Caring for those who've already served

Now that the Chinese government has settled the direction of health reform, it is turning its eye to pensions. China's problem is enormous. The number of people over 60 is increasing at more than 3 percent a year and proportionately faster than in most other countries.

The UN has forecast that by 2050 China will have more than 450 million people above the age of 60, that is about 30 percent of its population.

Unfortunately, unlike Western countries, China is entering this phase when more than 50 percent of its working population still don't have access to any kind of pension, and for many of those who have, it is or will be grossly inadequate.

The problem, however, set the central and local governments to work years ago. In 1997, the central government introduced a new pension scheme for people retiring from enterprises and public institutions. And thanks to an aggressive campaign to enroll (sometimes reluctant) employers the number of active contributors has gone up from 86 million in 1997 to over 160 million today.

Second, many local governments have introduced new types of pensions for migrant workers and farmers. In the case of farmers, offering matching subsidies to encourage farmers to sign up has worked successfully.

Third, the central government is already toying with the idea of introducing social pension. Many of the new rural pension schemes include the provision to pay a social pension to those over 60 with either no or small contributions from the beneficiaries or their children.

Finally, the central government has made efforts to refinance the system by setting up the National Social Security Fund (NSSF) as a reserve, supporting refinancing of individual accounts of the urban enterprise system in 11 provinces and raising the level of tax-financed subsidies to localities already running into deficit.

Though laudable, these measures do not add up to a strategy and there is a danger that piecemeal tinkering will only delay a more radical rethink. A pension strategy essentially needs to address four major issues.

The first is the balance between State-financed social pensions, mandatory contributory pensions organized by the State, occupational pensions (enterprise annuities) and voluntary private pensions -- the so-called pillar approach pioneered by the World Bank.

It is imperative that a national social pension scheme enables even those without any provision to have some income, although its full cost can be deferred by offsetting the entitlement of those in the urban system against their existing pensions (which are far higher than any minimum proposed).

I believe, along with most other analysts, that occupational and private pensions are an essential part of the system and need to be encouraged more by targeted tax concessions.

Second, the strategy needs to address the need for the system to be "joined up" - to enable a highly mobile population to move between different schemes and different localities. This has key implications for design and organization.

It would mean abolishing the increasingly meaningless urban and rural divide and replacing it with groups that are in an employment relationship (who can therefore make regular joint contributions with their employer) and those that are not - farmers, urban self-employed, contract migrant workers, who need to be in more flexible and highly elastic schemes.

This in turn will have implications on the role of the public and private sectors in terms of delivery. It is neither organizationally efficient nor fiscally sustainable for pensions to be organized by local governments.

It would be more efficient to organize the urban pension system at the level of province or "super" municipality, which would increase the size of pools, allow more sophisticated investment and reduce transaction costs significantly.

For flexible workers, it would be sensible to contract the management of their schemes to large private insurance companies, carefully regulated to control administrative costs but not regulated enough to throttle the benefits of competition.

The third aspect of the strategy concerns the individual account in the urban pensions system. When the system was introduced across the country in 1997, the contributions to individual accounts had to be used to finance the legacy costs of people retiring from the old system.

The individual accounts have been refinanced to varying degrees in 11 provinces, with part of the money being held by the NSSF and the other managed at local level.

In the other provinces the accounts have still not been funded, however. This system is messy, produces virtually no added value in terms of investment return and is costly to administer.

I would abolish the individual account, turn the urban pension scheme into one of defined benefit with entitlement based on perhaps a mixture of average individual salary and average local salary and make the adjustment of benefits related to the underlying health of the fund.

It is also vital to increase the period of contribution to 30 years (from the present 15) and to put in place steps to increase the retirement age.

Which brings us to the fourth and in some ways most difficult part of the strategy -- how to finance it. The system needs funding but it is important to remember it can and should be built steadily over time - after all pension commitments only fall due over a long period of time, and there is already in some localities some seed capital in the form of individual account balances and social pool surpluses.

To these could be added allocation of some shareholdings of State-owned enterprises (not just to the NSSF) to create equity portfolios for the new funds, and some of the large State holdings of foreign exchange which would help match a large external asset balance with a large internal liability.

It may also allow for a more disaggregated wind-down of some of China's large dollar holdings as the pension funds make rational decisions about how to increase returns.

Of course the proposed strategy is radical and makes a lot of demands on human and administrative capacity, particularly at the provincial government level. But if China is not to revisit this issue in 10 years time, a bold and brave strategy is indeed what is required.

The author is an expert on fund management with EU-China Social Security Reform Cooperation project

(China Daily 07/29/2009 page9)