BEIJING (CAIXIN GLOBAL) - As the world's largest population rapidly ages, China is in a race against time to build a pension system capable of providing for its ballooning group of elderly.

About 18.9 per cent of China's 1.4 billion people were older than 60 as of the end of 2021. The proportion expanded by 5.64 percentage points within a year, according to data from the National Statistics Bureau. By 2025, people older than 60 will account for 20 per cent of the population and by 2035, 30 per cent, the Ministry of Human Resources and Social Security (MHRSS) projected.

But the country's pension system is struggling to keep up with the pace of the greying population. At the end of March, the accumulated balance of all types of pension funds - including those funded by the government, by employers and by individuals - totalled 15 trillion yuan (S$3.09 trillion), or 13 per cent of GDP. That compares with a pension system equivalent to 150 per cent of GDP in the United States, 130 per cent in Australia and 90 per cent in Singapore.

China has spent more than three decades building a modern pension system around three pillars - the basic state pensions, company annuities and personal pensions. The government-funded first pillar has grown into the dominant part of the pension net covering 1.03 billion urban employees and rural residents as of the end of March. But the second pillar, which is supposed to partly rest on employers, is much smaller, covering 72 million employees, or fewer than 10 per cent of the workforce. The third pillar, personal pensions, is still at an early stage and even more marginal.

A well-developed personal pension system is in urgent need as China faces growing threats of a pension fund drain and a precarious retirement for many people. The state-backed program is under mounting pressure to pay benefits to a growing number of retirees, especially when government coffers are squeezed by slower economic growth. Since 2016, at least six provinces in less developed regions have run out of local pension fund reserves, forcing the central government to provide subsidies.

"The sustainability of the existing pension system is worrying," said Lou Jiwei, China's former finance minister, in a recent lecture. The full-fledged launch of a personal pension system could unleash vast amounts of household savings and contribute to a better allocation of capital in China, experts said. It could bring as much as 120 billion yuan a year into asset management institutions if 10 million people participate, according to research by Guotai Junan Securities.

That would mean huge business potential for wealth managers at home and abroad. In late April, BlackRock's majority-owned joint venture in China launched its first pilot pension wealth management product.

"We think personal retirement wealth management products with longer investment horizons will be more attractive," said Tang Xiaodong, head of BlackRock China.

The third pillar of the pension system

Chinese leaders have made efforts over the years to bolster the third pillar to supplement the state-backed pension system. The State Council last month issued a document laying out a policy framework for development of the private pension system.

"The issue of personal pension policy is symbolic to China's pursuit to build a multi-level and multi-pillar pension system," said Li Zhong, deputy minister of the MHRSS.

The new policy paves the way for a 2018 personal pension pilot program to be rolled out nationwide. The trial was launched in several cities and offered modest tax breaks to people willing to lock up their money in pension products offered by approved financial institutions. But the public reception was lukewarm.

Under the new policy guidelines, all people covered by the state-run pension system can take part in the private pension pilot program and make voluntary contributions of as much as 12,000 yuan a year, which will qualify for unspecified tax relief.

The money can be used to invest in eligible products and be locked up in a designated account until retirement. Compared with the 2018 pilot program, the latest design of the personal pension system provides more investment options and makes it easier for participants to receive tax benefits, experts said.

But how well the program will be received by the public will depend on many details of implementation, which have yet to be released, experts said. In the next step, the central government will select some cities to carry out a trial run for a year before the program is rolled out nationwide. Relevant state departments will specify details about the tax incentives and which institutions are qualified to participate.

Under the latest personal pension program, participants need to set up a pension account on a government-run information management platform and a fund account with a qualified institution, such as a bank. They can transfer money into the fund account for investment in a range of eligible products and receive tax benefits.

The new policy marks two major changes from the 2018 pilot run. It shifts from a product-based approach to an account-based model that is more in line with international practice and makes it easier for participants to claim tax benefits. It also expands investment options to include deposits, mutual funds, commercial pension insurance plans, and wealth management products operated by banks or their subsidiaries.

Initiated in Shanghai, Fujian and Suzhou, the 2018 pilot program allowed participants to invest only in commercial pension insurance plans, making it less attractive. As of the end of 2021, only 50,000 people enrolled in the trial, investing a total of 630 million yuan, according to Liang Tao, deputy chairman of the China Banking and Insurance Regulatory Commission.

It is urgent for China to expand the coverage of its personal pension system, experts said. "A system in which a few people participate is ultimately lifeless," said Zheng Bingwen, director of the Centre for International Social Security Studies at the Chinese Academy of Social Sciences.

In need of supplement

China's population is ageing into retirement before the country is rich enough to support them, said Dong Dengxin, a professor at Renmin University in Beijing. In 1991, China outlined the three-pillar pension system plan. But the third pillar was long been underdeveloped even as a state pension shortfall became increasingly imminent.

In 2016, the state pension fund in the rust belt province of Heilongjiang in the northeast became the first to run dry as the local economy slowed, and more young people left. In 2018, the central government set up a mechanism to transfer funds from richer provinces to help poor regions to pay retirees. In 2022, 10 provinces received funding support from the central government to cover pension shortfalls.

To enhance the sustainability of the pension system, the central government since 2013 has made a series of policy arrangements including better coordination of funds and the transfer of 1.68 trillion yuan of assets from state companies to supplement the pension system.

The basic state pension program will remain the main pillar of China's pension system for a long time, experts said. But the shrinking portion of young population contributing to the program and the expanding expenditure on retirees mean it is in urgent need of supplement.

The second-pillar employer-sponsored pension plans, which have been in place since 2004, were expected to provide the main supplement to the state pension system. But the plans' growth has fallen short of expectations.

The employment annuities system includes two separate programs for company employees and civil servants, covering 72 million people. But the two programs have been growing at different rates, creating a widening gap among retirees. The occupational annuities program for civil servants expanded rapidly as a mandatory benefit offered by state employers.

However, the enterprise annuities program for workers at companies lost momentum in recent years because of less stringent requirements for employers. As of the end of 2021, 28.8 million workers and 117,500 companies participated in the enterprise annuities program, under which employers and employees jointly put money equivalent to up to 12 per cent of employees' pay to individual pension accounts, MHRSS data showed.

"Companies taking part in the enterprise annuities program are mainly large and state-owned companies," said Sun Jie, an insurance professor at the University of International Business and Economics in Beijing. "Most employees in small and medium-sized businesses are not covered."

Those left out by the annuities system may seek better retirement protection from the personal pension program. Those third-pillar plans should focus on low- and middle-income groups, especially the 200 million flexible workers without long-term employment, said Zhao Yaohui, a professor at Peking University.

But how attractive the new program can be remains a question. The State Council didn't provide details on tax benefits for the private pension system, but experts said they are expected to be similar to those of the pilot program, which offers participants some income tax exemptions.

Given that a large portion of Chinese people are already exempt from income taxes and the country levies no tax on capital gains, the attractiveness of the program may not be enough based on currently available information, experts said.

Experts said China's private pension system can adopt automatic enrolment and a default product mechanism to make it easier for more people to participate. They also suggested that policymakers link the private pension system with the second, employer-driven pillar, allowing the two systems to share information and increasing the tax benefits for participants.

Long-term capital

To bolster the second and third pillars requires not only proper policy design but also support from the capital market enabling sound returns, experts said. In 2019, funds from China's second and third pillars accounted for only 1.37 per cent of the country's stock market value, much less than the global average of 21.47 per cent, according to the Chinese Academy of Social Sciences.

The roll-out of the personal pension program is expected to bring more long-term funds into the capital market, analysts said. Zhongtai Securities estimated that the third pillar will account for 18 per cent of China's total pension funds by 2042 with a total size of 9.7 trillion yuan.

China International Capital Corporation (CICC) projected that the personal pension program will bring 18 trillion yuan to 27 trillion yuan of additional funds into the market in about 25 years. Whether there will be enough attractive investment products available will be the key to turning the projections into reality, analysts said.

Shortly after the cabinet issued its policy on the personal pension program, the China Securities Regulatory Commission encouraged the mutual fund industry to develop more products for pension fund investment.

An analyst at a brokerage also predicted that wealth management institutions and asset managers will put more emphasis on products for personal pension investments to seek new growth.

Financial institutions have moved to tap into the burgeoning market. Ping An Annuity Insurance, the pension-focused subsidiary of Chinese insurance giant Ping An Insurance (Group), said in late April that it is raising 10.5 billion yuan from its parent to "to support business development." A source close to the matter told Caixin that the company is planning to expand its private pension business with part of the new capital.

China's major state-owned banks are also preparing to launch a pilot program for retirement savings products in several regions, Caixin learned last week. The banking and insurance regulator will let the "Big Four" banks - Industrial and Commercial Bank of China, Agricultural Bank of China, Bank of China and China Construction Bank - offer the first batch of products, sources said.

But before Chinese households will invest enthusiastically in the third pillar, the government and industry will have to educate them as pension products, with low liquidity and longer investment time horizons, are new to many Chinese investors, experts said.

This story was originally published by Caixin Global.