, corporate contributions were capped at 8.3% of the previous year’s salary, and the total contribution was capped at 16.6%.

The intention of the reduced top-level contributions is to attract more companies to participate, by lowering their maximum exposure. Additionally, the defined contributions from employers and employees will be negotiated by both sides, according to the new measures.

The contributions will be managed by a council (the trustee) comprised of representatives from both sides, according to the new rules approved by the Ministry of Human Resources and Social Security (MOHRSS) and the Ministry of Finance (MoF) in December 2016.

Limited impact

Experts say these measures are still not enough to improve overall contribution levels and corporate participation rates in the EA funds.

“Not many companies were paying the maximum contributions, so I don’t think it’s going to affect a lot of people,” Stuart Leckie, owner of Stirling Finance, an independent consulting firm in Hong Kong, told AsianInvestor.

Over the past decade, most Chinese employers and employees have yet to hit the upper limit of 8.33% with their respective contributions, so lowering that limit will not bring about much change, Serena Wu, head of retirement business for China at Willis Towers Watson (WTW), told AsianInvestor.

Stirling Finance’s Leckie noted that the EA schemes investment options have been limited. Contributions into the scheme could only be invested in cash, local bonds and local equities. International investments are prohibited, he said.

If they liberalise the investment restrictions and give proper tax relief, as well as educate people about what the EA schemes are, they will grow more rapidly, he said.

Tax incentives would be very helpful to persuade more people and companies to invest into the EA schemes. Unfortunately, China's current tax incentives are quite limited when compared with those offered in developed countries, AsianInvestor has reported.

The EA scheme’s maximum pre-tax income deduction is 4%; that compares to the US’s 401(k) and Individual Retirement Account pension plans, which offer deducations of 37% and 11%, respectively.

Despite these warnings about the dangers of insufficient tax incentives,  China has not proposed any changes to the taxation of the EA scheme.

However, WTW’s Wu believe that the new rules will encourage more corporates to set up EA schemes because the government has sent signals that it wants more corporates to put together EA schemes in the new document. 

Limited options

Another problem with the EA schemes is that they have relatively limited investment options. 

With several restrictions on equity investments under the EA scheme, as much as 80% of the assets are invested in domestic fixed-income products. Therefore, returns fall off a cliff when the bond market fares poorly, Wu Haichuan, head of retirement business for Greater China at Willis Towers Watson, told AsianInvestor.

That could explain EA schemes’ low investment return of 3.03% in 2016, when bond markets in China experienced a sell-off towards the end of the year. The scheme returned 9.3% and 9.88% in 2014 and 2015, respectively.

Key highlights of the EA scheme

  1. Contribution limits
  • Employers’ contribution is capped at 8% of an employee’s total salary in the previous year, while the total contribution from employers and employees is capped at 12%. The defined contributions from employers and employees are negotiated by the two parties in each company. In the trial rules, corporate contribution is capped at 1/12 (8.3%), while total contribution from employers and employees is capped at 1/6 (16.6%).
  • Employers’ maximum contribution for a single employee should not exceed five times of the average contributions for all employees
  1. Circumstances for termination, suspension and resumption of contributions
  • The EA scheme is terminated if the corporate shuts down or files for bankruptcy.
  • If a corporate is unable to pay contributions for the current period due to operational losses, reorganisation, merger and acquisition and other matters, it may suspend contribution upon consultation with its employees.
  • After the employers and employees resume their payment of contributions, they may make up for the contributions due.
  1. Vesting scales and withdrawals
  • Employers can negotiate with employees on at what time the latter can claim partial or full ownership of the EA. Employees have to wait for no more than eight years before claiming full ownership.
  • Employees who “completely loss the ability to work” can make withdrawals from their personal accounts, in addition to the conditions of reaching retirement age, migration and death set in the trial rules.

Funding gap

China needs to improve the appeal of the EAs, as part of its need to deal with a growing pensions burden.

While the country had roughly 7.6 workers for every retiree in 2016, this is expected to fall to 2.1 workers per retiree by 2050.

China’s retirement system comprises three pillars. The first pillar is the National Social Security Fund and provincial public pension funds (PPFs); the second is made up of EA and occupational annuities (OA); and the third covers individual pension schemes. The second pillar contains the voluntary EA scheme for both state-owned and private companies, and OA, a compulsory retirement scheme for civil servants.

China faces a large and growing challenge with respect to its pension liabilities under the first pillar. As AsianInvestor has reported, 13 local governments, representing almost a third of the country’s 1.4 billion people, are unable to cover their pension liabilities out of worker contributions, so will have to lean on fiscal budgets. 

The third pillar is still in its fledgling stage. The China Securities Regulatory Commission (CSRC) released a consultation paper on using fund of funds (FoFs) to spearhead the development of the third pillar of China’s retirement industry in November last year.