The winning strategy for the pension market in China

June 2019

Table of contents

Introduction 2

I. An overview of the global pension system 5

II. An outlook of China’s commercial pension market 14

III. Financial institutions’ winning strategy in the commercial pension market 21

65 Introduction

2 The winning strategy for the pension market in China On March 6, 2019, in the Work Report at the Two total AUM is around RMB 1.6 trillion, making up Sessions, Premier Li Keqiang said: “The social the remaining 30 percent. The third pillar, the security system and policy need to be further personal pension, is still at a nascent stage and perfected, and a multilevel pension security currently has no unified definition and scope. system needs to be developed.” This remark has The first pillar’s overall volume and amount have once again prompted Chinese society to reflect continued to rise, but the income replacement on elderly care and how China–a fast devel- ratio (defined as the ratio of the pension one oping country–can address this issue. Which receives upon retirement to the income received retirement types are most suitable for Chinese before retirement) remains less than 50 percent. pensioners? Moreover, the government’s burden continues to be a challenge, as it is faced with slowing rev- Traditional retirement models are enue, growing expenses, and complete depletion being challenged as China acceler- of funds in some areas. The financial subsidy for ates towards an aging population the first pillar is increasing year by year, though with a low birthrate this will be hard to sustain in the long run. The commercial reform of China’s pension system is Nations usually change into an aging society imminent, and the second and third pillars are in over a gradual and slow process. For example, it urgent need of a balanced development. took France and Sweden 115 years and 85 years, respectively, to reach that stage. However, it has It’s inevitable that the gap must be taken China only 25 years. In stark contrast, the closed quickly and the second and decreasing birthrate in China hovered around 1.6 in 2018, much lower than the replacement ratio third pillar of the commercial pen- of 2.1. Due to the double trends of aging and low sion developed birthrate, it is expected that the elderly depen- China’s retirement system should be composed dency ratio will fall from 9.9 (an average of 9.9 of the pension finance and retirement sector working people support 1.0 pensioner) in 2000 (Exhibit 1). Pension finance refers to financial to 5.8 in 2020 and then to 2.3 in 2050. There- activities to meet an individual’s retirement life fore, the traditional family elderly-care models needs, while the retirement sector refers to the will not be sustainable. related services, products, and property indus- tries to meet social retirement needs. China is developing a three-pillar There are two types of pension finance: institu- pension system, but it is a long and tional and noninstitutional. According to industry problematic route consensus, the institutional type has four main China’s three-pillar pension system started in characteristics: a unique and dedicated retire- 1991 and mainly relied on the first pillar of public ment account, the account is always locked ex- pension. The country itself is responsible for cept for withdrawal upon retirement, the account the pension system, with an AUM of about RMB is entitled to tax preferential policies, and pen- 4.4 trillion accounting for over 70 percent of the sion investment is subject to special regulation. total amount. The second pillar is enterprise and For historical reasons, China’s development of occupational annuity. The enterprise annuity's the commercial pension is relatively behind, and responsible owners are enterprises and their the first third-pillar product–the personal tax- employees, and the occupational annuity is deferred pension insurance–was only launched owned by the public sector and its staff. Their in the middle of 2018.

The winning strategy for the pension market in China 3 Exhibit 1: Overview of the retirement finance industry and value chain Focus of this paper

Pension finance: institutional and Retirement industry: services and non-institutional financial activities to manufacturing industries that meet the needs of meet the need of personal social retirement retirement

Services Products Properties

Institutional type Services: elderly care, 1st pillar: public pension medical/healthcare, etc. 2nd pillar: enterprise/occupational Capital Retirement pension needs needs 3rd pillar: personal pension Products: medical/healthcare products/equipment and products for the elderly Noninstitutional type

Retirement wealth Pension Pension manage- insurance trust Properties: dedicated nursing homes, ment retirement-themed medical institutions, and retirement community property and other retirement-related investments, e.g., property and precious metal

Under the current circumstances in China, clarifying ownership among the state, enter- McKinsey believes that a commercial pension prises, and individuals. Especially over the past system mainly supported by the second and two years, the development of the commercial third pillars has more advantages: (1) it will be a pension sector has gained traction due to the strong complement to the public pension; (2) it top-level design from the government authori- will provide more diverse and customized retire- ties, broad participation from enterprises, and ment financial plans for consumers and their elevated awareness from the public. enterprises; (3) it will enable investing in more This white paper focuses on China’s institutional asset classes to further promote China’s capital pension system, especially the development of market development. In addition, the pension the second and third pillars. We sincerely hope system's commercialization reform can also help this publication will offer insights on the develop- foster a stable pension system in the nation by ment of participants in China’s pension market.

4 The winning strategy for the pension market in China Chapter 1: An overview of the global pension system

The winning strategy for the pension market in China 5 Exhibit 2: Pension systems differ, mostly in market activities and levels of regulatory support and government control

Led by Balanced 2nd and 2nd and Canada US Japan mix of 3 S. Korea UK Germany Italy France 3rd pillars pillars Structure 3rd pillars lag behind features Led by Hybrid Led by DB DC Italy US France S. Korea UK Canada Japan Germany products products products Replace- Market Replace- ment Replacement Italy France Canada Germany ment ratio1 US S. Korea Japan UK effective- ratio11 = ratio1= 0% = 50% ness 100% Tax reduction/ UK Japan Canada US S. Korea Italy Germany France No tax exemption benefits Level of without cap regulatory support Account is Account is completely S. Korea UK Germany Japan France Italy US Canada completely mandatory voluntary

Level of Investment Investment is highly US Japan Canada UK Italy France Germany S. Korea is highly control flexible restricted

1 Net replacement ratio: calculated by the net amount of pension received by individuals, divided by the net amount of income before retirement, while considering the personal income tax and social security paid by pensioners. This indicator is used to measure the effectiveness of the amount of pension received under the pension system to replace pre-retirement income; here we use the male net replacement published by the OECD Source: OECD; expert interview; McKinsey Global Insurance database; McKinsey analysis

In the global market and in light of different dimensions, we believe that the pension market development paths and stages and retirement in advanced markets demonstrates three types: mindsets, countries show significant differences government-benefit type, commodity market in terms of pension structure, market efficiency, type, and multimonopoly type (Exhibit 3). Devel- level of policy support and governance (Exhibit 2). oping countries, including China, will evolve into one of these models as their economy grows and McKinsey evaluates each country’s pension their pension system matures. system along two dimensions: (1) the mix of pension structure: a higher proportion of the 1. Commodity market type. In mature markets, first pillar indicates the government’s take on such as the United States and Canada, pen- bigger responsibilities in the pension system, sion systems are completely market driven thus private retirement savings by the business after almost a century of development. The and consumers is a lower responsibility and has government’s role in the first pillar is very low less potential in the market. (2) The maturity (e.g., 10 percent in the United States), while of financial markets, especially the retail asset their retail asset management is highly ad- management market: the maturity of the market vanced. Consumers have been fully educated decides commercial pension products’ type by the capital market on where they can find and variety of providers. Based on these two a variety of easy-to-buy pension products to

6 The winning strategy for the pension market in China Exhibit 3: The global pension insurance market can be divided into 3 types

High Government benefit Led by the France govern Italy -ment

Development Germany level of the 1st pillar of the UK government’s South Korea pension system Japan Canada

market US driven Low Led by top players Commodity market Low High Concentrated market with little product Market is fragmented with a variety of selection products Development level of retail asset management

meet their needs, including low-cost ETF (ex- 3. Lead by top players type. In this kind of change-traded funds) and TDF (target-date market, as represented by Japan and South funds), among others. Retail asset manag- Korea, three pillars are evenly distributed. ers, led by fund companies like Fidelity and Unlike the commodity market type, Japan’s Vanguard, are the key market players. and South Korea’s capital and asset man- agement market is less developed, and their 2. Government benefit type. European coun- consumers highly value brand but know less tries like Germany and France provide good about pension and investment products. As benefits. The first pillar accounts for a large a result, the markets are dominated by big share in their pension system (e.g., 69 per- insurers and banks. cent in Germany). Meanwhile, the growth of the second and third pillar has flattened at a Each country’s pension system development large scale. Since their retail asset manage- has its own special circumstances and history; ment industry is less mature than the United therefore, there is not a single correct and ideal States and UK, insurers are the key play- model. We think the United States, Germany, ers, with much less competition from fund and South Korea are typical examples of each companies. model, providing a reference framework for Chi- nese regulators and pension companies.

The winning strategy for the pension market in China 7 The United States: highly advanced whether they choose a 401(k) or IRA. As the US capital market led by fund compa- capital market gradually matures, fund-type as- nies set managers have used their rich product mix, professional investment management, and bull markets to generate high returns on investment, Tax incentive policies enable the fast develop- thereby successfully overtaking banks and ment of the second and third pillars insurers to become the leader in the second and After a century’s development, the US pension third pillar pension markets in the United States. system is dominated by the second and third For example, asset management products’ pillars due to various government incentive proportion in the IRA plan has significantly risen policies. The 401(k) plan in the second pillar, the most important employee retirement plan for in the past 40 years. As of 2017, it accounted private companies, is a corporate supplementary for 65 percent in the total assets of the IRA plan retirement insurance plan jointly contributed (Exhibit 4). Blackrock,Fidelity, and Vanguard are to by employers and employees. The IRA in the major providers in the common fund prod- 1 the third pillar, an investment pension account ucts, contributing over 40 percent to market voluntarily contributed to by individuals, has be- share by AUM. come a pension product on par with the 401(k) in the US private pension market. In the past de- Germany: national public pension cades, the US government improved policies and dominates, while commercial pen- regulations, introduced tax-deferred incentive sion is catching up policies, and kept raising exemption amounts. Meanwhile, it also added automatic joint clauses Overburdened public finance is prompting and improve accounts’ transferability, by allow- pension responsibilities to move toward the ing a free transfer of capital among accounts. private sector So far, the second and third pillars’ individual Germany is the first country in the world that commercial pension capital has accounted for established a social security system. As one of 90 percent of the total pension asset. its key components, the pension system boasts a history of 120 years. The German government A mature capital market enables fund-type leads and pursues a long-term pension system asset managers to lead the market of “receive/pay on the go.” However, due to a Individuals have the freedom to select products, slowing economy, accelerated aging phenom-

1 McKinsey US Wealth and Asset Management Practice estimate. Tax incentive policies enabled fast development of the 401(k) plan and IRA in the United States, the commercial pension capital has accounted for 90 percent of the total pension market. Fund-type asset managers become leaders in the second and third pillar pension markets in the United States using a rich product mix and profes- sional investment management skills.

8 The winning strategy for the pension market in China Exhibit 4: Asset managers become the most important provider of investment products under the 3rd pillar of the IRA plan in the US Proportion of each kind of investment product under the IRA plan Percent, USD billions Securities Insurance Bank deposits AM products

100% = 38 159 404 637 993 1,467 2,651 2,532 3,425 3,681 5,153 7,292 9,200

12.6 15.3 24.6 26.1 25.9 23.7 28.5 32.9 32.0 31.7 31.7 28.1 27.6 6.0 8.1 6.9 10.6 9.4 7.0 9.2 10.4 7.8 17.6 11.1 8.8 26.5 9.3 10.2 71.6 65.1 48.2 41.8 12.2 7.5 7.0 59.4 63.4 6.6 49.9 54.6 51.0 54.2 7.4 42.9 45.8 7.9 33.6 8.7 19.8 23.1 7.1 11.7 1981 84 87 90 93 96 99 2002 05 08 11 14 2017

Source: US Federal Reserve, “ Financial Accounts of the United States” table 227

enon, and increasing social dependency ratio, United States and UK, the retail asset manage- its government pension gap is widening year by ment sector in Germany is not active. Although year. Unable to absorb this burden, the govern- the government encourages more financial insti- ment started to actively promote reforms in the tutions to participate in the commercial pension pension system at the start of the 21st century business, insurance types of financial organiza- by encouraging more pension responsibilities tions remain the key players in the enterprise an- to transfer from the public to the private sector. nuity and individual commercial pension market. For example, it introduced the BRSG to enable The top five insurers account for more than half annuity for low-income people through raising of the market (Exhibit 5). Due to its reputation, the tax-deduction cap and offering employ- brand, digital transformation, and customer- ers subsidies. The government also introduced centric product/service strategy, Allianz attracts pure DC products to foster the development of many German consumers. Its premium scale and the second pillar enterprise annuity. In addi- growth far outstrip other peers. tion, the German government also launched the Riester Reform to expand the pension scope to South Korea: late but fast mover; insurance, fund, and savings products, so as to banks and insurers gain advantages encourage insurers, banks, and fund companies to provide pension products. Profound reforms enabled the rapid develop- ment of three pillars Insurer giants dominate the commercial In the 1960s, South Korea set out to develop insurance sector its multitier, three-pillar pension system with The German public is risk averse and conserva- comprehensive coverage. The system is less tive in investment philosophy. Compared with the than perfect and still improving. Currently, the

The winning strategy for the pension market in China 9 Exhibit 5: Proportion of insurers’ income in the 3rd pillar in Germany in 2017

EUR billions Estimates Market Insurance ranking company Premiums Market share 1 Allianz Group 14 21% 2 Generali Group 9 13% 3 HDI/Talanx Group 4 6% 50% 4 R+V Group 4 5% 5 Debeka Group 3 5% 6 Zurich Group 3 4% 7 ERGO Group 3 4% 8 AXA Group 3 4% 9 VKB Group 2 3% 10 Nürnberger Group 2 3%

Note: Calculation method: insurers’ 3rd pillar premiums = total premiums – group premiums Source: McKinsey’s Germany Insurance database

government-led first pillar remains a major force, pillar, while insurers make up 90 percent of the and its asset size accounts for over 50 percent. total personal commercial pension market in the However, the public pension’s replacement ratio third pillar (Exhibit 6). Influenced by low interest is less than 40 percent, and the whole system rates, the public hopes to get a higher return on faces huge challenges. In 2001, the government investment for pension products. With incentive revised individual retirement plans and forced policies from the government, asset manag- the reform of enterprise annuity by introducing ers well versed in investment management are the IRP account. As a result, the second and playing more important roles and starting to third pillars have grown fast in the past decade. challenge the leading positions of insurers and As of now, the third pillar’s personal commercial banks. pension insurance asset accounts for over 30 When we compare each nation’s pension system percent of total pension assets. The mix of three development, there is no single ideal model. Chi- pillars is becoming more balanced. na is at the crossroads of pension reform. Based on China’s circumstances and global market de- Large banks and insurer giants dominate the velopment trends, McKinsey offers the following second and third pillars, respectively observations on China’s pension market: South Korea adopted an access-approval system for pension companies and places many ƒƒ Unbalanced development of the pension restrictions on pension investment. Currently, system with commercial pensions in urgent its enterprise annuity and commercial pension need of development insurance market is comprised mainly of repu- The unbalanced development of the three table insurers and banks. Banks account for 51 pillars cannot continue in the long run. The percent of total annuity business in the second first and second pillars need immediate re-

10 The winning strategy for the pension market in China Exhibit 6: Market shares in South Korea’s 2nd and 3rd pillars in 2017

Market share by each Top 5 financial institutions’ market share and rank type of financial institution (by asset size) Market Asset size 1 100% = USD 148 billion rank Company Industry USD billions Market share3

Securities 1 Samsung Life Insurance 19.9 13% companies 2nd 2 Shinhan Bank Banking 14.5 10% 19 pillar 3 Kookmin Bank Banking 13.0 9% 51 Banks 30 4 IBK Banking 10.8 7% Insurers 5 Woori Bank Banking 10.4 7%

100% = USD 293 billion2 Market GWP Securities rank Company Industry USD billions5 Market share4 companies Banks 5 5 1 Samsung Life Life 5.5 21% 3rd 2 Kyobo Life 3.1 12% pillar 3 Hanwha Life 3.0 12% 90 4 Nonghyup Life 2.8 11% Insurers 5 Samsung Fire Nonlife 1.6 6% 1 McKinsey South Korea; FSS 2 FSS, expert interviews 3 Market share of all kinds of financial institutions in the 2nd pillar 4 Market share of insurers in the 3rd pillar (excl. banks and securities) 5 KIDI

form, mainly due to the guidance and incen- assets, insurer giants such as Allianz enjoy tive of government policies. Our regulators huge advantages in the pension finance can learn from the experience and lessons market. They have also assumed more social of each country’s pension account, prod- responsibilities in participating in the deve- uct tools, investment management, and tax lopment of the personal pension market and incentives. investor education.

ƒƒ Lack of pension products, leaving bright ƒƒ Unbalanced regional development and future for product innovation advanced regions are expected to enter the China’s commercial pension market just got US-style industry landscape started with very limited product selec- As China has a huge population and regional tions. Due to consumers’ strong and diverse economic development is unbalanced, the needs along with policy liberalization, there reform of the commercial pension market is a huge space for innovation in third-pillar cannot be achieved at once. Developed products. There is also a great deal of poten- areas like large bay areas and the Yangtze tial in quickly identifying and responding to Delta Region enjoy obvious advantages in consumers’ personalized needs. terms of capital market maturity, residents’ ƒƒ Insurance giants enjoy huge advantages income level, and consumption demand. and should shoulder more social responsi- Therefore, in these economically advanced bilities areas, flexible and professional fund compa- With their brand image, a natural fit be- nies will also play important roles. Asset and tween insurance products and retirement, wealth managers like Fidelity can provide as well as experience in managing insurance good lessons for their Chinese counterparts.

The winning strategy for the pension market in China 11 Ontario Teachers’ Pension Plan’s (OTPP) Ben Chan on secrets to investment success

Ben Chan

—— OTPP Asia Regional Managing Director

OTPP is one of the most respected, special- they don’t participate deeply with the day-to-day ized, and professional pensions in Canada. operation of the fund. The professional staff of What do you think is the secret of OTPP’s OTPP are focused on maximizing the return on success? investment while ensuring appropriate liquidity. To talk about OTPP’s achievements today, you The Teachers’ Pension Act and other legislation must look at its history. Prior to the establish- ensure that such arrangements are not destabi- ment of OTPP in 1990, pensions for teachers in lized by changes in the government. Ontario were fully supported by the government. Today, the OTPP investment team’s goal is to Teachers received pensions in amounts linked achieve an “inflation + 4 percent” return on to their preretirement income (a typical defined investment on a sustained basis. It is not easy benefit scheme), and funds were invested mainly to achieve this goal year after year. As such, we in local government bonds. However, the fund have found the best investment talent in the was in a state of deficit and had to be bailed out industry. Regardless of educational background by the government. and personal vision, our employees always take OTPP’s goal to heart. Since then, we’ve made huge improvements. In April 2018, our net assets reached CAD 189.5 The return on investment of OTPP has not billion, and based on conservative actuarial as- only met the “inflation + 4 percent” target sumptions the pension’s overall profit stood at but has also exceeded it in many years. Can 105 percent. In 2017, we achieved a net invest- you share the principles and rationale of your ment income of CAD 17.0 billion with an invest- investment strategy? ment return of 9.7 percent for that year. We have three primary principles that guide our This improvement is primarily due to profound investment strategy. The first principle is to insist reforms of the pension governance system in on in-house investment management. We man- 1990. OTPP was set up as an independent and age 80 percentof our own portfolio, with only 20 professional investment institution responsible percent being handed over to other asset man- for the pensions of public-school teachers of agers. This principle is based on several con- Ontario. The whole setup is similar to a gen- siderations. The first is our objective of building eral manager system authorized by a board of the capabilities of our in-house team, because directors in the private sector. Government and we believe that our own investment team is the teacher representatives sit on our board, but most aligned with OTPP in values and mind-set.

12 The winning strategy for the pension market in China Next, an in-house team is more stable, and the risk across asset classes, it’s also a philosophy portfolio and intent of the investment are more of investment. We cover all investment catego- transparent. Therefore, the core management ries—including equity (secondary market and team knows the current state of our invest- PE), fixed income, credit assets, and real estate. ments and the goals behind them. And finally, From a geographical perspective, we have in-house teams have a long-term cost advantage traditionally been active in North America, but over external managers. This cost advantage as emerging markets (particularly Asia) build up has become increasingly obvious as our total their investment capabilities, our share of invest- assets under management has exceeded CAD ment there has risen every year. To this end, we 180 billion. While we are proud of our in-house follow a rigorous, top-down set of asset alloca- team, we also strongly believe in complementing tion logic, for which our global chief investment their efforts with the most appropriate partners officer is usually directly responsible. in different investment areas. Combining the knowledge and experience accumulated by our China is carrying out a series of pension long-term investment funds and partners helps reforms. From your experience in OTPP, what to achieve a win-win investment strategy. are your thoughts and suggestions on China’s pension reforms? The second principle is a focus on long-term I am not an expert on China’s pension policy, so investments. The professional investment sec- I will share OTPP’s experience. We believe that tor is generally affected by short-term volatil- professional investment teams should be given ity, including public, private, and hedge funds, authority in top-level design of pension systems. which are forced to make investment decisions To empower our professional team, we give them due to pressure on annual and even quarterly clear investment goals and mandates, which results. But we don’t have to. Pensions are well should be challenging but practical. Another suited for long-term investment, and OTPP priority is to pay attention to talent, which at outperforms many other investors (insurance OTPP is very market oriented. We offer competi- companies, public equity funds, and private tive, market-based compensation to recruit the equity funds) in debt duration, which is to our best people. advantage. We’re not pressured by short-term return expectations. We can configure more Finally, it’s important to consider risk manage- ment and corporate social responsibility. Of asset classes with better risk benefits over the course, we face both macro and micro invest- long term. For example, we invest in a lot of ment risks. We have rigorous processes and PE projects in Canada, usually with long lock standards to control such risks. The most impor- periods. We have real-estate and infrastructure tant risk to consider, however, is reputational. investments around the world, which are not only We only invest in socially responsible industries priority projects for many local governments but and businesses and won’t touch industries with often have good long-term returns. high returns but poor social reputations, such as The third principle is diversification of our invest- tobacco. This is both our investment policy and ments. We diversify not just to spread out our our corporate mission.

Pensions are well-suited for long-term in- vestment, and OTPP outperforms many other investors in debt duration, which is to our advantage. We’re not pressured by short-term return expectations.

The winning strategy for the pension market in China 13 Chapter 2: An outlook of China’s com- mercial pension market

14 The winning strategy for the pension market in China The overall second pillar’s annuity ing from May 1, 2019. Therefore, it is unlikely that market enjoys a stable development private enterprises shall be obliged to establish annuity plans, and their annuity market will not Enterprise annuity customers are mainly large experience explosive growth. companies and this won’t change in the short term Occupational annuity enjoys stable growth After 14 years of development, China’s cur- with limited potential rent enterprise annuity size stands at about The Occupational Annuity Guideline in 2015 RMB 1.2 trillion, accounting for 1.6 percent of essentially changed the former DB pension its GDP. It is, however, still well below the level scheme of the government authorities and insti- of developed countries like the United States tutions to the DC pension scheme. It replaced (27.3 percent) and Australia (>100 percent). MOF’s sole financial responsibility with MOF plus Furthermore, the coverage of annuity among the market so as to mitigate financial risks. Un- Chinese enterprises is relatively low, with about like enterprise annuities, which have a coverage 20 million employees participating in annuity issue, occupational annuities are mandatory and plans. The participants are mainly SOEs whose thus their market size is clear and predictable. workforce account for only less than 5 percent in Currently, its main growth lever is accumulated the total working population in cities and towns payments, which are expected to experience across the country. In addition, their growth has stable growth in the following years. However, stagnated. Private enterprises’ coverage is very its potential is limited and will gradually enter a low due to their rising operational costs. Many stage of balanced payments and withdrawals. of them, especially SMEs, have not yet paid the basic social security for their employees, let Limited profit for annuity management and alone annuities. The Management Guideline of investment, B2C cross-sales can be used to Enterprise Annuity, introduced in 2018, encour- realize value aged enterprises to establish annuity systems Currently, annuity management and investment and increase long-term incentives for key tal- are regulated via strict license approvals. Market ents. However, as the global economy slows, the players cannot expect to reap extra investment government is now trying to support the private returns, and each has some slight differences. sector by further reducing their burden. The Annuity products are rather undifferentiated in Ministry of Finance said that it would further dial features and the employee participation ratio is down the social security contribution ratio start- relatively low. Currently, overall profitability of

Restricted by economic affordability, pri- vate enterprises especially SMEs have less chance to join the enterprise annu- ity scheme, hence will not drive explosive growth in the annuity market.

The winning strategy for the pension market in China 15 the annuity business is low, and its competition personalized needs. mainly focuses on price, investment returns, and sales relationships. In the middle to long Preferential policies spurred the rapid devel- run, however, annuity can be a hook product for opment of China’s personal pension business insurers and banks to build a long-term relation- On May 2018, the pilot of personal income-tax- ship and explore other businesses with medium deferred pension insurance heralded the third and large enterprises that have a large number pillar. The income tax reform in the same year of workforce with stable income. expanded the tax base from compensation to comprehensive incomes and called out the sup- The third pillar of personal com- port areas of education and retirement. This pro- mercial pension has “explosive” vided the policy support for capital, which was growth potential­ invested in financial products and real estate, to switch to the pension investment. In October An alarming gap in social retirement savings, 2018, Guo Shuqing, Head of CBRC, stated at the and huge demands for third pillar's basic IOPS’s annual meeting: “China will further reform needs and promote the supply-side structural reform in The first pillar public pension's replacement ratio the pension market, with a focus to improve the is less than 50 percent, and monthly pensions replacement ratio in the second and third pillar payment in cities and towns are about RMB and to promote the commercial pension insur- 3,000. The coverage of the second pillar of oc- ance to provide more effective long-term capital cupational/enterprise annuity is very low, with for the economic development.” 2018 was a most uncovered by annuity and suffering from milestone in the development of China’s pension a huge gap in retirement savings. Most non- business, witnessing the introduction of multiple institutional pension products, like commercial policies and pilots that laid a solid foundation for pension insurance and retirement investment the long-term healthy growth of the third pillar. products are very much undifferentiated and unsupported by tax benefit policies. Compared Public policies set the direction for with traditional investment products and real the personal pension industry estate investment, their return are less competi- tive and cannot meet the retirement financial Based on the global experience in pension needs of the middle class and HNW segments. development, regulatory policy guidance and support are core drivers of explosive growth Individual retirement needs are becoming in the market. McKinsey believes that China more diverse, resulting in more comprehen- needs to fully learn from global experience while sive commercial retirement products considering its own specific circumstances so as With China’s fast-growing economy, devel- to continue optimizing regulatory systems and opment of medical technologies, and longer supporting the rapid and healthy development average life expectancy, the first generation of personal pension businesses in the following of the middle class (mainly post-70s/80s) are three areas: expecting more from their retirement life. The requirements of wealth management, pension Enhance system design management, and health management have con- The current pension system is lacking a unified verged and become more diverse and complex. top-level design, with CBRC and CSRC push- Compared with the institutional and standard- ing pilots via different product types in each ized first and second pillars, the third pillar industry. Furthermore, the account system is enjoys a unique advantage in quickly identifying yet to be linked with the information platform, and responding in a timely fashion to consumers’ and a unified tax incentive policy has yet to be

16 The winning strategy for the pension market in China Foreign insurers have entered China's pension market, bringing leading global experience and concepts that will benefit the industry's healthy and diversified growth.

launched. In addition, the current pension regu- Foreign insurers have entered the latory mechanism is not clear, with professional market to support the fast develop- supervision from the Ministry of Human Affairs ment of China’s third pillar personal and financial supervision from CBRC. It is sug- pension market gested the governance body and mechanism for the pension be articulated and professional or- On March 27, 2019, CBRC announced that it had ganizations be engaged for its top-level design approved Heng An Standard Retirement Insur- to ensure the policy is consistent and cohesive. ance Co., Ltd to establish the first foreign pen- Using the top-level design, the following should sion insurance company in China, signaling the be introduced as soon as possible: a reliable and official entry of foreign insurers into the pension unified pension account, management platforms, insurance market. tax incentive policies, and investment guidelines aligned with the pension industry, so as to regu- Foreign insurers are confident in the Chinese late the industry development. pension insurance market’s potential Due to the policy incentives in 2018 and un- Guide an open innovation covering the middle class’s retirement needs, Currently, the pension pilot scheme has exposed foreign pension financial companies are con- a series of issues like limited tax incentives, a fident in China’s pension market. The market narrow product scope, and complex policy pur- has just opened, so it is still small and has weak chase and tax redemption. It is recommended competition. It is the best time to enter this that more companies be allowed to participate, market. Additionally, the middle to high earners the pension policy restrictions be lifted rea- in tier one and two cities are the first group of sonably, the tax incentive ratio raised, and the core users of personal pensions, and they prefer investment scope and volume cap extended so foreign brands. as to create a sound policy environment for in- novation. Their leading concepts and investment man- agement experience will help China’s pension Strictly safeguard baselines from risks market grow faster With consumers’ long-term pension security and Foreign leading pension companies have accu- legal rights as a starting point, we should estab- mulated profound experience in product design, lish a sound risk prevention and control system, customer service, and investment management strengthen process supervision and monitoring, over a long period in the past. On one hand, they and severely penalize incompliances. Meanwhile, will bring richer pension products and consumer we should also improve the systematic risk pre- selections to promote the industry’s innovation. warning and management mechanism to guard On the other hand, as professional long-term against systemic risks related to longevity and institutional investors, foreign pension companies investment. can help China’s capital market grow stably in the long run.

The winning strategy for the pension market in China 17 Developing China’s pension system: An in- terview with Professor Keyong Dong

Professor Keyong Dong —— Professor at the Renmin University of China (RUC), Ph.D. in Economics, Ph.D. tutor

—— Director of the Research Center for Retirement Finance, Renmin University of China (RUC)

—— Secretary-General of CAFF 50 (China Aging Fi- nance Forum)

How will China’s pension system develop in the pension system to address the challenges of the future? What are your suggestions on the an aging population. reform of the pension system? I think we need to reform each of the three pil- As China’s population ages, the pension system lars in distinct ways. First, we need to consoli- is now in the spotlight. After several decades of date the first pillar and standardize its payment development, China has established a complex, models. The urban and rural components should three-pillar pension system with wide coverage be united into one national public pension. and multiparty participation. Despite remarkable We should then build a transparent payment achievements, the system faces many challeng- scheme by standardizing all components of the es—chief among them the fragmented nature system, including the base and ratio of pay- of the system’s structure. Currently, the first pil- ment from employers and employees, methods lar—the public pension system, which is split into of salary calculation and adjustment, and fund urban and a rural components and is funded by management. To improve the sustainability of employers through a pay-as-you-go scheme and the system, we need to study the incentives and employees via individual accounts—is the most approaches for deferred retirement. developed and serves most workers in China. The second pillar offers voluntary enterprise an- Second, we need to promote the development nuities to employees of state-owned enterprises of the second pillar by doing several things, as well as voluntary occupational annuities to starting with strengthening tax incentives for government employees. The third pillar is still participation. We should also consider automati- nascent but in theory offers a path for supple- cally enrolling eligible employees, as opposed mentary private retirement savings with govern- to making them opt in; rectify the unfunded ment tax benefits—akin to individual retirement accounts of some occupational annuities; and accounts in the United States. The first pillar achieve real account management as soon as is currently dominant, while the other two have possible. Meanwhile, we should also improve the developed slowly and are currently insufficient. investment management mechanism and intro- The experience of developed countries shows duce the "personal investment choices", e.g. an that only a multipillar mix of pension systems and employee has choices in the underlying pension options will enable the sharing of retirement- investments in his/her second pillar accounts, at savings responsibilities of governments, enter- the right time. When the time is right, we should prises, and individuals. In this way, we can better also consider consolidating the enterprise an- spread risks and promote the sustainability of nuity with the occupational annuity to form a

18 The winning strategy for the pension market in China unified second pillar. the financial institutions in risk guarantee and investment management. Third, we need to speed up the development of the third pillar. At present, the third pillar of Chi- Finally, we need to establish proper supervision na’s pension system is still in the pilot phase. We of the third-pillar system. This monitoring will should use that pilot experience to guide policy involve several sectors and agencies, so mu- making to strengthen fiscal and tax policies tual cooperation, good interaction, and smooth that will facilitate expansion and maturation of communication among regulatory authorities private pension products, optimize the process will be an important foundation for the healthy of individual participation, and set up a complete and rapid development of the personal pension personal pension scheme as soon as possible. system. In the near term, the number of partici- pating financial institutions should be carefully The third pillar of personal pensions is cur- expanded and the regulation model tested rently nascent. What are your suggestions for before scaling out to all corners of the market in its system design? the future. The system design of the third pillar can be ap- The third pillar of personal pensions is a new proached in the following ways. First, we need concept for Chinese people. How should we to expand access to the system to the entire promote pension finance education for them? Chinese workforce. In my view, the third pillar is a supplement to the public pension scheme to It is very important to improve people’s retire- cope with an aging population and improve the ment-related financial knowledge through sys- pension system. This platform should be open to temic, diversified educational methods involving individuals, governments, and enterprises. The multiple parties and following relevant laws and relevant departments should fully discuss the regulations. To promote and implement pension platform development to optimize the individual finance education, it’s necessary to coordinate participation process and facilitate system all kinds of resources and carry out a compre- supervision. hensive evaluation. Specific considerations may be considered in the following areas. Second, as I mentioned earlier, we need to set up fiscal and tax policies to facilitate the expan- First, we should take full advantage of the sion of both the second and the third pillars. government’s general guidance role. In general, Such policies will be the core driving force for financial activities are proactive actions taken by developing the second and third pillars. Apart participants. However, many pension investors from the EET model, we can also explore the are mainly attracted by tax benefits and are pas- sively engaged in pension investment without EEE model—that is, include personal pensions financial knowledge. Therefore, the pension as additional special deductions under the Indi- finance education is, to a certain extent, univer- vidual Income Tax Law. Fiscal subsidies can be sally needed as a public welfare. It’s necessary offered to low- and middle-income groups. for the government to guide all sectors of the Third, we need to drastically increase the society to establish a pension finance education number of personal pension products available. system. The first action is to include pension Today, just a few financial institutions provide finance in the national education agenda for individual pension products. To meet the diversi- preparation of an aging society. In 2018, the fied product needs of the participants, a much National Office of an Aging Society, the Ministry larger set of financial institutions, such as banks, of Central Publicity, and the Ministry of Central funds, and insurers, should study the market Organization jointly issued the Notice on Carry- and begin offering a diverse set of products ing out the Education of an Aging Society, which that meets the different needs and experiences is the first time China has promoted aging edu- of citizens. They should follow the principle of cation at the government level. Including pension providing long-term and convenient service financial education in that initiative will go far for participants to design the pension financial in promoting national awareness. The second products and fully leverage the advantages of action is to design the framework of the pension

The winning strategy for the pension market in China 19 finance education system, set guidance for co- tion. Professional investment consultancies can operation across all financial sectors, and ensure formulate and refine educational programs with systematic development going forward. The different features according to different ages, third action is to make sure necessary financial cultural backgrounds, and asset statuses of cus- support is in place, for example, by setting up a tomers to meet the diversified needs of financial special fund for the education efforts to encour- education. age involvement from more social institutions. When it comes to financial education for the Second, we should take full advantage of market elderly in particular, all parties should pay at- forces. The first action is to reiterate the crucial tention to both the development of investment role of financial institutions such as insur- ability and mitigation of fraud risk. In recent ers, banks, and funds in individuals’ pension years, there have been frequent reports of finance education. These organizations have a criminals taking advantage of middle-aged and wide range of customers, and this makes them elderly people’s lack of financial knowledge to important channels to roll out financial education perpetrate financial fraud using pension prod- for the elderly as well as the general popula- ucts as bait. This illegal behavior has affected tion. Financial institutions should integrate the the healthy and legal development of pension concept of pension finance education into the system, as well as the population’s trust in it. design, investment, information disclosure, We need to ensure our citizens are investing and post-investment management of pension in proper pension products through legitimate products. They should also provide customized investment channels. consultation and guidance according to inves- By implementing a multiparty pension finance tors’ risk preferences and return characteristics education system throughout the country, we and set up an education scheme tailored to can help our people improve financial aware- different customers and products. The second ness, establish positive pension planning and action is to strongly support the development investment management behaviors and mind- of the third-party investment and consultancy sets, and enhance the retirement security of our institutions related to pension finance educa- citizens.

We need to consolidate the first pillar and standardize its payment models. The urban and rural components should be united into one national public pension. And we need to set up fiscal and tax policies to fa- cilitate the expansion of both the second and the third pillars.

20 The winning strategy for the pension market in China Chapter 3: Financial institutions’ win- ning strategy in the com- mercial pension market

The winning strategy for the pension market in China 21 Exhibit 7: Major players in China’s pension market

Unqualified or almost no involvement Light participation Heavy participation

Key roles of the 2nd pillar Business value chain of the 3rd pillar

Invest Market Invest- Customer Account Account Product ment Trustees ment Custodian acquisit- manage- positions of manager provision manag manager ion ment ement pension

End-to-end provider Insurers

One-stop service provider of “wealth management + Banks pension”

Pension financial investment Funds management expert

Source: Literature Research; McKinsey analysis

Commercial pensions go hand in hand with com- Securities Investment Funds (Pilot) Nov 2017 by mercial institutes, all types of which are enter- CSRC and Notice on the Pilot of Deferred Com- ing the commercial pension market via different mercial Retirement Insurance for Individual Tax positions on April 2018 by MoF). It was initially decided that insurers and public fund companies should The second pillar of annuity business in China is be the providers of core products, while banks subject to license granting, and approved finan- should be account managers (Exhibit 7). cial institutions of each type play their respective roles: insurers and banks possess full license Insurers: strong first-mover advan- qualifications, but with a different focus. Using their unique strength in long-term asset man- tages to become end-to-end service agement, insurers play the role of trustees and providers in commercial pension investment managers as providers of integrated insurance annuity plans. Commercial banks act as account With the continual development of the pension managers and custodians as providers of opera- commercialization reform in China, large insur- tional services, thanks to their advanced account ers, which historically enjoyed unique policy management system. Public fund companies advantages, have become important participants play the main role of investment managers due in China’s pension market. Due to its full license to their outstanding investment management qualifications, distinctive insurance product skills. In addition, some trust and securities service capabilities, and extensive experience companies are also getting involved as trustees in insurance asset management, insurers enjoy and investment managers, respectively. China’s first-mover advantages. They are set to become third-pillar individual commercial retirement fund end-to-end service providers in the second- and just got started (Guideline on Retirement Target third-pillar pension market. McKinsey believes

22 The winning strategy for the pension market in China Exhibit 8: Insurers should leverage first-mover advantages to become end-to-end providers in the 2nd and 3rd pillar pension market Key initiatives Customers Products Investments Investment products Asset Hone basic Annuity 1 2nd allocation investment skills pillar Individual Group compre- compre- Employee hensive Corporates hensive Insurers Reach diverse + family finance finance Stocks 2 customer groups

Diversify 3 product innovation Bonds Offline Asset Establish agents 4 smart operation 3rd Online allocation services pillar platform External Control Individual partners Ecosystem Non- 5 consumer partners standard longevity risks Pension finance + assets… one-stop service solution

that insurers should focus on five areas to win in insurance assets to further expand their the Chinese pension market (Exhibit 8). advantages in configuring large-class as- Hone basic investment skills sets and acquiring nonstandard products to improve their skills in managing annuity ƒƒ Leverage insurance company’s asset man- agement capability and close the gap in investments. However, compared with fund securities/investment companies, insurers have weak investment Annuity customers value absolute guaran- skills in securities. Therefore, they should teed returns and low volatility in pension actively close this gap and improve their investment. Insurers can meet these needs comprehensive investment management by using their natural abilities in managing capabilities.

McKinsey believes insurers have strong first- mover advantages, and should focus on honing investment skills, reaching diverse customer groups, diversifying product innovation, estab- lishing smart operation services and controlling longevity risk, which will help them become end-to-end commercial pension providers.

The winning strategy for the pension market in China 23 ƒƒ Break the stagnant talent management The CAFF50 Survey indicates that banks system and accelerate the development of are the most important channel for consum- investment teams ers to buy pension products while insurers In investment management, the capabilities lag behind. It is understood that insurance of the investment team are core to improv- agents do not have strong incentives to refer ing financial institutes’ investment levels. and promote commercial pension insur- Currently, some domestic insurers’ annuity ance products due to lower commissions. investment teams suffer from a stagnant Therefore, insurance companies should use talent management system as well as from multiple methods to motivate agents and an ineffective compensation and incentive leverage other channels to inform consum- system, which result in the high turnover ers about and sell commercial pension of top investment management talent and products to them. First, consumers need to thus low-performing teams. Insurers should be segmented by industry, age, and family therefore adjust the current stagnant talent structure. Second, banca channels should management system in terms of incentives, be used, especially HNW private banks, to evaluations, and training. Available initiatives educate consumers about pension products. include adding quantifiable measurements ƒƒ Develop targeted data-driven customer like AUM size and long-/short-term perfor- marketing to improve acquisition efficiency mance to the evaluation system as well as Pension products cover a wide variety of inviting overseas investment management target consumers – hence the right chan- experts for professional trainings. nels need to be selected based on each ƒƒ Develop a systematic investment manage- segment’s age, occupation, and consump- ment procedure tion habits. Compared with traditional tied As mentioned before, a top investment team agents, targeted data-driven online market- is a core growth engine, while systematic ing can greatly improve customer acquisi- investment procedures and methodologies tion. Insurers can partner with social media, are the cornerstone to guarantee a stable search engines, or other internet companies performance over the long term. Compared to pinpoint users interested in pension prod- with international leading peers, domestic ucts. Leading domestic financial players have insurers rely more on individuals or depart- already taken action with targeted marketing ments for investment management.The lack as well as tailor-made products and pricing. of a companywide process or procedure Pension insurance companies with weak negatively impacts decision making, which digital capabilities should learn from these is very impulsive. Therefore, insurers should players and build online customer acquisition standardize key procedures in investment skills. research, credit rating, risk management, ƒƒ Improve tied agents’ professional skills and post-investment management, and review. In enhance internal cross-sales addition, they should strengthen IT applica- Compared with other financial institutions, tions in each process and improve long-term insurance agents have varied levels of pro- investment and management skills. fessional skills but poor professional product knowledge and retirement advisory skills. Reach diverse customer groups Insurance companies should improve life ƒƒ Promote investor education and improve insurance agents’ knowledge of commercial pension finance awareness pension products and enhance their profes- In recent years, Chinese consumers’ aware- sional skills to offer customers better-quality ness and acceptance of insurance products and comprehensive product consulting ser- has improved significantly, especially of vices. Secondly, it is necessary to strengthen health products like CI. However, many con- the cross-BU cooperation within the group sumers are not aware of pension savings and and unlock the vast amount of customer data have very limited professional knowledge. available to them. Insurers would then be

24 The winning strategy for the pension market in China B2B2C model is the key breakthrough to achieve profitability.

able to design targeted commercial pension ucts is as short as three years, and medium- product recommendations based on the uni- and long-term pension products are scarce. fied internal customer data, thus fully seizing This is mainly because some insurance com- the opportunities of internal cross-selling. panies overly pursue the scale of short-term premiums at the expense of the essential ƒƒ Use the annuity business as a springboard demand of long-term retirement savings. to deep dive into business customers (B2B), In such a market environment, insurance individual customers (B2C), and data value companies should actively explore different The companies that established the annu- types of commercial insurance products, ity system are the largest and strongest in move away from the mindset of pursuing China. Their more than 20 million employ- short-term performance in product interest ees are among the higher income groups in rate and duration design, and pay attention China. Therefore, the group’s customers and to new policy values and long-term stable individual users brought by the annuity busi- return on investment. ness and their network have great monetized value. Most financial companies that ob- ƒƒ Expand the scope of product services and tained the annuity license also have exten- provide value-added services based on re- sive comprehensive financial service capa- tirement security to meet needs of one-stop bilities. By using the annuity business as a pension services springboard, they could establish a long-term The boundary between pension and private cooperative relationship with business cus- wealth management is becoming blurred, tomers as well as employees to strengthen with consumer needs for both increas- the group’s integrated financial services and ingly overlapping. The one-stop solution of promote individual integrated financial cross- providing pension and services has become the development trend of the industry. As sales. China’s leading insurance companies banks and fund companies entered the third have started to provide group-comprehen- pillar of the commercial pension market, sive employee benefits for business annuity the ability to provide value-added ser- customers, but most of them do not have vices and integrated financial solutions for the ability to serve individual customers. To retirement security purposes will become a make a breakthrough in the B2B2C business, differentiated competitive edge for financial they should improve products, channels, and institutions. Therefore, insurers should fully service operations. In addition, they could leverage resources within the group, actively establish a long-term user relationship with expand the scope of services, and add pen- employees and their families to gain data sion insurance consulting services on top of insights. Insurance companies should use insurance products, including pension invest- data integration, big data analytics, and other ment advice, financial planning, family asset means to fully unlock the data value, conduct allocation, etc. For example, Fidelity offers more accurate marketing, and tailor services value-added consulting services to its cus- to individual users. tomers based on consumer needs. Its inter- active intelligent service “myPlan” fully takes Diversify product innovation into account consumers’ need for retirement ƒƒ Overcome the excessive pursuit of short- income planning. Consumers cannot only term performance and meet long-term pen- create individual retirement savings plans, sion needs of customers but also effectively predict the amount of Currently, pension products are extremely money needed to achieve retirement savings homogeneous. The duration of most prod- goals to better optimize retirement plans.

The winning strategy for the pension market in China 25 Establish smart operation services fully meet the longevity risk transfer needs from ƒƒ Establish an intelligent data-driven cus- the insurance company. Based on the experi- tomer operation services system to realize ence of overseas mature markets, we believe process automation that domestic insurance companies should rec- Under the influence of the fast-growing ognize the necessity of longevity risk manage- internet, most insurance companies in China ment as soon as possible. They also need to lay have established basic front-end online self- the foundation for longevity risk avoidance by service platforms and provide remote profes- optimizing product design, developing reinsur- sional customer support, combining on- and ance, leveraging the financial market function, offline functions. On this basis, how can and investing in “reverse-risk” businesses. insurance companies further promote the ƒƒ Optimize product design customer operation services system? From More accurate life calendar should be used best practices of leading financial institutions in product pricing, e.g., by increasing the fre- at home and abroad, the key is to establish quency of life calendar updates and adding a complete and well-developed user data specific segments of the population to more platform, including user labels, user historical closely track trends in population mortality. behavior, and so on. At the same time, it sup- In addition, consideration may be given to ports the whole process service automation adding a “reverse longevity risk” death guar- by combining the algorithm engine based on antee liability to product terms as a natural artificial intelligence. hedge. ƒƒ Strengthen link between on- and offline ƒƒ Explore the reinsurance market services and improve overall customer Currently, the number of providers in China’s experience reinsurance market is relatively small, the While realizing an automated and intelligent reinsurance capacity is limited, and the customer operation service, the insurer technology level is not mature, which means should not ignore the development of their insurers should keep an eye on it and explore offline agent channel, especially in customer actively. relationship maintenance and demand track- ƒ ing. They should ensure the seamless con- ƒ Leverage the function of the financial mar- nection between online and offline channels, ket improve customer experience, and look for Although the domestic capital market is not the potential opportunity of the second sale yet mature enough to fully meet the longev- and cross-sale. ity risk transfer needs in the short term, we can draw on the experience of European and Control longevity risk US markets. With the further opening of the With the significant increase of the life expec- capital market, pension insurance companies tancy of the Chinese population, the develop- could consider finding a counterpart with a ment of the second and third pillars, and the natural preference for “longevity risk,” e.g., increasing number of Chinese residents enter- life insurance companies, to exchange lon- ing the pension stage, the risk of longevity will gevity risks (longevity swap), fully leverage become more and more prominent in the future. market function, and build a risk hedge. As one of the main undertakers of the longevity risk, insurance companies’ annuity and personal ƒƒ Increase investment in “reverse-risk” busi- pension business will face the problem of an nesses insufficient ability to make payments brought by Insurers could consider transferring longev- the longevity risk. However, because the domes- ity risks by investing in “longevity-favored” tic capital market is not mature and the reinsur- industries, such as nursing homes, elderly ance market is just getting started, they cannot tourism, and biomedical start-ups.

26 The winning strategy for the pension market in China Not everyone has insurance, but almost every­ one has a bank (account). McKinsey recommends that banks should grasp customer touch points, export quality assets, and strive to become a “wealth management + pension” one-stop service provider in the pension market.

Banks should grasp customer touch In addition, banks have taken on the role of ac- points to become one-stop service count administrators in all three pillar business- providers of “wealth management + es, with a different level of business intervention and a large number of users. In South Korea pension” management and Hong Kong, we have also observed that banks have become the core traffic entry point Not everyone has insurance, but almost every- to personal pension products, such as insur- one has a bank (account) ance or funds, via personal wealth management. Compared with insurance and fund companies, McKinsey recommends that banks should firmly banks have natural advantages in their channel hold on to customer touch points, export quality footprint, customer resources, and brand repu- assets, and strive to become a “welath manage- tation, which has become the most important ment + pension” one-stop service provider in the traffic entry point to the retail financial market. pension market (Exhibit 9).

Exhibit 9: Banks should grasp customer touch points to export quality asset and become a one-stop service provider of “wealth management + pension”

Example Only Customers Services Products

Account Product providers 1st management pillar

Banks Financial Insurers products

Companies Individuals Account 2nd management pillar Assets One-stop Funds service Account + provider of wealth “WAM + 3rd management pension” Other potential providers: pillar banks, securities, and trusts

1 Grasp 2 Export customer quality touch assets points

The winning strategy for the pension market in China 27 Standard Chartered Bank has partnered with Hong Kong’s Manulife to offer Mandatory Provident Fund (MPF) products. It installed MPF agents at its outlets to provide long-term retirement savings planning consulting ser- vices to form a one-stop retirement pension service solution.

Grasp customer touch points to become a riers between account systems and data “wealth management + pension” integration China’s second and third pillars currently consultant have low penetration rates, and private pen- With the increase of life expectancy, the sion management remains a new space for boundary between pension and private wealth many consumers. Therefore, banks have a management is becoming increasingly blurred, unique advantage in entering this open mar- and consumers’ demand for both is increas- ket. A bank holds many kinds of consumer ingly overlapping. Providing integrated financial accounts, e.g., savings, credit cards, and solutions will thus become the core trend of the pension funds. By breaking the data barrier, future pension industry. Banks should consider banks can let users access their whole asset using the pension and wealth management ser- level and income on a single website. Mean- vices to become one-stop service providers. while, banks can provide the data basis and operations to establish value-added services ƒƒ Banks have become the leading wealth such as investment planning, retirement life management service providers in China Banks boast a wide range of outlets through- planning, tax planning, etc. out the country, and they have become the ƒƒ Banks should establish their professional main channel for diversified insurance and service ability of “wealth management + fund products and private wealth manage- pension” based on customer needs and ment. According to the 2017 CAFF50 Survey, convert the touch point into traffic 31.5 percent of consumers access pension With the increasing awareness of insurance/ investments and financial products through wealth management and the mutual con- banks, as opposed to just 13.9 percent version of private wealth management and through insurance and 11.2 percent through commercial pension insurance, domestic fund companies. By providing a wide range consumers wish to receive integrated pro- of financial services (e g., deposits, loans, fessional advice on “wealth management + credit cards), banks have established high- pension.” Leading domestic retail banks have frequency contact with customers and ac- established considerable wealth manage- cumulated a large amount of data, including ment service abilities. The core influence on consumption habits and capital status. consumption decisions is gradually shifting ƒƒ Banks enjoy unique advantages in the field from product providers to banks, enhanc- of commercial pensions and can integrate ing their power and benefit distribution in customer touch points by breaking the bar- the value chain. Currently, the professional

28 The winning strategy for the pension market in China abilities of pension management and plan- planning consulting services to form a one- ning in China are still at quite an early stage. stop pension service solution. In addition, McKinsey suggests that banks should build Standard Chartered Bank offers insurance up pension investment advisor abilities via products through partnering with Prudential self-development or work with insurers to meet customers’ diversified retirement on the basis of wealth management. They wealth management needs (Exhibit 10). should also pay attention to long-term return on investment and provide customers with Integrate group resources, export high-quali- comprehensive asset allocation sugges- ty assets, and close the pension finance loop tions, including pension. At the same time, Asset management companies affiliated with banks also need to continuously optimize the banks have unique advantages in resources and portfolio of financial products to expand the data risk control on assets. They hold compre- range of options for investors. For example, hensive customer credit information to provide Standard Chartered Bank and Hong Kong’s the pension investment management companies Manulife have partnered to offer mandatory with high-quality assets suitable for pension provident fund products, and Standard Char- investment, and thus can close the pension tered Bank installed MPF agents at its out- finance loop. lets to provide long-term retirement savings

Exhibit 10: Standard Chartered Bank partners with insurers to establish “wealth management + pension” service abilities

Business provider Product service

Standard Chartered Bank Provide one-stop installs MPF agents in its outlets financial products and services for HQ retirement MPF MPF Retirement Outlets products planning MPF specialist

Provide all kinds of insurance products for long-term retirement planning

Other pension finance

Source: Standard Chartered Bank’s Web site; McKinsey analysis

The winning strategy for the pension market in China 29 Fund companies: investment experts sumers who become more sophisticated in terms in the pension industry with rich of investment and finance. Learning from the product design and flexible configu- successful experience of Fidelity and Vanguard, ration strategy McKinsey suggests that domestic public equity firms should continue to leverage their own in- vestment management advantages and actively Just as supermarket shoppers like a full array of products, consumers are no longer satis- promote investor education in order to increase fied with standard pension products brand influence. As consumer demands are growing and private wealth management and retirement financial Fully leverage the advantage of investment investment are increasingly overlapping, more management and establish diversified invest- and more customers are no longer satisfied with ment abilities standardized pension products. Instead, they Public equity firms play a very important role have higher requirements on diversity, flexibility, as investment managers in all three pillars of and the return rate of investment products. The domestic pensions, accounting for 40 percent CAFF50 Survey shows that the most important of the market share of the second pillar, with an factors influencing pension investment deci- average yield of 6.34 percent over the past six sions are stability, safety, value pappreciation years – higher than insurers, securities firms, potential, as well as the flexibility of investment and bank investment managers. Annuity invest- and good credit of financial institutions. Com- ment and the retirement target fund investment pared with insurers, fund companies typically management are fundamentally different in have higher returns on investment, more flexible product tool scope and investment management designs, and are able to cater effectively to con- durations. Public equity funds should fully lever-

Exhibit 11: To become reliable investment managers, public equity funds should leverage their ability and build their brand images Key actions Client Product Investment

Social security fund Investable Social security products 1st investment pillar management Public equity funds Asset allocation Stocks Annuity Companies trustees Annuity 2nd investment Asset allocation pillar management Asset allocation Bonds Reliable investment Pension target fund managers Individual investors 2 1 3rd Direct Grasp Leverage advantages Non- customer pillar in investment standard Banks touch points management products Securities …

30 The winning strategy for the pension market in China Just as supermarket shoppers like a full array of products, consumers are no longer satisfied with standard pension products. McKinsey recom- mends that public equity funds should fully lev- erage the advantage of investment management and actively develop investor education and im- prove brand influence.

age their investment management advantage, nonstandard assets, such as infrastructure further promote large-class assets configura- liabilities. Therefore, in annuity investment, tion, and nonstandard assets’ investment ability public equity funds should actively build in annuity investment business. Retirement tar- large-class asset allocation capabilities and get funds should develop long-term investments further strengthen the advantages of stock as their core and provide corresponding support investment to increase their competitiveness. mechanisms. ƒƒ Establish a stable long-term third-pillar ƒƒ Strengthen capabilities to allocate large- pension fund investment concept with a class assets and invest in nonstandard corresponding long-term investment-ori- assets in the second pillar ented support mechanism In the annuity market, public equity firms can Referring to the international model and only act as investment managers providing policy guidance of CSRC, we believe the annuity pension products to corporate cli- pension target fund products’ positioning ents. Because the annuity market is relatively is long-term held and long-term investment mature and public equity fund companies products. However, at present, domestic cannot play the role of trustees, their influ- public fund equity companies are under great ence on clients is limited, and their front-end pressure for short-term returns, and the sales and customer operation ability is not turnover of their personnel is relatively high. the main competing factor. It is therefore Therefore, most of them have not yet agreed necessary to focus on investment capacity on a long-term investment strategy. McK- building, mainly including large-class asset insey recommends that public equity firms allocation capabilities and nonstandard asset establish a stable long-term, corporate- investment capabilities. Annuity products approved investment concept for pension have a variety of investment product configu- fund products to maintain the stability and rations, including stocks, bonds, nonstandard sustainability of pension investment manage- assets, etc. However, traditional public equity ment. Meanwhile, they should build invest- funds tend to focus on a single type of asset ment and team management capabilities, investment, not paying enough attention to including investment and research abilities, large-class asset allocation. At the same with a focus on judging long-term economic time, there are more investment restrictions, dynamics (e.g., macroeconomic trends, aging e.g., not being allowed to invest in nonstan- of population) and optimizing the declining dard assets and their lack of investment curve of asset allocation. In terms of man- experience. Some insurance companies, agement mechanisms, they should avoid which are also active in investment manage- short-term ranking and instead focus on the ment, have accumulated a great deal of asset evaluation of long-term investment perfor- allocation experience for their own insurance mances of fund managers. funds. Aside from this, they have owned more

The winning strategy for the pension market in China 31 In China, public equity funds need to actively ers of retirement target funds lack an in- develop investor education and improve brand depth understanding of the fund’s products. influence As the “shelf time” of these products is short, The nature of first and second pillar pension is a there is little variance in performance and a 2B business, therefore the key is to strengthen lack of long-term performance information. investment capabilities. While the nature of third Therefore, brand popularity has become the pillar pension is a 2C business, serving both decisive factor for investors to choose fund existing fund investors and large amount of con- products. We suggest that public equity sumers who have limited knowledge of financial companies build a professional image of investment. Consumers thus have difficulties pension finance for consumers and regula- with selecting fund companies, especially when tors to promote social recognition, improve comparing facts such as historical performance customer participation, and obtain regulatory return, investment ability, or management scale, policy dividends. Specific initiatives include and therefore tend to choose companies with the publication of studies and indexes and the best brand reputation and market trust. the participation in academic forums, etc. For example, since the establishment of the ƒƒ Public investment philosophy education is a IRA in 1975, Fidelity has become the big- key lever to increase brand reputation and gest pension financial platform in the United influence States by actively marketing its brand in Current Chinese consumers tend to invest newspapers and on television. After enter- in retirement through bank wealth manage- ing the Chinese market, Fidelity has also ment and insurance products. According to been working with Ant Fortune to release the the CAFF50 Survey (2017), only 13.2 percent China Pensions Survey Report (see Exhibit invest for retirement through buying stocks 12). or funds, whereas 30.2 percent invest in bank deposits/wealth management and 20.5 percent in commercial pension insur- Building a “Health + retirement” ance. This is mainly due to consumers’ lack of finance and service ecosystem could awareness of fund products and fund invest- be considered and explored by rel- ments, insufficient access to fund products, evant enterprises or reluctance to choose fund products as a In the next 10 to 20 years when the 65+ age means of retirement savings investment due group will be retiring, people’s consumption to short-term speculation losses. Therefore, awareness, health habits, and retirement needs public equity companies need to continu- will keep changing. As a result, health and retire- ously promote multichannel investor educa- ment service needs will also increase signifi- tion and services, basic knowledge of fund cantly and become more overlapped. Pension products, the concept of long-term holding financial enterprises, represented by leading through overseas case sharing and data insurers, banks, and fund companies, have analysis reports, as well as long-held fund already invested different levels of capital in the investment modes. Therefore, consumers healthcare service industry to develop a health- should be encouraged to choose long-term care and retirement ecosystem. On the one investment because the risks of pension fund hand, they should meet the end-to-end needs of products are stable, incomes are good, and “retirement + healthcare” to improve customer the products meet the retirement demand. satisfaction and loyalty. On the other hand, they ƒƒ Establish professional image of pension can nurture the pension financial business to finance and promote brand influence improve their market competitiveness and hedge Unlike fund investment users, most consum- the longevity risks of pension products. At this

32 The winning strategy for the pension market in China Exhibit 12: Fidelity, the biggest retirement financial platform in the US, has used multichannel marketing since 1975 to improve brand awareness

In the smartphone era, it released the film to promote one-stop service via mobile 2014 devices In the TV era, it targeted “baby boomers” and used a song from a famous heavy 2005 metal band as the background music of its TV commercial

In the newspaper era, it introduced the IRA account and promoted its 1975 smartness, flexibility, and ease of use

stage, McKinsey has observed two main models has become very popular. From the experience of participation: one is an asset-heavy model, of United Health Group (UNH.N), we can see which provides a package of retirement solutions that a well-developed information system has covering pension products, real estate sales, become the core competence in its expansion and elderly care and medical services through to the health insurance and service chain. Its their own properties. The other is a light-asset dedicated Health Information Technology Ser- model driven by technology and finance, with a vices Corporation under the OptumInsight Group health management and IT platform as its core. focuses on core systems’ development and busi- They will develop an ecological alliance with ness data analysis. On one hand, it can enhance healthcare institutions and retirement com- the health management service capability of munity operators to provide insurance finance insurance companies through technology. On and health management services. In the latter the other hand, it can also effectively assist its model, technical capabilities and the setup of an insurance business, strengthen medical behavior IT platform is critical. Take the United States for monitoring, effectively reduce claims costs, and example: due to its fully market-driven medical promote risk control (Exhibit 13). system, the “insurance + healthcare” solution

The winning strategy for the pension market in China 33 Exhibit 13: Union Health Group deployed the health insurance business with IT as a core competitive advantage

Business provider Product service

Union Health 1 Provide a customized health management Group service for group customers

Healthcare: Optum Stable Chronic Daily Emotional business disease healthcare management 1 source management Health management： OptumHealth 2 Provide health IT service for hospitals and Health insurance governments business: UnitedHealthcare 2 Health IT: OptumInsight Increase risk management capability Information Data Data-driven Medicine system design management optimization of management: medical OptumRx healthcare solution Source: Web search; expert interview

There's ample room for imagination in the retire- ment ecosystem strategy, but at present, most enterprises are still testing the water and facing many challenges, including overall low profit- ability, long return cycle, difficult management of ecological partners, etc. They need to continue thinking and actively exploring, and the develop- ment of the ecosystem is an enormous task.

34 The winning strategy for the pension market in China Interview with Tingjun Liu, CEO of Taikang Healthcare Investment Hold- ings Co. Ltd. Tingjun Liu —— The Vice President of Taikang Insurance Group and Chief Executive Officer of Taikang Healthcare Investment Holdings Co. Ltd. —— Researcher, Dong Fujian Institute of Research at Wuhan University —— Member of the National Committee of Experts on Retirement Services of the Ministry of Civil Affairs —— Director of the Supervisory Board of the Insurance Asset Management Association of China (IAMAC)

Chinese tradition favors a stay-at-home care teams, this ratio has fallen to 0.6:1, with a retirement model, but it is facing more and higher level of service and quality. In terms of more problems. Taikang has created a unique nursing service professional abilities and service community of retirees, and the social re- efficiency, the retirement community has more sponse is very good. What’s your view on the advantages than stay-at-home retirement. future Chinese retirement model? Another area to cover is psychological needs. The retirement model chosen should be based Many retirees are excluded from society, but on the actual needs of the elderly. they also have social needs. The most difficult The first view has to do with the way of living. problem to overcome is the loneliness of stay-at- Nowadays, the overall health of the elderly has home retirees. The retirement community can increased gradually, and life expectancy has solve this problem very well, and its residents been prolonged. Many people hope to maintain can interact and connect through activities, in- a healthy and positive lifestyle that does not terests, and other means. In this way, the elderly necessarily mean living for a long time, but living can live in social environments on a continuous healthily, happily, and energetically. At the same basis. time, retirees have more spare time, so making Finally, medical healthcare. From the perspec- use of their time in a quality and meaningful way tive of medical services, large-scale medical is also a focal point for the elderly. A large-scale healthcare communities can better supplement retirement community is well-equipped and rich the current medical system. At present, the in activities, physical exercise, culture and art, medical system in China is based on the treat- social gatherings, and entertainment. Compared ment of diseases. The main task of the hospital with traditional stay-at-home retirement, it has is to diagnose and treat critical diseases. The unparalleled scale advantages. closed-loop system of registration, treatment, Next are the service capabilities. At the begin- hospitalization, and discharge is repeated every ning, the ratio of service staff to the elderly in day. However, out-of-hospital services, including the Taikang Retirement Community was 1.6:1; disease prevention, chronic disease manage- meaning a single elderly person needed 1.6 pro- ment, general practice treatment, and rehabilita- fessionals to serve them. But with the increase tion are relatively lacking. The medical resources in community occupancy rates and the multidis- in hospitals are both tight and expensive, and ciplinary collaboration and specialization of our the provision of these services will result in high-

The winning strategy for the pension market in China 35 Through continual improvement on service and operation quality, the ratio of service staff to the elderly in the Taikang Retirement Community has falled from 1.6 to 0.6, showing advantage in comparison to stay-at-home retirement.

er costs and a waste of resources. So, it is not service efficiency. The third biggest cost is the appropriate for hospitals to provide these servic- capital complementarity of the insurance busi- es, and in contrast, healthcare communities can ness and the pension investment. The insurance fill this gap. Rather than treatment, the elderly business generates a great deal of cash each need GP services, chronic disease management, year and has long-term investment demand, and rehabilitation care, especially for cardio- while retirement real estate is a good long-term vascular, endocrine, and respiratory chronic investment object. With the increasing needs diseases. Large-scale retirement communities of Chinese retirees’ health, the future return of can set up their own community hospital. Each retirement investment can be promising. community of Taikang has a secondary hospital Meanwhile, we think that Taikang’s model also featuring general practice medicine, manage- has a certain threshold, which includes the ment of chronic diseases, rehabilitation care, capital threshold. With investments into each diagnosis and treatment of common diseases asset-heavy project of over RMB hundreds of of the elderly, and first aid care. The community millions or even billions and a long investment can fully understand the patient’s medical his- tory and carry out all of the closed-loop health profit cycle, it requires stable capital support. management, general practice medical treat- What is more difficult to replicate is our manage- ment, and rehabilitation care services. ment and operation threshold. The retirement industry covers a large span, which requires a multidisciplinary team, including engineering Taikang has spent 11 years in the retirement community and has basically developed a development, property management, hotel/ model combining the finance and retire- apartment management, medical health man- ment industry. What do you think are the core agement, retirement care services, etc. Thanks elements of Taikang’s retirement model’s to our years of practice, we have developed a success? management system, which is our core com- Taikang adheres to the coordinated mode of petency. Finally, the threshold of our brand. As insurance, asset management, and medical the early adopter of this model, Taikang has care. In retirement real estate, we focus on asset established a good reputation, which is our most ownership and independent operation, and our important intangible asset. Additionally, we core need is to lock in the costs of the future. have also invested many resources into market The biggest costs are land and rent. China’s promotion and customer service improvement to urban land prices have changed rapidly, and the finally establish our Taikang medical healthcare asset-light model is not able to lock land prices. brand image. The next largest expense is the cost of service, so we insist on building an in-house team and What do you think of China’s future retire- independent operation. The ratio of our service ment finance system? For different financial staff to the community residents has dropped institutions in the future, who will stand a from 1.6:1 to 0.6:1, which underscores the im- better chance of sharing the dividends of the provement in our professional service capability market? and the cost advantage arising from improving China is getting old before it gets rich. Com-

36 The winning strategy for the pension market in China pared with developed countries, China is gener- tively large, mainly because they have the skills ally unprepared for retirement and saving, which and characteristics necessary for long-term in- is the consensus reached by the government vestment, which is also what pensions require. In and industry. In the future, the government will addition, insurance also gives a prudent impres- put in place more policies to encourage individ- sion that lets ordinary consumers have a natural ual pension savings. In accordance with inter- sense of trust. From the regulatory pilot policies, national experience, the most common initiative it is also hoped that strong insurance institutions is the introduction of tax incentives, which was will take on this social responsibility. Banks also already piloted in 2018. It is believed that similar have their advantages, including their existing, policies will be further increased, deepened, and large customer bases. City or town residents implemented in the future, which will open the may not have insurance products, but generally door to enormous market opportunities. they have bank accounts. If banks can boost The future market opportunities should be their professionalism, and if regulation permits, judged in light of China’s national conditions. they can certainly sell tax-deferred pension First of all, China’s capital market is still relatively products for other institutions. underdeveloped, and the acceptance of the █ █ █ capital market by the general public is still not high; thus, replicating the US-style “fund model” 2018 was a memorable year for China’s commer- will entail some difficulties in the short term. cial pension reform. With the launch of individual Additionally, China’s retirement health service tax reform, a tax-deferred pilot, and pension market is huge, and there are great differences target fund pilot, the market-oriented reform of between urban and rural areas and among China’s pension system has been launched. The regions. Therefore, market dynamics can be set commercial pension market will take a leap for- up in different places by various institutions, and ward, and the leading insurance, bank, and fund economically advanced bay areas may be the enterprises will embrace a historic opportunity first ones to try new business models. Finally, for development. We hope that the publication of the financial knowledge of the general public this article will bring some thoughts and enlight- in China is relatively low. Therefore, regulators enment to the development of the industry and need to adopt some prudent policies to protect that China’s pension financial companies can the public, and regulation authorities will have a grasp this rare opportunity to grow and contrib- great and far-reaching impact on industry. ute to the sustainable development of retirement In general, the advantages of insurers are rela- industry in China.

The winning strategy for the pension market in China 37 38 The winning strategy for the pension market in China On the Finance Practice at McKinsey Greater China

McKinsey is a global management consulting firm that provides strategic, organizational, operational, and technical advice and related services to private and public institutions. More than 10,000 of our consultants are deployed in more than 120 cities in over 60 countries. McKinsey Greater China is composed of the Bei- jing, Hong Kong, Shanghai, Shenzhen, and Taipei offices. McKinsey Greater China’s Financial Practice provides services for the leading banking, securities and trust companies, wealth and asset management companies, insurance companies, and other financial institutions in China. It covers a wide range of areas such as transformation and innovation, internet finance, global- ization, strategy, corporate finance, sales and marketing, operations, digitization and technology, risk and capital, leadership development, and cultural transformation. We have more than 300 dedicated financial consultants in our region who have profound professional experience in financial institutions. Meanwhile, we leverage McKinsey’s vast resource system of consultants and R&I professionals from financial institutions around the world to provide knowledge and support to our customers in the region.

About the authors

Joe Ngai John Qu Senior Partner Senior Partner Hong Kong office Hong Kong office [email protected] [email protected]

Arthur Bi Hongming Chen Partner Associate Partner Beijing office Hong Kong office [email protected] [email protected]

Zheng Sun Sisi Zhang Engagement Manager Associate Shanghai office Shanghai office [email protected] [email protected]

The authors would also like to thank several McKinsey colleagues for their contributions to this report, especially Zoe Huang, Joyce Liu, Athena Yan and Chris Fang from Shanghai office; Kathrin Habrich from Frankfurt office; Owen Jones from New York office; Hyunjoo Lee from Seoul office; Wendy Chiang from Hong Kong office Finance Practice By McKinsey June 2019 Copyright © McKinsey & Company Designed by GC Design Center www.mckinsey.com