Enterprise Annuity in China

1. Oct 28, 2009 Enterprise Annuity in China Prepared by Wentao Yuan

2. Content • Overview of China’s Pension System • Overview of Enterprise Annuity • Application of Actuarial Mathematics in Actuarial Modelling • Q&A

3. Prior to China’s “Open Door” policy, Chinese workers tended to stay with one company (almost all are state-owned) for the duration of their whole careers State-owned enterprises (SOEs) were responsible for all their employees’ salaries and benefits - cradle to grave provision After retirement, employees received a generous pension which could be as high as 100% final salary Other benefits provided: medical care, education, life-long security, housing and transport subsidies China’s Previous Pension System: The Iron Rice Bowl from 1950s to 1970s

4. State Council Document No.104 (1978) Pension Benefits in relation to years of service Funding: Since most of the pensioners were from SOEs, the funding was based on a pay-as-you-go (PAYG) system and/or loans from the state-owned banks. Result: Many of the SOEs ran into financial difficulties and could not afford to pay pension Loans from SOE banks accumulated into Non-Performing Loans (NPL), and these banks gradually stopped making loans to finance pension payments China’s Previous Pension System

5. China’s Current Pension SystemDocument No. 26 (1997) • Because of the PAYG problems, the government had been trying to reform the pension systemsince the 1990’s • State Council Document No. 26 (1997) • Under Document No. 26, new Social Security system was established across country • The purpose of Document No. 26 was to shift the pension burden from the state to employer and employee. • Document No. 26 was based on the recommendations by the World Bank that China undertakes a Three Pillar Pension System • Pillar I: Mandatory/Social Pension • Pillar II: Occupational Pension (Supplemental Pension) • Pillar III: Personal Savings

6. China’s Current Pension System Three Pillars Pension System • Three pillars of the ‘Retirement savings concept’: • Pillar I: Mandatory / Social • The government provides a basic level of benefits, including pay-as-you-go funded benefits through social pooling and Individual Retirement Accounts (IRAs). • Pillar II: Occupational • Companies offer supplemental pension plans above state benefits to complement Pillar I • Pillar III: Personal • Employees draw on their individual savings to purchase an enhanced level of benefits. Basic Pension SupplementalPension

7. China’s Current Pension System Social Pension: Employer and Employee Contribution • For Social Pension, employer and employees make mandatory contribution to each city’s labor and social security bureau • The contribution amounts vary by city. As an example the table below shows social pension contribution requirements in five different cities. *Adjusted each year, which is equal to three times of prior year’s city average monthly salary

8. Replacement Ratio from the Social Security at Age 60 * 70% 60% 50% 40% 30% 20% 10% 0% 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 Salary as a Multiple of City Average Monthly Salary (CAMS) China’s Current Pension System Social Pension: Employee Benefits • The social pension’s benefit payment is means tested. For example, assuming 35 years of service, for a low wage earning employee the replacement ratio is about 60%; as salary increases, the ratio drops significantly A A Aa • Limitations regarding China’s social pension: • - Inadequate: social security system does not adequately cater for those on higher incomes • Under funding: Pay-as-you-go results in unfunded liabilities/high contribution. • Misappropriation of pension assets by government officials *Estimated based on known general policy

9. Overview of Enterprise Annuity • In April 2004, the Ministry of Labor and Social Security issued legislation on Enterprise Annuity or EA • Voluntary employer sponsored defined contribution plan for the employees who are under coverage of social security pension system, and considered as China’s 401 (k) • EA must be set up under trust arrangements. The plan trustee (which can be company internal trustee or a third party professional trustee) appoints other EA service providers - plan administrator, custodian and investment manager • Fees for EA providers are capped: • Trustee: up to 0.2% of assets • Plan administrator: up to RMB5 per month per participant • Custodian: up to 0.2% of assets • Investment manager: up to 1.2% of assets

10. Overview of Enterprise AnnuityStructure Employee Employer Contributions Trustee EA Plan Benefits Administrator Custodian Investment Manager

11. Responsibility of Trustee • Select, monitor and replace administrator, trustee, investment manager • Set EA fund’s investment strategy • Produce EA fund’s management and financial accounting report • Monitor EA fund’s management based on contract • Collect employer and employee contribution based on contract and pay benefit to beneficiary • Accept inquiry from employers and beneficiary, provide EA fund management report to employers, beneficiary and authority regularly • Keep relevant records for at least 15 years • Other responsibilities stipulated by legislation and contract

12. Responsibility of Administrator • Establish EA fund’s enterprise account and individual account • Record employer and employee’s contribution and investment return of EA fund • Check contribution data with trustee and change of EA fund’s asset with custodian • Calculate EA benefit • Provide EA fund inquiry service on employer account and employee account • Provide EA fund’s account administration report to trustee and supervising authority • Keep relevant records for at least 15 years • Other responsibilities stipulated by legislation and contract

13. Responsibility of custodian • Preserve EA fund’s asset safely • Open fund’s capital account and security account in the name of EA fund • Set up separate accounts for different EA funds and ensure the independence of fund’s asset • Based on trustee’s instruction, distribute EA fund’s asset to investment manager • Based on investment manager’s instruction, deal with settlement and delivery in time • Responsible for EA fund’s accounting check and estimate, check fund property’s net value calculated by investment manager • Check relevant data with administrator and investment manager and monitor investment manager’s investment operation according to regulations • Provide EA fund’s custodian report and financial accounting report to trustee regularly • Provide EA fund’s custodian report to supervising authority regularly • Keep EA fund’s custodian operation record, account book, report and other relevant materials at for 15years • Other responsibilities stipulated by legislation and contract

14. Responsibility of Investment manager • Invest EA fund asset • Check EA fund’s accounting and estimate outcome together with trustee in time • Establish EA fund’s risk reserve • Provide investment management report to trustee and supervising authority regularly • Keep EA fund’s asset account warrant, account book, annual financial account report and investment record at least for 15 years based on legislation • Other responsibilities stipulated by legislation and contract

15. Overview of Enterprise AnnuityDesign • Coverage: • It should generally cover all employees after their probation • Contributions: • Both employer and employee are required to contribute • Maximum employer contribution: 1/12 of last year’s payroll • Maximum employer and employee contribution: 1/6 of last year’s payroll • Contributions are portable when changing jobs • Benefits: • Payable at legal retirement age (60 for male and 55 for female) • Or at death, emigrate overseas • Paid as a lump sum or installments

16. Overview of Enterprise AnnuityInvestment and tax • Conservative assets allocation limits are set: • Money Market: >=20% of net assets • Fixed Income: <=50%, and government bond: >=20% • Equity: <=30%, and Stocks: <=20% • Domestic investment only for now • Investment managers must set aside 20% of management fees in a reserve fund until reaching 10% of net assets under management • Employer Contributions • Pre-tax salary base • Employee Contributions • After-tax salary base

17. Application of Act. Math in Act. ModellingCash flows Employer Contribution Employee Contribution Retirement Benefit Salary Base … Date of retirement Date of hire Date of Death …

18. Application of Act. Math in Act. Modelling Comparison between EA and life insurance (endowment) • Eligibility vs Insurability • Contribution vs Monthly Premium • Retirement Benefit (retire, die, emigrate) vs Death Benefit (attain a specific age, die) • Turnover Rate (change job) vs Lapse rate • Vesting Schedule vs Surrender Charge

19. Q&A

20. Thank you