China’s latest efforts to reform its pension market could help the country improve its rate of retirement savings, but it needs to pursue even more changes if it is to avoid a massive pension deficit, say industry experts.

The nation is slowly reforming its three pillar retirement system by trying to coax individuals to save more in retirement accounts – its so-called ‘third pillar’ of pension vehicles, to help make up for a drastic funding shortfall in its basic social security pension.

Market observers expect to see a one-year pilot scheme for third pillar pensions, which was first introduced in May last year, to be extended imminently.

Mainland fund manager China AMC’s chief executive officer Yimei Li told AsianInvestor she believes “the release of the third pillar will be a new starting point for the Chinese fund industry, which will bring about tremendous changes”.

Li acknowledged the Chinese government needs to do a lot more to expand the pension market as quickly as is needed. The country’s entire public and private pension assets totalled around Rmb10.5 trillion ($1.6 trillion) at the end of 2017, according to the Chinese Academy of Social Sciences (CASS). By contrast, the US retirement system has about $30 trillion of assets, or 20 times the amount of assets to support roughly one quarter the amount of people.

Even taking into account China’s overall lower cost of living compared to western countries, its pension pot is insufficient for the needs of its aging population, Wina Appleton, retirement strategist with JP Morgan Asset Management in Hong Kong, told AsianInvestor.

“In China the pension assets over GDP number is about 12%, whereas in the US it is 150%, so there’s a drastic difference.”

FIRST PILLAR FAULT

China’s biggest pension problem is that its population is quickly aging. Appleton noted that in 1980 the country had 10 workers to support one retiree, but this ratio has fallen to five to one today. By 2050 it will weaken further to two to one. As a result, Appleton’s research on strengthening pension systems projects that China will run out of first pillar pension assets by 2033.

In addition, the country is overly reliant on a traditional first pillar basic pension provision that doesn’t have enough money, and isn’t returning enough. First pillar pension assets are mainly conservatively invested in cash and Chinese local government bonds, which means they only returned around 3% over a 10 year period. The National Council for Social Security Fund (NSSF) which manages the pension assets, is now being encouraged to invest more in stocks and risk assets to boost returns.

The Chinese government has introduced a central redistribution system to move pension funds from provinces with a surplus towards those with a funding deficit, but Appleton noted that over one-third of provinces still face a shortfall despite these efforts.

Countries facing a first pillar funding shortage typically encourage second pillar, or employer-sponsored pensions. But while China has done this, introducing enterprise annuities (EA) and occupational pensions (OA – for civil servants) over the past decade, they have not been massively successful. All-told, EA and OAs cover just 24 million and 37 million people respectively, less than 10% of the potential market.

Yimei Li, China AMC
 

That has led the country’s financial authorities to increasingly pin their hopes on developing third pillar pensions, which are comprised of individual voluntary savings. In May 2018 the Ministry of Finance introduced a one-year pilot scheme for tax-deferred commercial pension insurance in Shanghai, Fujian province and the Suzhou Industrial Park zone.

According to Norman Yu, a research consultant at EY in Shanghai, people in the pilot areas can deduct contributions to qualified commercial pension plans from taxable income, up to a specified cap. Salaried individuals have their allowable deduction amount capped at the lower of 6% of monthly salary or continuous labour remuneration of Rmb1,000 ($157) a month.

With the one-year trial period just concluded, market players anticipate the Ministry of Finance will extend the scheme and expand it to include pension target funds. AsianInvestor was unable to get a response from official Chinese sources about this potential extension.

But even if the tax-deferred commercial pension insurance idea does take off, the contribution amount and tax incentives are fairly paltry.

Worse, the government reduced the mandatory contribution rates of Chinese companies into the first pillar from 20% to 16% after employers complained about making the payments in a slowing economy. “This may temporarily help ease the economic burden, especially on SMEs (small and medium enterprises), but it does not bode well for long term sustainability,” said Appleton.

FURTHER REFORMS

Meanwhile, local asset managers have been launching target date funds to cater for the expected growth in demand for pension-target products. Since the fourth quarter of 2018, the China Securities Regulatory Commission (CSRC) has approved several batches of funds that pursue either target-date or target-risk strategies in a fund of funds structure.

Target date funds shift their investments as individuals age, moving from higher allocations to riskier but potentially higher earning assets when they are young to a more defensive allocation as they near retirement.

There’s still a lot of things to be ironed out, such as the tax status of these funds. But if the pilot for pension insurance products turn out to be a success, the authorities could well extend tax deferment benefits to target-date or risk pension funds, said Appleton.

China’s regulators could also stimulate target pension funds by accelerating the approval process. Li confirmed that China AMC currently has to get approval from the regulators for one fund at a time, and “we do not have any information from the regulators about expediting this process”.