China’s Social Insurance Law - What Does It Mean for Employers and Foreign Individuals?

On September 9, China’s Ministry of Human Resources and Social Security finally clarified that foreigners are to be included in the Chinese social insurance system. The implementation date for this transition is to be October 15, 2011, however it remains to be seen whether social insurance bureaus across the country will be ready to accept the participation of foreigners at that time.

Whatever happens, the inclusion of foreigners was formally indicated when the new Social Insurance Law was promulgated in October 2010 and has been anticipated for quite a while. Now the focus for foreign direct investors will shift to an assessment of the consequences of the change and reviewing their HR policies to see if they need amending.

Overview of the New Social Insurance Law

On July 1, 2011, China implemented its new Social Insurance Law (“new law”). In introducing this new law, the three main objectives of the central government are to:

(i) Take more direct control over the funds contributed to the system

(ii) Tighten administration so that companies are compelled to make contributions in full; and

(iii) Improve the overall social security safety net for Chinese residents

Of these objectives, the third can be considered the ultimate goal and the first and second a means by which to meet this goal. The Chinese government is acutely aware that in the long term it cannot rely on foreign investment, a cheap labor force and heavy fiscal spending to continue to drive the economy. What is lacking is an appropriate amount of domestic spending by Chinese households.

One major reason that Chinese people are reluctant to spend is the lack of an effective safety net in the event something undesirable happens to them or to a family member, as well as a general distrust that funds contributed for mandatory pension will still be available when they reach retirement age. Instead they save, and a side-effect of this phenomenon is that, in the absence of alternative avenues to invest the money that is being hoarded by Chinese households, too much of the money is flowing into unsustainable real estate investment, creating a potentially dangerous bubble.

By overhauling the social security system the government is making an effort to address the problems mentioned above as well as related issues affecting Chinese society in recent years. However, as always in China, the difficulty will arise in the implementation. We will address this more specifically in a later article.

First of all, let’s look at some of the fundamental issues addressed by the new law.

The Five “Insurances”

The five “insurances” covered by the mandatory welfare system refer to pension, medical, work-related injury, unemployment and maternity insurances, which have been part of the existing social security framework in China for a number of years now. Let’s look at them in turn.

Pension

The new law states that the employer must make contributions based on the total wages paid to their employees, while individual employees make contributions based on the salary they actually receive. In general the burden on employers is set to rise in comparison to the calculation methods that have been adopted up to now.

The new law also clarifies that employees who move from one jurisdiction to another will be able to transfer their pension funds, and that when they retire they will be able to receive a pension based on the entire amount of their accumulated funds. However, the specific method for calculation when “merging” these funds will be detailed in a separate piece of legislation that has not been finalized yet.

This aspect of the new Social Insurance Law addresses one of the most serious problems under the current system. The lack of transparency for individuals relating to treatment of their pension often dissuades them from transferring to jobs outside of the city they are living in. This in turn reduces the overall mobility of labor, which is a major problem in a society that lacks sufficient skilled workers across the country.

Implementation Challenge

As well as being a serious problem in itself, we can also say that the resolution is also going to be an arduous task. The groundwork has been done by the central government in passing and implementing this law, but cooperation and agreement between the innumerable local governments concerning the practicalities of these transfers will be time-consuming. It is unlikely that China will be able to realize the ambition of the central government to ensure a smooth transition of pension funds between jurisdictions for several more years.

The new law also refers to introducing a pension system for rural workers, even opening up the possibility of merging the system with the urban pension system in the future. This provision is aimed at reducing the effect of the “hukou” system, which limits the options available to the rural Chinese population and is a source of much dissatisfaction in China in recent years. Again, realization of an effective integrated system still seems a long way off, and the law provides only the direction without specifying tangible methods of reaching this ideal (for the central government at least) situation.

Medical Insurance

Similar to improvements mentioned in the pension system above, the government is intending to enhance the overall operation of the Chinese healthcare system. One particular point of note is that the medical insurance fund will be responsible for directly refunding medical expenses to the hospital that carries out the treatment, avoiding the situation that happens frequently where the patient has to first pay treatment fees in advance and later receive compensation from the fund.

The current system has a particular weakness in that when an employee travels and becomes sick or injured in an area remote from his/her administrative jurisdiction there are considerable complications when paying for the treatment and getting reimbursed by the insurance fund. Article 29 specifically proposes to resolve this solution through creating administrative units to process such payments directly from medical funds to medical institutions. Once again, this may take a long time to realize in practice.

Work-related Injury Insurance

The law mainly concerns itself with the circumstances under which compensation will be provided, and clarifies which payments will come from the work-injury funds and which payments from other funds, such as pension.

The most important point relates to the government’s commitment to ensure provision of treatment for work-related illness or injury even in the absence of contributions made by employers. The law states clearly that it is the employers that must make the contributions, but in the absence of such contributions the employee can still claim the relevant treatment expense, the administrative agency is then obligated to chase up the employer for the cost of the treatment (as well as, presumably, outstanding work injury insurance contributions).

Unemployment Insurance

Most of the law is simply a generalization of previous laws and circulars. Key points include the length of time that unemployed people may claim benefit (depending on the amount of time they worked) and the amount they may receive (to be designated locally, but not related to the salary they used to receive / the premiums they paid while employed).

One point that has been included to resolve a particular problem is an obligation on the employer to provide the “termination of employment” evidence to the employee within 15 days of his / her release from the company. This is to resolve a particular problem whereby the employer refuses to release such a document for some reason, putting the terminated employee under unreasonable pressure because without this document they cannot start claiming unemployment benefit.

Maternity Insurance

There has been an important change to the rules here. Article 56 of the new law states that monthly payments from the insurance fund to women during their maternity leave will be made based on the average salary paid by the company to its employees. This is in contrast to the current practice, where the woman on maternity leave receives an amount equal to her salary (as defined by the social insurance contributions made by the company prior to her maternity). 

This is an interesting concept, meaning that irrespective of a woman’s rank at a company, she will receive a set amount during her maternity leave. If we make the assumption that men working at companies in China, on average, receive a higher salary than women then the aggregate amount receivable by women should rise even though the cost to the company effectively remains the same as before. However this will be bad news for those female employees in senior positions, as the amount they receive during maternity will fall considerably.

Implementation Side Effect

This change will also have a couple of interesting side effects. The first will be that employees will become aware of the average salary paid in the company. This will cause issues of confidentiality (especially for small organizations) and also possibly encourage certain employees to seek salary increases to what they consider to be “fair” levels – no valued employee wants to know that they are earning way below the company’s average salary!

Secondly, this policy could encourage a trend of “maternity arbitrage,” where employees who expect to become pregnant in the near future consciously look for work at a company paying a high average salary. This situation is likely to be more prevalent in cities such as Dalian, which provides a total of five months of maternity leave to employees, as the financial benefit to an individual of taking maternity leave would be higher. We can take the case of an individual leaving a company paying an average salary of RMB3,000 and joining a company paying an average salary of RMB9,000. The switch would potentially benefit such an employee by RMB30,000.

Final Thoughts

The above summary covers the main scope of the first 56 articles of the new law. The remaining 42 clauses relate mainly to methods of strengthening collection and the responsibilities and liabilities of the various government organs that collect and handle these funds. These clauses reflect the importance the government attaches to transparency. They realize that there is general public distrust relating to the current usage of funds, and have addressed some of the issues in this law.

For instance, article 80 is quite interesting. It proposes that committees be setup consisting of employers, social insurance participants and trade unions, legal experts and economic experts to oversee the management of these funds as supervisory bodies. That sounds very promising in theory. How these committees are formed in practice will determine how much transparency is injected into the system.

Despite all the legal provisions aimed at enhancing transparency and creating a more healthy system, the law can be accused of lacking teeth. For instance articles 87 and 88 impose punishments for organizations or individuals that make fraudulent claims or forge documents. However the fines imposed on such organizations or individuals are restricted to 200 - 500 percent of the amount of the claim made, hardly a punitive punishment. There may be organizations and / or individuals that come to the conclusion that the punishment does not adequately fit the crime, and will continue to abuse the system.

As a final comment on this law, one of the articles (article 97) could have the biggest impact on readers of this publication. It states that foreigners working in China should be covered by this law. The vague nature of this statement and the fact that it seems to have been tacked onto the end of the document suggests that the government, when drafting this law, had not really considered the ramifications of extending coverage under the Chinese social security system to foreigners.

Dezan Shira & Associates is a specialized foreign indirect investment practice, providing business and legal advisory, tax, accounting, payroll and due diligence service to multinationals investing in China, Hong Kong, India, and Vietnam. Established in 1992, the firm is a leading regional practice in Asia with twenty offices in four jurisdictions, employing over 170 business advisory and tax professionals. To contact Dezan Shira & Associates please email info@dezshira.com or visit www.dezshira.com.