China’s Aging Population Brings Opportunities for Insurers

The rapidly aging popula- tion in China is a great challenge for the country’s development and social security system， while it presents opportunities for insurance companies， according to a recent report by The Boston Consulting Group (BCG) and Swiss Re.

“Insurance companies must develop a concrete plan for where and how to participate to take advantage of the challenges and opportunities of aging，” said the report.

The aging population

Aging is a global phenomenon， and China is no exception. For decades， China has benefited from a“demographic dividend.” Its robust population structure has driven a prolonged period of socioeconomic growth. However， as China’s workforce ages and moves towards retirement， the country will join many others in facing up to the challenges of supporting an aging population， said the report.

Over the next five years， the growth of China’s workforce， which has long contributed to the expansion of the country’s booming economy， will finally slow down and eventually become negative. The working age population will peak in size in 2015 and then begin to decline.

Indeed， the silver segment is growing fast in China. By 2050， this group will represent more than onethird of the country’s total population， an eye-popping 439 million people， a far greater number than even in Japan， another nation facing severe demographic shifts.

“By 2050， China will be most‘aged’ among BRIC countries with a much larger 60-and-over population size，” said Robert Wiest， President of Swiss Re China.

The scale of China’s aging population is much greater than that of other RDEs. The silver segment as a percentage of the total population will nearly triple from the current 12 percent to 34 percent by 2008， a much higher increase than those forecast for other BRIC countries and far exceeding the estimated increase in developed countries.

In China， as elsewhere， the aging population is driven by both lower fertility rates and increased longevity. Life expectancy at birth increased from under 45 years of age in 1955 to 73 years of age in 2010， a level approaching that of developed countries. Four specific factors are responsible for the fact that the impact of aging in China will be particularly severe: the rise of the middle class， the “One Child Policy”， the 4-2-1 (four grandparents， two parents， one child) family structure and urbanization.

Overall， the report pointed out that China’s aging population will have three major implications for companies and for the country’s economy:

Historically， China’s economic growth has largely been driven by workforce increases and productivity improvements. Without further major breakthroughs in productivity， economic growth is expected to slow down due to a much lower or even negative workforce growth.

Both the mix and profile of consumers in China will change substantially as the population ages. In particular， the silver segment and the lower socioeconomic class possess distinct needs. Companies seeking to thrive in the coming decades must be prepared to cater to these segments and win their loyalty.

An altered and flatter population structure will increase the inter-generational burden on both a family and national level， testing the sustainability of the current pension system.

The current social security system amid challenges

According to the report， China’s aging dynamics will place major pressures on the country’s social security system. In the pension system， the mandatory social insurance scheme’s benefits will not keep pace with the rising cost of living， yet the market for voluntary pensions is still underdeveloped. In health care， the system is stymied by limited coverage and a lack of adequate resources， particularly regarding long-term care which will become increasingly important as the population ages. Finally， demographic shifts have led to a weakening of the traditional family support network due to the mass rural-urban migration and the 4-2-1 family structure.

China’s social security system faces pressure on two fronts: the rapidly aging population and increased life expectancy. In the coming decades， the system will be expected to cope with large numbers of retirees departing the workforce—people who will require long-term pension payouts and health care. Without major reform， the current social security system appears unsustainable. But reform will come. The alternative millions of Chinese people spending their old age without adequate pensions， health care， or family support — is unthinkable for government planners.

China’s pension system is based on three pillars: mandatory social insurance ， voluntary employer enterprise annuity and group pension schemes and voluntary personal pensions， including commercial pension insurance， supplemented by the government’s minimum-livingstandard guarantee(Dī B?o)， personal savings， and family support.

The report indicated that compared to mature markets， China’s Pillar II and III are largely underdeveloped. As of February 2011， these two pillars combined were estimated to have USD$80 billion to $100 billion in assets under management， equivalent to 1.7 percent of China’s total GDP and approximately the size of Pillar I individual accounts. This figure is significantly lower than that of developed countries， such as the Netherlands with (134 percent) and Switzerland (126 percent).

The report expected substantial growth potential for Pillar II and III going forward. This expansion will be driven by inadequate coverage of Pillar I， the rise of Chinese middle-class and affluent consumers， and the weakening of the family support network. But it expected changes to be gradual. Concerted action from both the government and insurers will be required to develop this market.

China’s healthcare system had achieved roughly 95 percent coverage of the population by the end of 2010， up from around 15 percent in 2000. However， this system is still limited in terms of the scope of treatments， services， and medicines. Notably， there is no long-term care (LTC) component in China’s current healthcare system.

As the size of the silver segment increases in China， so will the demand and costs for health care. This demand will add to the government’s financial burden and in turn reduce the funding available for seniors and affect the quality of healthcare services.

The LTC gap has not gone unnoticed， however. Unless LTC is rolled out in the near future， Chinese people will need to rely on commercial insurance to provide them with protection. And most LTC products currently sold in China offer a fixed sum rather than the coupling of commercial insurance with caring services and do not eliminate the risk of potential price increases in LTC services.

“China’s ability to deal with these challenges will have a significant impact on its prosperity level for decades to come，” said Richard Huang， a BCG partner based in Beijing. What is more， failure to address the difficulties could have dramatic consequences such as an onerous public-deficit burden， a delayed retirement age， and a reduction in retiree benefits. The worst-case scenario would be a full-scale rupture of the country’s social security net.

The scope of this problem should not be underestimated. Finding solutions will require a concerted effort among the public and private spheres. Indeed， the Chinese government will need to drive meaningful reforms of the social security system and corporations will have to take more initiative in providing post-retirement services. Consumers， for their part， will need to adopt a longer-term view on savings and investments.

“It takes the efforts of all stakeholders — the Chinese government， corporations， and insurers — to meet the challenges posed by China’s aging population，” Jia Jingwei， Head of China Business Development of Swiss Re.“Insurance companies， in particular， will need to play a larger role.”

Implications for insurers

China’s social security system is unlikely to be able to cope with the challenges of an aging population. Therefore， the report suggested the following solutions.

Proactively Lobby for Reform and Educate Consumers. The role of commercial insurance must be expanded through the development of voluntary employer and personal pension systems (Pillars II and III) in order to address the shortfalls of the mandatory system.

The same principle applies to commercial healthcare and long-term care insurance (to complement the national healthcare system).

Regulatory reform must be undertaken to create a more robust pension and health care system. Insurers should proactively drive and support reforms， particularly changes that could be catalysts for the development of voluntary pension systems. Such reforms could include tax incentives， the portability of pensions， and the construction of a risk trading platform for insurers， reinsurers， and other investors.

The importance of fiscal incentives in prompting corporations and individuals to join voluntary， complementary insurance schemes is widely recognized. Indeed， Germany provides a good example of the impact that fiscal incentives can have. Since the beginning of 2002， Germany has carried out a series of pension reforms known as the Riester plan to foster the development of private personal pensions (equivalent to China’s Pillar III).

Under this plan， private retirement savings are promoted both by state subsidies and by tax-deductions for contributions and purchases of bank and insurance investment products. As a result of this plan， the German commercial pension market has grown tremendously — from around four million pension contracts in 2002 to over 14 million in 2011.

At the individual level， the most critical necessary change in China is the adoption of a longer-term view on savings and investments. Currently， Chinese people tend to focus more on short-term profit opportunities， neglecting investing in their post-re- tirement income， health care， and longterm care needs. Insurers can play a key role in educating individuals about the increasing challenges that they will face to sustain their standard of living and how they can successfully clear these hurdles through personalized financial planning and investment/savings offerings. The good news is that China’s savings rates， standing at an average of around 50 percent of GDP， are very high， representing huge opportunities for insurers that can successfully channel these savings into the right investment and insurance products.

Cooperate with the Social Security System. Besides lobbying the government for reforms， insurers should also collaborate with the social security system to help the government manage its pension and healthcare systems at lower levels of risk and cost.

China’s national pension funds， as well as corporate pension schemes， are exposed to different degrees of longevity risk. By Swiss Re’s estimation， an additional mortality improvement of 1 percent per annum would increase a pensioner’s liabilities by roughly 5 percent to 6 percent. Insurers， reinsurance companies， and capital markets can play a significant role in helping transfer part or all of the longevity risks of China’s national pension system.

“Joint risk management” between insurers and the government can strongly support the development of healthcare system in China. Some local governments with limited experience in health insurance have decided to involve insurers in managing and limiting their risks. In exchange， insurers are allowed to increase their premiums(or limit their coverage and payouts) whenever the medical claims reach a certain threshold. In the event that insurers make a profit， the government can claim a share of the profits. Such public-private partnerships have helped enhance the management of social medical funds. We have already witnessed good examples of cooperation such as the ZhanJiang social medical system， in which a specialized health insurer contributed expertise in terms of claims management and risk control， giving the local government a cushion for its liabilities.

Further Understand Customer Insights and Innovate with Products and Channels. Shifts in demographic structure directly change the profiles of mainstream consumers and their needs.

The fast-growing group of relatively young middle-class and affluent consumers that will become the silver segment in 20 to 30 years time will become more and more influential， with substantial purchasing power and unique needs. To succeed in the future with this segment， insurers should actively explore innovations in products， marketing， and distribution.

For example， insurers may consider de-averaging customer groups through segmentation， which could enable them to identify niche segments with distinct risk-pricing profiles， all the while bearing in mind the differences between more-developed and less-developed provinces. For customers in each segment， insurers can also customize value propositions to differentiate their strategies.

Overall， innovative products can be developed to meet the silver segment’s higher expectation for life quality and security after retirement.

Finally， insurers could try to establish dedicated pension sales and cooperate with HR consulting firms to address the key needs of the rising silver segment. Innovative distribution channels could also be adapted to this segment’s lifestyle (e.g.， distributing through hospital networks， or collabo- rating with pharmaceutical companies’distribution networks).

Develop Managed Long-Term Care Services. There is a significant gap in long-term care insurance， services， and facilities in China. Investing in long-term care can offer synergies and advantages for insurers. The clearest advantage is the ability to offer long-term care products with services， rather than fixed payments， as benefits. Also， insurers’ investments act as a natural hedge against the risk of increasing costs in long-term care services.

Manage for Profitability and Risks. Economic growth is expected to be hindered by a shrinking workforce and associated productivity losses.

A prolonged climate of low real interest rates is a likely scenario， which would have an adverse impact on insurers’ profitability levels. Looking at Japan’s experience， several insurance companies went bankrupt due to a prolonged low interest rates environment， while others managed to adapt and thrive. Chinese insurers can learn from the Japanese experience and take steps to better prepare themselves in asset/liability management and in company operations. Several levers are available to mitigate the impact of prolonged low rates， including:

The other major risk that insurers in China will be facing is longevity risk. In order to assess this risk， insurers should consider adopting robust forecasting approaches and disease-based actuarial models. A potential solution to limit longevity exposure on insurers’portfolios is to pass some or all of this risk to another insurer or reinsurer with better funding and resources to meet the long-term commitment.

The entire insurance industry， including reinsurers， should push the public sector to create diversified capital-market solutions， which would potentially allow the transfer of longevity risk in their annuity/pension portfolios.

Prepare for the Impacts of Aging on Their Own Workforce. Insurers in China will face challenges in their own human resource management. With a stagnant workforce inflow and a much faster workforce outflow， insurers will find it more and more difficult to recruit young talent and maintain a stable employee structure.

Insurers have a vital role to play in reducing the negative socio-economic threats from aging in China. Ongoing reforms are encouraging private participation in pension and healthcare provision， and insurers need to position themselves to take advantage of this window of opportunity. Developing provincial and national lobbying strategies will be critical， as will educating consumers. More focus needs to be put on innovating product and distribution channels to better serve unmet needs， and better access customers — either as individuals or through employers. And building robust data to support accurate pricing of both medical and longevity risks will be an essential strategy. In addition， insur

ers will be grappling with their own challenges. Some of these， like workforce demographic risk， are similar to those that other industries will face. However， others — such as a prolonged period of low real interest rates — will have direct impact on insurers’ profitability.

In conclusion， the report proposed that insurance companies should develop a concrete plan for where and how to participate to take advantage of the challenges and opportunities of aging. They need to start building the capabilities and relationships that will be required to win. And they need to put in place HR strategies to manage the impact on their own workforce. Those that move fast and boldly can catch the wave — and truly turn silver into gold.