Abstract: In this paper, the author first examines different models of pension funds asset management worldwide and explains the differences between budget-based, market-based, and hybrid management models. Diving into China’s pension schemes, he points out the inappropriate gap between sovereign and family pension funds and a too-low share of the latter. He believes with China’s introduction of an individual pension scheme in 2022, family pension wealth will see booming development, a critical factor in helping the country cope with the accelerating population ageing.
Abstract: In this paper, the author first examines different models of pension funds asset management worldwide and explains the differences between budget-based, market-based, and hybrid management models. Diving into China’s pension schemes, he points out the inappropriate gap between sovereign and family pension funds and a too-low share of the latter. He believes with China’s introduction of an individual pension scheme in 2022, family pension wealth will see booming development, a critical factor in helping the country cope with the accelerating population ageing.
I. DIFFERENT MODELS OF PENSION FUNDS ASSET MANAGEMENT
To start with, I’d like to make clear some definitions. By public pension, I mean the first pillar of pension insurance, the statutory and basic pension. By private pension, I refer to both the second pillar, which consists of work-related pension schemes, and the third pillar, the individual pension insurance. The second pillar can be defined benefit (DB) or defined contribution (DC), and the third pillar assumes DC.
Since the establishment of the pension system in Germany in 1889, pension insurance systems have evolved and improved worldwide. From the perspective of wealth management of pension funds, today, there are mainly two investment models: one is the Greek model, also known as the budget-based management model, having nothing to do with wealth management; the other is the North American model featuring market-based wealth management, represented by Canada and the United States, and boasting a huge asset scale.
To be more specific, the budget-based management model is represented by Greece. The first pillar of pension insurance adopts the traditional pay-as-you-go system, which does not aim at the scale of wealth accumulation and normally requires payment ability for three months. Concerning wealth management strategies, all pension funds are used to buy government bonds. They are fully public finances. The country’s second pillar of pensions was established in 2001 and has remained on a very small scale. Greece does not develop a third-pillar pension. The Greek model is characterized by the absence of a financial market for pension funds.
Canada represents the market-based wealth management model. The first pillar of pensions adopts a radical pay-as-you-go system. While pursuing a vast scale of assets, its pension system is able to pay for nearly five years. It adopts market-oriented and professional investment approach and is open to global assets, and the pension system is fully exposed to the financial market. The second and third pillars also weigh heavily in Canada with assets equivalent to 100% and 60% of GDP, respectively. The financial market for pensions is so developed that the reform of Canadian pension funds is known as Maple Revolutionaries. The market-based management model is characterized by both the timely payment of basic pensions and a very well-developed financial market for pension funds.
In addition to the above two models, there is a third one, hybrid management, which is in between the first two, represented by the US. The first pillar implements a modified pay-as-you-go system. Under this model, pension investment also pursues asset scale, which is able to pay for nearly three years. However, it does not implement a radical market-oriented reform like Canada. Its pension funds are used to buy treasury bonds. The pension system has strictly stuck to fiscal attributes and keeps away from the capital market.
Like Canada, the US has very large second and third pillars of pensions, with the second pillar's assets equal to 110% of GDP and the third pillar 60% of GDP. This hybrid management model is characterized by a highly developed pension financial market.
II. SOVEREIGN PENSION FUNDS AND FAMILY PENSION FUNDS TO COPE WITH POPULATION AGEING
An important feature of China's pension system compared to other countries is the relatively high share of sovereign pension funds. Globally, excluding Norway, which holds sovereign pension funds of $1 trillion, the average global sovereign pension fund accounts for only 0.5% of global GDP; when Norway is included in the calculation, the ratio rises to 1.5%. However, China's sovereign pension funds account for 2.5% of its GDP. If the first pillar pension of more than $6 trillion is regarded as contributory sovereign pension funds, they would add up to 7.5% of the country’s GDP.
China's sovereign pension wealth also appears small compared to countries with market-based management models, both in terms of the years of payment and as a percentage of GDP.
The issue is that China's sovereign wealth in pensions is larger than household wealth. China's pension wealth needs to be better structured and benefit its people, narrowing the significant difference between China and other countries.
As the National Medium and Long Term Plan for Actively Coping with Population Ageing (hereinafter referred to as the “Plan”) states, "the social wealth reserve for coping with population aging should be consolidated." China has intensively proposed developing a multi-level and multi-pillar pension insurance system over the last two years, as emphasized in the report of the 20th National Congress. China will develop both sovereign wealth and family wealth pensions, as well as close the gap in terms of family wealth pensions.
According to international practice, household wealth pensions include occupational pensions (second pillar) and private pensions (third pillar), not the state pension (first pillar) that come as equity accumulation under the pay-as-you-go financing method, where people live to have a source of pensions.
In China, both sovereign wealth (sovereign pension fund + public pensions) and household wealth have a smaller share of its GDP in comparison with other mixed and market-based countries. Six Anglo-Saxon countries have the highest share of household pension wealth, and the P7 (seven largest pension markets) also have a significant share, followed by the G7.
China's household pension wealth is only 2.5% of GDP, compared to a global average of 72%, 91% for the G7, 117% for the P7, and 129% for Anglo-Saxon countries. This demonstrates two problems: first, China's pension wealth is too low as a percentage of GDP, and the gap is enormous; second, China's pension wealth is structurally imbalanced between sovereign wealth and household wealth, with the former being greater than the latter, whereas the opposite is true in developed countries.
III. THE DISPARITY IN PENSION “HOUSEHOLD WEALTH” BETWEEN CHINA AND DEVELOPED COUNTRIES
Gross Pension Wealth, or GWP, is the total value of a country's retirees' average lifetime pension, expressed as a multiple of the average social wage.
China has one of the highest levels of GPW among OECD countries, with a GPW of 18, i.e., China's pension is 18 times the average social wage, compared to 7 times in the US. GPW, therefore, measures the cost of spending on a country's pension, rather than the wealth reserve to cope with an aging population, and is therefore not the same as household wealth.
Private pensions account for only 0.3% of the net wealth of urban households in China, a percentage that is 82 times higher in the US, 79 times higher in Canada, and 138 times higher in the UK. If rural households were included in the comparison, the share for China would be even lower, probably less than 0.2%.
In contrast, in developed countries, household retirement assets are around 25% or even higher as a percentage of net wealth. Property accounts for 60% of Chinese household wealth, compared to 1/4 in the US, 1/3 in the UK, and less than 1/2 in Canada. With an aging population, the value of household wealth in the form of property will inevitably decline. Improving the composition of household wealth should be prioritized, and a personal pension system will be a significant step forward.
IV. A NEW PHASE OF "PENSIONS FOR THE PUBLIC" AS "FAMILY WEALTH”
China's pension wealth management has gone through three phases since the start of the reform and opening up in 1978.
Phase 1(1986-2003): Budgetary Management
? The primary goal was to ensure payment.
? Low accumulation.
? Pensions did not enter the investment market.
? The National Social Security Fund was established in 2001 with only a few ten billions yuan
? There was no pension financial market.
Phase 2(2004-2021): Primary Market-Based Management
? Corporate and occupational pensions were established as the second pillar, which is trust-based with defined contribution and market-based investment.
? Pension wealth accumulation accelerated.
? China’s Social Security Fund (SSF) grew rapidly.
? The investment system for public pensions was reformed to be more market-oriented.
? A pension investment market ecological system was established.
? Sovereign pensions were established.
Phase 3 (2022-present): New Market-Based Management
? The third pillar of the personal pension system is in place.
? The three-pillar pension structure is set up.
? The conditions for the joint development of "sovereign wealth" and "family wealth" are in place.
? The third pillar has created the conditions for the vigorous development of pension family wealth, and a new phase of "public pension" has arrived.
Although the second pillar is part of the family wealth of pensions, the theoretical value of the number of people in China who can set up corporate pensions is much lower than the number of people who can open individual pension accounts, because the labor market in China is typically "dualistic," with a limited number of people in formal employment and more than 200 million people in flexible employment.
Personal pensions cover both groups, while corporate pensions only cover the former. Personal pension accounts under the third pillar can be opened by 470 million urban and rural workers who are covered by basic social insurance. The introduction and establishment of the third pillar of personal pensions have allowed China to enter a new phase of truly public pensions.
Besides, the Plan points out that by 2035, the institutional arrangements to cope with population aging should be more scientific and effective, and the social wealth reserve should join the ranks of high-income nations. The third pillar of personal pensions, as one of the "family wealth," is an important part of the social wealth reserve to deal with the aging population.
Therefore, theoretically speaking, by 2035, the third pillar "family wealth" reserve will be pivotal to China's ability to enter the ranks of high-income countries in coping with an aging population.
The willingness of residents to participate and how to attract their participation is the key to making the personal pension system work and to the true development of a multi-layered pension insurance system. The second pillar (corporate pension + occupational pension) covers 58 million people in total. It has been two weeks since the personal pension system was launched and implemented (editor's note: the author's speech is dated 11 December 2022), and the number of daily account holders has surpassed one million; by this count, there are at least ten million account holders.
Data from home and abroad shows that if a new pension system is flawed in its design, the development of its participation rate is cyclical, beginning with euphoria and progressing through flattening, decay, and stagnation in that order. Since 2015, corporate pensions have almost always been stagnant, and it will be difficult to break out of it without reforms.
Will the personal pension system face the same situation? It is difficult to say. However, the momentum from the opening of the first personal pension accounts in the 36 pilot cities to the present is greater than that of the personal tax-deferred commercial pension insurance piloted in 2018. Of course, much of the system design could be improved further.
This article was the transcript of the author's speech at the 2022 Bund Summit on Dec. 11, 2022. It is translated by CF40 and has not been subject to the review of the author himself. The views expressed herein are the author’s own and do not represent those of CF40 or any other organizations.
