Asset–liability models and the Chinese basic pension fund

Abstract

Pillar 1B (individual accounts) of the Chinese basic pension fund (BPF) has suffered from substantial underfunding due to a series of challenges such as rising longevity, conservative investment policies, and the fragmentation of the pension system. Using an asset–liability model (ALM), we investigate the effects of the pre-2015 and post-2015 limits, as well as no limits, on asset allocations. We also investigate the likely effect on investment performance of transferring the pillar 1B funds to the Council of National Social Security Fund (NSSF) and raising the retirement age to 65. We find that an ALM is superior to an assets-only analysis, and removing the limits on investment in domestic assets (but not foreign assets) would be beneficial, as would transferring the assets to the NSSF and raising the retirement age. Finally, the official notional rate on individual accounts should be set at a realistic level.

Keywords:

• Pension scheme
• portfolio theory
• asset–liability model
• retirement age
• cash balance

Acknowledgments

The authors thank Erick Fung, Shuyuan Qi, Chengcheng Miao and Jing Ning (University of Reading) and the referees for their comments on an earlier draft of this paper.

Disclosure statement

No potential conflict of interest was reported by the author(s).

Notes

1 In 2016 the one-child policy was replaced by the two-child policy (Feng, Gu, and Cai 2016).

2 The Social Security Fund was established in 2000, and the Chinese government described it as a ‘strategic reserve fund’ and ‘the last ditch to the problem of ageing’. The assets of the Social Security Fund come from four sources: allocations from the central government’s treasury, equities of SOEs, state lottery proceeds and its own investment revenues (Leckie and Pan 2007). The Social Security Fund was the only fund managed by the NSSF before pooled investment of the BPF pillar 1B funds was permitted in 2015.

3 Only a few coastal provincial administrative regions, such as the city of Shanghai and Shandong province, have experience of selecting and hiring external asset managers.

4 We aggregate the liabilities in these six groups across all the provinces. Since the proportions of these six liabilities and their age distributions differ as between provinces, our ALM solutions apply to China as a whole, and may differ at the provincial level.

5 We assume the pension contributions in year t in the individual accounts will be increased by at the notional rates of return in year t + 1.

6 Measures for Unifying and Standardising the Notional Rate of Return on the Individual Accounts of Urban Employees’ BPF.

7 MSCI China A-level Onshore Index captures 537 large and mid-cap constituents of Chinese equities listed on the Shanghai and Shenzhen Exchanges (MSCI 2019a).

8 The growth index captures the equities in MSCI China A-level Onshore Index, which exhibits growth style characteristics (MSCI 2019b).

9 The value index captures the equities in MSCI China A-level Onshore Index, which exhibits value style characteristics (MSCI 2019c).

10 The yield curve of the China Corporate Bond (AAA) Index from China Bond: https://www.chinabond.com.cn/cb/eng/zzsj/cywj/syqx/sjxz/zzqyzqx/list.shtml, last viewed on 31 July 2018.

11 The MSCI World Index contains 1,632 large and mid-cap constituents across 23 developed markets. It covers around 85% of the market capitalisation in each market (MSCI 2019d).

12 The FTSE World Government Bond Index – Developed Markets measures the performance of fixed-rate, local currency, investment-grade sovereign bonds issued in developed markets (FTSE Russell 2018).

13 FTSE WorldBIG Corporate Bond Index is one of the sub-indices of FTSE World Broad Investment-Grade Bond Index, which is a multi-asset, multi-currency benchmark that provides a broad-based measure of the global fixed income market (FTSE Russell 2019).

14 For example, ALM portfolio 11, which plots close to the actual BPF portfolio, has an expected return of −25.52%, not 5.52%, when the liability returns are included.