Watsonwyatt.com.cn 华信惠悦咨询公司（上海分公司） Tel: 8621 5298 6888 Fax: 8621 5298 6889 Public Pension Fund Operation and Management: The case of China Yvonne Sin

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华信惠悦咨询公司（上海分公司） Tel: 8621 5298 6888 Fax: 8621 5298 6889

Public Pension Fund Operation and Management:The case of China

Yvonne SinHead of Investment Consulting, ChinaOctober 16, 2007

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2

Old Age Income Support in China

Dibao (minimum living standard guarantee)

Tier 1 Social pooling

Tier 2Individual accounts

Enterprise annuity/ Supplementary pension plan

Individual savings Voluntary personal

pillar III

Voluntary employer pillar III

Mandatory social insurance pillar I

Government provided pillar 0

Informal supportFamily support

pillar IV


3

Only 30% of working age population covered

State Organizations

Rural Pensions

Civil Servants

Urban Old-Age Insurance

In 2006, China had 764 million workers; 233 million workers were covered by one of the four government sponsored pension schemes; 531 million workers had no pension coverage.


4

Huge unfunded liabilities

0

2,000

4,000

6,000

8,000

10,000

12,000

14,000

Assets Liabilities

Am

ou

nts

in

RM

B (

bill

ion

s)

Source: Extrapolated from Sin (2005)


5

Other pension assets add up to Rmb 1 trillion

National Social Security Fund

283

Provincial reserves 549

Rural pensions 35

Others 90

Supplementary pensions 91

Unit: RMB in billions

Source: www.molss.gov.cn


6

Worsening system demographicsWithout coverage expansion

With coverage expansion

Source: Sin (2005)

2005 2010 2020 2030 2040 2050

Total contributors (000) 98,280 104,651 100,346 99,472 93,712 90,640

Male 57,431 61,149 61,275 60,842 59,389 56,525

Female 40,848 43,502 39,071 38,629 34,323 34,115

Old age pensioners (000) 45,053 57,327 79,863 98,963 110,950 115,785

Male 17,836 21,604 30,521 41,326 50,371 56,471

Female 27,217 35,723 49,342 57,637 60,579 59,314

System dependency ratio 45.8 54.8 79.6 99.5 118.4 127.7

2005 2010 2020 2030 2040 2050

Total contributors (000) 103,194 115,117 150,520 198,943 222,565 249,260

Male 60,303 67,264 91,913 121,685 141,048 155,444

Female 42,891 47,852 58,606 77,259 81,517 93,816

Old age pensioners (000) 45,739 60,291 93,151 129,208 161,523 183,462

Male 18,172 23,086 37,267 57,322 77,432 93,956

Female 27,567 37,205 55,884 71,886 84,090 89,506

Dependency ratio 44.3 52.4 61.9 64.9 72.6 73.6


7

Government’s actions

Big picture: Set up "dibao" for urban and rural Establish NSSF as "fund of last resort" Gradually and partially funding the Individual Accounts Promote Enterprise Annuities to supplement retirement income Promise to develop a social security system for both urban and rural

residents

Parametric changes: Modify accrual formula to discourage under-reporting of contributory

wage Remove incentive to reduce early retirement Amend amortization factor to be more or less in line with life

expectancy


8

NSSF – the fund of last resort

Injection from various sources– Fiscal allocation from central government– Capital and equity assets from reduction of SOE shares– Tax levied from lottery pool

However, mandate and when claims against funds are unclear

Also manages funds transferred from MOF for funded accounts on behalf of the provinces

Promise to provide a minimum return guarantee of 3.5% per year over any five-year period

Questions: What is NSSF’s governance structure? Does NSSF have the best practice model?


9

Provincial reserves

The slogan of “preserve value, add value” largely misunderstood at the provincial level

Permissible investments are government securities and bank deposits Provincial portfolios primarily in government bonds and NCDs with

banks including second-tier banks and those that might be in financial distress

Returns well below wage growth and further jeopardized by amounts invested in NCDs of insolvent banks

Now, there is desire for autonomy and latitude on permissible investments

But, clearly lack of investment management capacity and experience, transparency and accountability, as well as proper governance structure


10

Privately managed EA funds also restricted in scope

Asset

Categories

Liquid assets

Fixed Income

Equities2/ Total

Limits >=20% <=50%1/ <=30%3/ 100%

1/ at least 20% in government treasury bonds2/ includes unit trust and insurance products3/ no more than 20% of assets in direct stock purchases


11

Returns were well below wage growth

100

250

400

550

700

850

100019

90

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

Year

Acc

umul

ated

Val

ue

I nflation Wage Growth Term Deposit

RMB981

RMB220

RMB255


12

ROI’s impact on pension levels

0%

10%

20%

30%

40%

50%

-3% -2% -1% 0% 1% 2% 3%

Credited Interest > Wage Growth

Rep

lace

men

t R

ate

(as

% o

f O

wn F

inal

Wag

e)

Target Replacement Rate

Men @ age 60

Women @ age 55

Assumes contribution at 8% of wages for 35 years for men (30 years for women)Amortization at retirement is based on factors prescribed in Doc #38


13

Challenge: can ROI exceed wage growth?

Time

Rat

e o

f g

row

th Return on

assets

Wage growth

Time

Rat

e o

f g

row

th Return on

assets

Wage growth


14

NSSF no better

0

5

10

15

20

25

30

35

2001 2002 2003 2004 2005 2006

Realised gains Realised and unrealised gains Wage growth

(%)


15

NSSF’s asset allocation

¹ includes domestic and international investments in fixed income and equities

0

50,000

100,000

150,000

200,000

250,000

300,000

Dec 2000 Dec 2001 Dec 2002 Dec 2003 Dec 2004 Dec 2005 Dec 2006

Fund size in book value as at

(Rmbm)

Cash and equivalent Fixed income

Equity Outsourced¹


16

Internal versus external

0%

25%

50%

75%

100%

Dec 2000 Dec 2001 Dec 2002 Dec 2003 Dec 2004 Dec 2005 Dec 2006

Internally managed

Outsourced


17

National Social Security Fund

Pragmatic approach to adding new asset classes and strategies Broader array of permissible investments Open minded towards innovative investments

But, Funds managed from an asset return perspective Unclear liability profile and liquidity requirements Incompatible investment strategy with governance model Diversification constrained by regulatory limits Not fully marked-to-market Requirement to provide minimum return guarantee to provinces Possible threat that the fund may be used for more than just pension

obligations Difficulty in retaining the few experienced staff and investment talents


18

Investment policy and governance

Public funds have often been constrained by mandates and restrictions– Forced purchase of government bonds– Prohibition/limitation on foreign or equity investments – Requirement to provide minimum return guarantees

Governing boards typically lack investment and other relevant professional competence

Accountability is often weak– Disclosure and reporting standards are absent– Governing body is not subject to supervision– Standards for performance are not well-defined


19

Need enabling environment

Change the traditional mindset Build the necessary infrastructures Strengthen the regulatory environment Create proper incentives


20

Without enabling environment

If no changes are made to improve investment policy, develop the necessary institutions or undertake concurrent reforms, this will likely lead to: Significant fiscal input Low investment return Inadequate levels of pension Risk of potential loss of the accumulated fund Further subsidy by government


21

With enabling environment

Professional investment boards Market-based investment mandates (with foreign

investment) Establish clear investment policy statements taking

account of risk and return preferences Rigorous reporting and disclosure Use of professional asset managers with clear

monitoring criteria, and rules to reduce potential conflicts of interest


22

How can ROI exceed wage growth? Be mindful of costs as high fees negate returns, so be mindful of

front loaded and back loaded fees as well as periodic expenses Fixed interest products provide guaranteed nominal returns but

difficult to provide inflation protection and unlikely to catch up with wage growth

Well diversified portfolios have higher probability to catch up with (or even exceed) wage growth but must manage downside risks and avoid large losses

Adopt investment options that can customize to the retirement needs of members (different age/income groups)

Establish process that allows independent and professional decision making

Adopt and refine a proper governance model

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Watsonwyatt.com.cn 华信惠悦咨询公司（上海分公司） Tel: 8621 5298 6888 Fax: 8621 5298 6889 Public Pension Fund Operation and Management: The case of China Yvonne Sin