Practical analysis for investment professionals
19 February 2014

Pension Reforms in China — A Race against Time

This post was contributed by Stuart H. Leckie and Rita Xiao, CFA, Chairman and Consultant, respectively, at Stirling Finance Limited, an independent research and consulting firm focusing on the pension fund and asset management industry in Hong Kong and mainland China.

China is a very large, complex, and fast-changing society, facing difficult challenges to provide sufficient old-age pensions for its 1.35 billion citizens. In the past three decades, the long standing one-child policy, with gender imbalance as its side effect, plus much improved longevity, has significantly accelerated China’s aging process. As characterized by the saying “Growing old before getting rich,” China is now facing a looming pension crisis and is in an urgent race against time for pension reforms.

Realizing the latent pension realities, the Chinese government started to reform the pension system in the 1990s, with the focus on building a multi-pillar pension system for urban employees, broadly in line with the World Bank’s five-pillar model (PDF). Furthermore, a new rural pension system was initiated in late 2008; and the residents’ pension scheme, targeting urban citizens not eligible for the urban employees pension system, was launched in July 2011. These two latter reforms, initiated on a voluntary basis at first, are expected to become compulsory for their respective constituents by 2020.

More recently, the Communist Party’s Central Committee decided in the third Plenary to allow urban couples to have two children if only one of the parents is a single child. However, doubts have been cast on the effect of this change in the light of the current trend towards smaller families in Asian cities such as Hong Kong or Singapore, due to the continuously rising cost of living and job-related pressure for women. This minor change will scarcely save the country from adverse demographic trends; for example the working age population is now shrinking as a proportion of total population. China is therefore seriously considering options for future pension reforms.

There are always two dimensions in a pension system: design and financing. In terms of design, the nationwide urban system is rational, as it aims to cover the full population when complemented by the other two systems. However, benefit levels differ considerably for these three systems, and also vary significantly among cities and provinces, so that portability issues between them remains a huge problem. Meanwhile, special generous arrangements still apply to civil servants and public servants, while migrant workers are left largely uncovered by pension systems, resulting in perceived unfairness by citizens.

On the financing side, although significant assets have been accumulated in Pillar Ib (i.e., the individual account part of the urban pension system), the funding of “empty accounts” is still a major concern. However, the successful expansion of the National Social Security Fund (NSSF) since its inception in 2000 is a major resource in China’s pension development. As a “fund of last resort” to support pension financing difficulties, the NSSF is also at an experimental stage to manage some individual account money, and this may lead to changes in the investment scope for all state pension assets in the near future. However, other than the pilots mandated to the NSSF, state pension assets can only be invested in bank deposits and government bonds, resulting in an average 2% per annum return over the past decade, much lower than the original expectation of matching the rate of long-term salary escalation in China. The result of these abysmal returns is that pensioners will only receive perhaps a quarter of the expected individual account pension.

In addition, given the enormous size of China, together with the economic and cultural diversity across the nation, implementation issues for a unified pension system add a third dimension facing numerous challenges and difficulties.

In the race against time to improve China’s pension systems, certain reform items have been agreed to in principal and recorded in state documents:

  • To relax the one-child policy for the urban population nationwide;
  • To progressively increase the retirement age, and/or pension age, and/or compulsory pension contribution period;
  • To uplift the pooling level for state pooled pension assets first to the provincial level, later to the national level;
  • To direct more SOE profits into the NSSF to increase reserves for pension liabilities in future.

Additional reform items on the agenda are now being discussed:

  • To put in place a mechanism to recognize the trend of improving longevity with a gradually increasing retirement age;
  • To progressively fund all empty individual accounts;
  • To enhance the current unsatisfactory individual account returns through a wider range of investment channels;
  • To improve portability among different locations and different pension systems, aiming at unifying the whole pension system in the second half of the century.

In our opinion, a perfect pension system should ideally:

  • Provide an integrated long-term approach to ensure adequate retirement income;
  • Recognise changing employment structure, family patterns, and personal interest;
  • Maximize coverage and participation;
  • Lead to a savings culture by individuals;
  • Increase national savings and engender economic growth;
  • Have widespread support from the community and policy makers;
  • Have an effective regulatory structure;
  • Be simple to understand.

In order to effectively carry out all pension reforms with world-class coordination at all levels, a China Pensions Regulatory Commission should be established as a new regulator specifically for the pension sector, and should take over full responsibility and oversight for pension design and financing in China.


Stuart Leckie will be speaking at Reforming the Pension System in Mainland China at the HKSI Training Centre on 7 March 2014. A limited number of free seats are available for CFA Institute members to attend. Register now.


Please note that the content of this site should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute.

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