State Pension System in China and Its Impact on Employee Benefit Practices for Companies - Case Study Example

State Pension System in China and its Impact on Employee Benefit Practices for Companies in the Country The state of the pension system in China is complex. From increased fragmentation of different schemes under different administrative bodies to the need to grow the different types of assets under the system, the Chinese pension system is characterised by many factors which not only define its current state but also present a number of challenges for its future. This is because of the many demographic and social changes that the country is currently experiencing. Also, the complexity in the Chinese pension system arises from the fact that the system has undergone tremendous changes in the past decades. Social and economic transformation has resulted into many changes in the general administration of different funds under the system. On the other hand, the pension system bears a strong impact on the way companies manage the benefits of their employees. This paper examines the current state of the pension system in China and evaluates its impact on company benefits, including retirement benefit practices in China. It presents the following information: a brief account of the history of the pension system in China over the years; a detailed description of the current system; and lastly, ways in which the pension system has affected the practice of employee benefits for companies in China. In order to understand the impact of the pension system on the practice of employee benefits in companies in china, it is important to take into consideration the historical developments of the public pension system in the country. According to Dorfman et al. (2013, p. 35), the Chinese pension system has undergone tremendous changes in the last five decades. These changes have been a reflection of the social, economic and political transformations that have been taking place not only within the country but also globally as a result of the changes brought about by globalisation. In the early 1950s and 1960s, the social security system in China consisted of the following benefits: guaranteed employment, medical care, pensions and other social welfare benefits (Jiange 2005, p. 16). Under the system, all state owned enterprises were tasked with the responsibility of ensuring that their employees enjoyed all these benefits apart from supporting their retirees from their current revenue (Sha 2003, p. 18). One important characteristic of the old system is that the workers did not have to make any contributions. In the event of the employer contributions, which were set at 3% of the total wage bill, being insufficient, the state budget would allocate more resources to the scheme. Another characteristic of the early system is that it tended to ignore the rural population. According to Impavido, Hu and Li (2009, p. 29), the system favoured the young urban population at the expense of the majority of the rural population who did not have any formal systems of pension and other old age benefits. Lastly, because the system actually covered the relatively young workforce in the urban areas, the demands on the system were relatively few. This resulted into a substantial build-up of surplus resources within the system during the early years (Jiange 2006, p. 21). Several changes have occurred in the system in the recent past. For instance, shorter careers, higher rates of replacement and guaranteed job security for one child per retiree increased the costs of maintaining the pension system (Wyatt 2009, p. 34). This led to restructuring measures that sought to transform the pay-as-you-go systems of social security into modern ones. In addition to this, the rise of the private sector, increased labour migration to the urban areas and an increase in the number of individuals who sought cover led to the transformation of the system into a modern one (Pearson 2000, p. 40). These factors created the need to transform the system into one that incorporates the following characteristics: a supplementary scheme funded by the enterprise; basic pension for retirees financed by the state, enterprise and the workers; and lastly, an account funded by individual workers on voluntary basis (Pearson 2000, p. 47). According to the World Bank, a sustainable pension model is made up of three key pillars: public pensions, occupational pensions and voluntary pension savings (Hunter, Lam & Lin 2008, p. 99). Whereas the public pensions are publicly managed and are defined by general taxes and social security contributions, occupational pensions are funded and managed privately (Brown 2010, p. 102). Also, there are two types of occupational or private pension plans. On one hand are defined benefits under which the sponsor or financial institution bears the long-term risk of investment. On the other hand, defined contributions entail the investment risk in the plan being borne by the individual members who make contributions. According to Brown (2010, p. 124), the current system in China is composed of four different systems: the urban enterprise pension subsystem, the rural pension scheme, the pension scheme for the non-employed urban population and the civil service pension scheme. All these arrangements have different characteristics that define their mode of operation, management and their impact on companies in the country. For instance, the civil service pension scheme provides benefits for employees of government agencies and other related bodies. Members of these institutions are not required to make contributions in order to benefit from the system. Also, both the rural pension scheme and the pension scheme for the non-employed urban population allow individuals to make voluntary contributions to individual accounts which are in turn subsidised by both the local and central governments (Lardy 2001, p. 87). In addition to this, workers who generally work for large private enterprises and state-owned enterprises fall under the category of the urban enterprise pension system. Another factor that distinguishes the current pension system in China entails the existence of what is generally referred to as ‘legacy enterprise annuities’ (Wang & Long 2013, p. 87). This includes different funds that are managed by different entities as discussed next. First, there are the industry funds which are created and managed by specific industries within the economy. Second, there are local social security entities which manage assets that have been created elsewhere and simply handed over to them. Thirdly, there are administration centres which manage large amounts of assets that have been accumulated in particular geographical regions in the country. Lardy (2001, p. 45) states that the development of ‘legacy assets’ is in line with the policy of the government to externalise the assets that are being held by local governments. As such, many regional administration centres for pension schemes are being restructured to become independent commercial trustees of funds (US International Trade Commission 2008, p. 129). This is meant to enable enterprise assets become the largest source of funds under the system. There are several ways in which the current setup of employee benefits has had an impact on companies in China. The first one regards how to deal with the financial burden of the pension and other related expenditures. The pension system comprises five different types of assets: social pool contributions, contributions from individual accounts, enterprise annuities, and contributions made by employers and other supplementary pensions including the National Social Security Fund (Wyatt 2009, p. 45). It is observed that although the financing of employee benefit plans is mainly accounted for in terms of government expenditure, individual companies also share a financial burden in handling the matter (Tian 2006, p. 53). For instance, the social benefits pool in the first pillar of the system is financed by employers. This means that private enterprises are obliged to remit up to 41% of the employee wages to social security schemes. This situation is worsened by the fact that demographic studies indicate that the percentage of GDP spent on employee welfare is set to rise from the current 4% to over 10% by 2050 (Muma 2008, p. 78). As a result of pressure on private companies to make contributions, the future of growth of different types of assets under the system remains uncertain. The second impact lies with the development of the enterprise annuity under the second pillar of social security and benefits for employees in China. According to Sha (2003, p. 76), the current system in China hampers the development of the enterprise fund in many ways. For instance, although the assets under the annuities are under the private management of the companies which establish them while at the same time being under the supervision of a trustee appointed by the company, there are limits in the way the funds can be invested (Dorfman et al. 2013, p. 79). With more stringent regulations, increased tax deductions and the need to invest in mainland Chinese instruments only, the enterprise funds follow a limited and conservative scope in investment (Muma 2008, p. 173). In addition to this, many companies find it difficult to establish and develop enterprise annuities as part of the social security plans for their employees because of the high costs associated with maintaining them. With the need for annual audits by certified financial auditors, the role of different parties who take part in the management of the fund and the absence of tax incentives, many private companies are finding it difficult to establish enterprise funds for their employees (Kan & Lau 2008, p. 234). In conclusion, the current pension system in china bears a strong impact on the way companies manage the benefits for their employees. This is mainly experienced in the way in which the demands of the system exert pressure on private companies in meeting the obligations for contributions. 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