In Depth: As China’s State Pension System Strains, Companies Must Step Up

China's state-supported pension program faces increasing difficulty in managing payouts to an escalating number of retirees as economic growth slows. This has heightened interest in the second pillar of the Chinese pension system: enterprise annuities. These are employer-sponsored pension plans intended to supplement the state-run basic pension system, yet they cover only a small fraction of China's workforce due to various impediments.[para. 1][para. 2][para. 3]

As of late 2023, only 141,700 companies provided enterprise annuities, covering a mere 31.44 million employees, less than 7% of the corporate workforce. The limited uptake is partly due to the complex setup process involving negotiation with employees, obligatory approvals, financial qualifications, and other thresholds which most SMEs find burdensome.[para. 4][para. 5][para. 8][para. 9]

China’s three-pillar pension system relies heavily on its first pillar, the basic state-run pension. This covers over a billion people but is under growing strain to balance income and expenditure. The second and third pillars—enterprise annuities and personal pensions—are essential to enhance overall retirement benefits and increase the replacement rate, which is significantly lower than the global benchmarks set by entities like the World Bank.[para. 6][para. 7][para. 9]

One problem facing the expansion of enterprise annuities is the relatively low tax incentives and high contribution burdens, especially compared to international standards. China's EET tax model for enterprise annuities does not sufficiently attract enterprise participation due to its limited tax benefits. High employer contribution rates to the basic pension system further discourage participation as they remain high despite fee reductions in 2019. SMEs, in particular, tend to prioritize immediate employee income over long-term benefits from annuities due to these financial pressures.[para. 10][para. 11][para. 12]

The second pillar’s enterprise annuities have seen limited capital growth, registering an annualized return of only 6.26% from 2007 to 2023. These returns surpassed inflation but were lower than general economic growth and some other regional pension funds. Accounting for a smaller equity allocation in their portfolios compared to international peers is one of the limiting factors. Policy reforms have recently eased restrictions, allowing higher equity allocations in hopes of boosting investment strategy dynamism.[para. 13][para. 14][para. 17]

China's approach to enterprise annuities is evolving, with experts advocating for a shift from a voluntary system to a more comprehensive, multi-tiered pension system integrated with broader policy reforms. Proposals include automatic enrollment with provisions for opt-out, similar to systems in countries like Sweden, Finland, and the Netherlands, where coverage exceeds 80%. Such measures aim to extend enterprise annuities' reach, especially into small to medium enterprises, marking potential advancement toward a mandatory or quasi-mandatory model.[para. 15][para. 16][para. 19]

Overall, there is a consensus that integrating enterprise annuities into China's pension framework is crucial for reducing reliance on the first pillar. The transformation of annuities from supplementary to essential components of pension security is essential in diversifying risk and securing retirees' futures in an aging society, while also seeking to match financial sustainability with economic realities.[para. 20]