Pension Reform in China:
Meeting the Challenges Posed by Societal Aging1
C. H. Kwan
Senior Fellow,
Nomura Institute of Capital Markets ResearchI.

Introduction

China's population is aging rapidly. According to figures from the United Nations,the proportion of its population aged 60 or over in 2010 was 12.3%, the same as inJapan in the late 1970s, and is expected to rise to the same level as in Japan in 2010(30.5%) in the early 2040s (Figure 1). Generally speaking, societal aging is acharacteristic of developed economies. However, China will have to face thechallenge of getting old before it has had time to get rich. Particularly urgent is its
need for a proper pension system.

Figure 1: Comparison of societal aging in China and Japan－Percentage of total population aged over 60－（%）
45
Japan

40
35

China

30
25
20
15
105

1950
1955
1960
1965
1970
1975
1980
1985
1990
1995
2000
2005
2010
2015
2020
2025
2030
2035
2040
2045
2050

0

Source:Nomura Institute of Capital Markets Research, based on United Nations,
World Population Prospects, 2010 Revision (incl. estimates)

1The original (Japanese) version of this report is reproduced from Kikan Chuugoku Shihon
Shijou Kenkyuu, 2012, Vol.6-3 with the kind permission of the Nomura Foundation.

1Nomura Journal of Capital Markets Winter 2013 Vol.4 No.3

II. China's current pension system
Until the early 1980s (i.e., when China was still a planned economy), the state bore
the entire cost of the urban pension plan system. As a result, there was no need forindividual workers to contribute. However, following a series of reforms to the system,
the cost is now shared by the state, companies, and workers. In addition to the existing
urban workers' basic pension, public service workers' pension, and rural pension
schemes, China's public pension system now also includes two pilot schemes, namely,
the “urban social pension scheme” and the “new rural social pension scheme” (Figure2).
The urban workers' basic pension covers employees (of state-owned enterprises,
collective enterprises, joint-stock companies, foreign-invested enterprises, privatecompanies, and one-man businesses) and can be considered the cornerstone of China'spension system. Membership is mandatory. As of end-2011, there were 284 million
members, 216 million of whom were still working and 68.26 million of whom wereretired. The urban workers' basic pension is a two-tier pillar consisting of a (pay-asyou-go) social pooling element and (funded) individual accounts. Companies
contribute 20% of their total wage bill to the social pool, while workers contribute 8%of their wages to their individual accounts. To receive a pension, members must havecontributed for at least 15 years by the time they reach the age of retirement (60 formen, 55 for women in white-collar jobs, and 50 for women in blue-collar jobs). The
income replacement rate is supposed to be 40–50%.
Unlike the urban workers' basic pension, the public service workers' pension is still
financed entirely by the state and has a high income replacement rate of 80–90%.
Because of regional differences in economic growth there is no nationwide rural
pension fund. Instead, membership of the rural pension scheme, which is also open torural enterprises, is voluntary and on a (funded) individual account basis. Reflecting
the fact that economic growth in rural areas has lagged that of the country as a whole
and that rural incomes are insufficient to be able to make pension contributions, therural pension scheme has the lowest coverage among the public pension schemes anda very low income replacement rate.
With a view to establishing a universal pension scheme, the government introduced
two new pilot schemes in designated regions: the "new rural social pension scheme"
in 2009 and the "urban social pension scheme" in 2011. The latter extends pension
eligibility in urban areas to those not covered by the urban workers' basic pension
scheme. As of end-2011, the two schemes had a total membership of 332 million, 240
million of whom were aged less than 60 and 91.85 million of whom were pensioners.
Both schemes are voluntary and have many basic similarities. First of all, their two
main sources of finance are individual contributions and government subsidies.
Scheme members can choose within a given range how much to contribute to theirindividual accounts each month. The more they contribute, the more they will receive
when they retire. Furthermore, those who have contributed for at least 15 years will
receive a basic pension of at least RMB55 each month along with 1/139th of thePension Reform in China:
Meeting the Challenges Posed by Societal Aging

2balance of the principal and interest in their individual account when they reach theage of 60.
Figure 2: Comparison of urban workers' pension scheme and urban social
pension scheme/new rural social pension scheme
Urban workers' basic pension

Urban social pension scheme

New rural social pension
schemeRelated policies

Establishment of a Unified Basic Pension
System for Enterprise Employees(State Council Document No. 26 (1997))
Strengthening Pension Reform for Enterprise
Employees (State Council Document No. 38,2005)

Guidelines on Development ofUrban Residents' Social Pension
Insurance Pilot Project (StateCouncil Document No. 18, 2011)

Guidelines of State Council on theDevelopment of Rural Social
Pension Insurance Pilot Project(State Council Document No. 32,2009)

Coverage

Employees of state-owned enterprises,
collective enterprises, joint-stock companies,
foreign-invested enterprises, privatecompanies, and one-man businesses

Urban residents aged over 15(excluding those in full-timeeducation) who fail to meet thecriteria for membership of theurban workers' basic pension
schemeRural residents aged over 15(excluding those in full-timeeducation) who are not members of
the urban workers' basic pension
schemeMandatory/voluntary

Mandatory

Contribution basis

Voluntary

Members can choose any of 5
Members can choose any of 10
Enterprises contribute 20% of total wage bill, different contribution levels (in units different contribution levels (in unitsof RMB100) between RMB100 and of RMB100) between RMB100 andemployees 8% of wages
500/year
1,000/year

Sources of finance"Social pooling element" is employer
contributions; "individual accounts" areemployee contributions. Government
subsidies are available in the event of ashortfall.

"Individual accounts" are employee contributions supplemented, wherenecessary, by government subsidies

Eligibility criteria(official age of retirement)

At least 15 years of contributions(60 for men, 55 for women in white-collar jobs,
and 50 for women in blue-collar jobs)

At least 15 years of contributions (at 60) (Note 1)

Individual
account

Balance of principal and interest in individual
account / Average no. of annuity payments
after retirement

Balance of principal and interest in individual account/139 (average no. of annuity payments after 60)

Basicpension[(Regional average wage for previous year attime of retirement + average wage over periodof contributions/2)] × years of contributions ×1%

Fixed amount(currently a minimum of RMB55/month throughout China,
with the option of a larger amount in some areas)

Membership (end-2011)

284 million(216 million still working,68.26 million retired)

332 million(240 million below 60, 92 million pensioners)

Scheme income (2011)

RMB1,689.5 billion(RMB1,395.6 billion in contributions,
RMB227.2 billion in state subsidies)

RMB111.0bn

Scheme payments (2011)

RMB1,276.5bn

RMB59.8bn

Scheme balance (2011)

RMB1,949.7bn

RMB123.1bn

Formula(Note 2)

Note: 1. As a transitional arrangement, from 1 January 2012, members who have reached the age of 60 will
not have to make any contributions and will receive a basic pension. Members aged between 45
and 59 will receive a basic pension when they reach the age of 60 if they pay the balance of their
15 years' worth of contributions.
2. The formula for calculating pension payments under the urban workers' basic pension scheme in
the above table is that for the "new group" (i.e., those who joined the workforce after the 1997
reforms). In addition to these benefits, the "middle group" (i.e., those who joined the workforce
before, and were due to retire after, 1997) receive transitional benefits. The formula for calculating
pension payments for the "old group" (i.e., those who retired before the 1997 reforms) is [(regionalaverage wage for previous year) × 20% + (balance in individual account/120)].
Source: Nomura Institute of Capital Markets Research, based on various sources, including statistics
published by the Office of the China National Committee on Aging in July 2012

3Nomura Journal of Capital Markets Winter 2013 Vol.4 No.3

III. Shortcomings of current pension system and direction ofreform
As we have seen, China has made efforts to reform its pension system.
Nevertheless, there are still many unresolved issues and considerable scope forimprovement.
First of all, coverage is still low. According to a follow-up study on thedemographic situation of the elderly population in rural and urban areas by the China
National Committee on Aging (CNCA) published in July 2012, coverage in urban
areas as of 1 December 2010 was 84.7%, whereas in rural areas it was only 34.6%.
China will need to continue to try to extend coverage to people in rural areas and to
the unemployed in urban areas.
Another unresolved issue is the wide discrepancy in benefit levels between thedifferent pension schemes. Levels are higher in urban areas than in rural areas.
According to the aforementioned survey by the CNCA, an average monthly pension
payment of RMB1,527 in urban areas compares with one of only RMB74 in ruralareas. And even in urban areas, pension payments to public service workers are muchhigher than those to company employees. The current system has therefore failed toredistribute incomes in the way that was expected and needs to be improved.
Another problem is a lack of pension portability as a result of the fact that each city
tends to administer its own pension scheme. As China's labor market becomesincreasingly mobile, shortcomings such as this make it difficult for migrant workers tojoin a public pension scheme. According to Article 19 of China's Social Insurance
Law, which came into force in July 2011, when an individual is employed in anotherpooling region, arrangements for the individual’s basic pension, medical insurance,
and unemployment insurance shall move with him/her to the new region, and thecontribution years for the social security funds shall be calculated on a cumulativebasis.
Last but not least, as societal aging in China accelerates and people live longer, thenumber of those in work and making contributions will decline while the number
retired and receiving payments will increase, making it increasingly difficult tofinance pension schemes. As investments are confined to a narrow range of financial
instruments with low returns, there have been cases in some areas where the funds inindividual accounts have been diverted to cover deficits in pay-as-you-go schemes. Inorder to make good this underfunding, the Chinese government will probably need toprovide fiscal support and may ultimately have to raise the official age of retirement
as well as the age of eligibility for social security retirement benefits.
Resolving these issues and building a better pension system are essential elements
for China to achieve its goal of becoming a "harmonious society."

Pension Reform in China:
Meeting the Challenges Posed by Societal Aging

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