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

2. 1 Mercer Content  Overview of China’s Pension System  Overview of Enterprise Annuity  Application of Actuarial Mathematics in Actuarial Modelling  Q&A

3. 2 Mercer China’s Previous Pension System: The Iron Rice Bowl from 1950s to 1970s  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

4. 3 Mercer China’s Previous Pension System  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 Years of Service Pension Benefits 20+ years of continuous service 75% of standard wages 15-19 years of continuous service 70% of standard wages 10-14 years of continuous service 60% of standard wages

5. 4 Mercer  Because of the PAYG problems, the government had been trying to reform the pension system since 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 China’s Current Pension System Document No. 26 (1997)

6. 5 Mercer  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 Supplemental Pension China’s Current Pension System Three Pillars Pension System

7. 6 Mercer China’s Current Pension System Social Pension: Employer and Employee Contribution Location Employer Contribution as % of Prior Year’s Salary Employee Contribution as % Prior Year’s Salary Maximum Monthly Contribution Base* Beijing20%8%RMB9,966 Shanghai22%8%RMB8,676 Guangzhou20%8%RMB6,546 Xi’an20%8%RMB5,310 Kunming20%8%RMB4,680 *Adjusted each year, which is equal to three times of prior year’s city average monthly salary ▪ 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.

8. 7 Mercer 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 *Estimated based on known general policy 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 China’s Current Pension System Social Pension: Employee Benefits Replacement Ratio from the Social Security at Age 60 * 0% 10% 20% 30% 40% 50% 60% 70% 123456789101112131415 Salary as a Multiple of City Average Monthly Salary (CAMS) A Aa A

9. 8 Mercer 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. 9 Mercer Trustee EA Plan EmployerEmployee AdministratorCustodian Investment Manager Contributions Benefits Overview of Enterprise Annuity Structure

11. 10 Mercer  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 Responsibility of Trustee

12. 11 Mercer  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 Responsibility of Administrator

13. 12 Mercer  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 Responsibility of custodian

14. 13 Mercer  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 Responsibility of Investment manager

15. 14 Mercer  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 Overview of Enterprise Annuity Design

16. 15 Mercer  Conservative assets allocation limits are set: – Money Market: >=20% of net assets – Fixed Income: =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 Overview of Enterprise Annuity Investment and tax  Employer Contributions Pre-tax salary base  Employee Contributions After-tax salary base

17. 16 Mercer Application of Act. Math in Act. Modelling Cash flows Date of hire Date of retirement … … Date of Death Retirement Benefit Employee Contribution Employer Contribution Salary Base

18. 17 Mercer 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. 18 Mercer Q&A

20. 19 Mercer Thank you