China operates a three-pillar pension system dominated by the state-run "first pillar," which is the basic pension insurance funds. The "second pillar" refers to enterprise and occupational annuities while the "third pillar" is personal pension schemes.

The Chinese central government has recently adopted the Opinions on Promoting the Development of Pension Insurance, which means that the "third pillar"of China's pension protection system is about to take off. According to recent reports, financial institutions represented by insurance companies, banks and public funds are looking forward to this and the incremental market space it will bring in the future. However, researchers at ANBOUND believe that from the perspective of public policy research, at least so far, the support brought by the new trend of personal pension policy since this year should not be overestimated. At present, there are still obvious shortcomings in fund raising, market capacity, institutional norms and other aspects, and the positive impact after the establishment of the system may need long-term observation.

First, it should be acknowledged that the introduction of the "third pillar" system has provided new support to the current unbalanced and increasingly stressed pension system in terms of the direction of system construction. In the face of the significant trend of rapid aging in China, the development of pension structure in China is seriously unbalanced. In terms of fund balances, the first pillar accounts for 62% of China's current pension balance, the second pillar accounts for 37%, and the third pillar account for almost 0. The expenditure on basic pension insurance, the first pillar, reached RMB 5465.6 billion in 2020, while the expenditure on enterprise annuities, the second pillar, was only RMB 57.6 billion in the same period, accounting for only about 1% of the first pillar, with a much wider gap. At the same time, an analysis has estimated that the current average replacement rate of the "first pillar" is only about 38%, which is far below the level of the replacement rate recommended by the World Bank, the International Labor Organization and other institutions, and its replacement rate has been declining in recent year. At this time, the establishment of the "third pillar" in the form of tax-deferred personal pension system can indeed share the pressure for the "first pillar" which has insufficient protection level and a continuous decline in replacement rate.

However, from a practical point of view, the "third pillar" system needs a feasible implementation direction in terms of funding sources, investment space and other issues in order to truly achieve effective support.

First, there is a huge funding pressure on the third pillar. As a fully accumulative pension system, to ensure that the "third pillar" is truly effective, a pool of funds that can generate sufficient and stable cash flow is fundamental. However, with a little estimation, we found out that the required fund size is huge, and it is not destined to be formed effectively in a short period of time. Researchers at ANBOUND have estimated the size of the required pool as below:

In terms of basic data, taking the 55% replacement rate recommended by the International Labor Organization as the ultimate goal, and drawing on the relevant research, the replacement rate of the "first pillar" is 38%. In the "second pillar", the replacement rate of enterprise annuities is 10%, and the replacement rate of occupational annuities is 20%-30%. It can be seen that the replacement rate target is not difficult to achieve for workers with complete first and second pillar benefits. However, it should be emphasized that the current coverage of the second pillar is too narrow: as of the end of 2020, a total of 999 million people participated in basic pension insurance, while the coverage of corporate annuities during the same period was only about 27 million; occupational annuities with personnel from institutions as the main contributors, the current number of participants is also only about 41 million people. In this case, at least 930 million people need to rely on the third pillar to achieve a 17% pension replacement rate. This part of the total annual pension, with reference to the basic pension insurance fund expenditure of RMB 5465.6 billion in 2020, the replacement rate is estimated at 38%, and the annual capital expenditure formed by the third pillar needs to be at least RMB 2.45 trillion. The return on investment of the social security fund refers to the National Social Security Fund, which has been established for 20 years (according to the 2020 annual report, the long-term average annual return is 8.51%). Even if the sustainable operation of the fund is not considered and its operating cycle is set at 50 years, the pool of funds required for the "third pillar" will reach RMB 24.2 trillion. The pool of funds needed for the "third pillar" is even larger than that of rebuilding an insurance industry.

After estimating the size of the fund, another important question is "where will the money come from?" Although theoretically for the personal pension system, the source of funding should be individual compulsory savings, yet in the general trend of downward economic growth, attracting the public and carrying out "market education" is almost bound to become a difficult problem. First, the residents lack sufficient savings, and second, the acceptance of insurance products is still seriously insufficient. According to the central bank's data, as of the end of the third quarter of this year, the balance of household deposits was RMB 101.93 trillion, the balance of loans was RMB 69.54 trillion, and the net savings of residents was only about RMB 32.4 trillion. Under the competition from funds, stocks, and physical investment, it is difficult to expect the resident sector alone to meet all the funding needs of the "third pillar". At the same time, the public's acceptance of the "third pillar" insurance products has been low: in terms of the results of the personal tax-deferred commercial pension insurance scheme implemented as a pilot program in Shanghai, Suzhou, and Xiamen since 2018, the total number of insured persons in the three places in the past two years was only 47,600, and the total premium income is only RMB 300 million, both in terms of insurance density and insurance depth are far less than expected, adding further gloom to the development prospects of the "third pillar".

Apart from the resident sector, the transfer of state-owned capital may be another feasible direction, drawing on the experience of previous transfers of state-owned capital to social security funds, and transferring part of the state-owned capital to the newly established National Pension Insurance Company this year to enrich the "third pillar" pool of funds. However, the influence of insurance funds in the operation of state-owned enterprises is far from the State-owned Assets Supervision and Administration Commission of the State Council (SASAC). To ensure the effective participation of the transferred fund in the operation of the corresponding state-owned capital, the relevant mechanism needs to be improved.

Another point of view is the investment space. Even if sufficient funds can be raised, individual pensions still need to rely on market-oriented means to achieve value-added with the through the investment market. In terms of investment direction and ratio, with reference to the relevant provisions of the Basic Pension Insurance Fund Investment Management Measures, based on the stock-to-debt ratio of 3:7, it means that RMB 8.7 trillion will enter the stock market and about RMB 20 trillion will enter the bond market. As of December 30, the total market capitalization of stocks in Shanghai and Shenzhen stock markets totaled RMB 74.7 trillion; as of the end of the third quarter, the stock size of China's bond market was only about RMB 125 trillion. In the face of the huge capital scale of "individual pension", how to avoid the formation of short-term market shocks, which in turn lead to financial risk events, requires a considerable buffer time in the construction of relevant markets and regulatory systems.

Final analysis conclusion:

The "third pillar" policy, which has taken more than ten years to be implemented, may play a complementary role in China's national pension structure, and the current significance of the policy structure may be far greater than its actual effect. When it comes to practice, where the money comes from, where it is invested, and how the relevant mechanisms are built will have a significant impact on the ultimate supporting role of the "third pillar". This means that the construction of the "third pillar" needs to be prepared for a long time and should be promoted in accordance with the situation of market and social development.