3. The Era of Wealth, A Life of Wealth

In the long agricultural era of human beings, social production units were scattered, isolated peasant households, and older people were supported by their families. Because of the low social productivity at the time, there might not always be enough food and resources for the entire family to survive, and the elderly could lose their support. Folklore has it that there was a chilling custom in some poor areas in ancient Japan: to relieve the burden of the family, the elderly would be carried to the mountains by their children as “sacrifice to the mountain god”, but in fact they were abandoned deep in the mountains and left there to die. These deep mountains are called “Ubasuteyama” (grandmother abandoning mountain) in Japan.

From the end of the nineteenth century to the beginning of the twentieth century, the Industrial Revolution swept across Western Europe. As a result of large-scale factory production, the personal and family risks of the aging of a large number of workers and their illness began to upgrade into social risks. Policy makers had to consider formulating social policies to deal with such risks. The pension system was created in Germany under this exact social background. Interestingly, such a pension system full of social sympathy was first initiated and established by Otto von Bismarck, the chancellor who delivered the famous “Iron and Blood” speech. Bismarck was an advocator of force. He provoked three wars to unify Germany and brutally suppressed the workers’ movement, but he was also the founder of the modern social security system. The establishment of a series of social security systems, such as the pension system, eased various conflicts within Germany at that time and played an important role in Germany’s economic development. In the late nineteenth century, industrial production in Germany grew rapidly, much faster than in Britain and France. Since then, other countries have followed Germany’s footsteps in introducing government-led public pension systems.

As a pioneer in pension system reform, Chile has exerted a profound influence on the pension plan design of many countries. However, Chile’s experience was not entirely successful: personal accounts provided a very limited incentive, and the system did not have a redistribution function; at the same time, decreasing ROI resulted in a very low pension benefits. The Chilean people went on street protests against the pension system many times. Entering the twenty-first century, Chile started its further reforms.

In the US, the three-pillar pension system is relatively mature. At present, the second pillar and third pillar account for more than 90% of the total assets of the US pension system. They are playing a pivotal role in the pension system and an important asset to ensure the retirement living standards of the US people. The development of the second pillar in the US pension system was quite a history. Before the 1970s, corporate pensions were mainly defined-benefit pension plans (the DB plan): the employer paid a fixed amount of pension directly to the retired employees, and the employer bore the investment risk of the pension fund. The population aging crisis and economic stagflation prompted the United States to start the pension reform in the 1970s, and the DB plan was shifted to the defined-contribution plan (the DC plan). The famous 401(k) pension plan¹ was invented in this very period. In the DC plan, the contribution standards of both the employer and the employee are fixed, but the amount of pension benefit the employee will enjoy is no longer a fixed figure. In the DC plan, the employees bear the investment risk of the pension funds in their own pension accounts. The DC plan eased the burdens on enterprises and gradually became the mainstream corporate pension plan. Additionally, 401 (k) plans enjoy tax benefits and provide a wide range of investment options, including loans, insurance, stocks, funds, etc.

Currently, the pension financing system with “three pillars” as the core has become a common practice in many developed countries and regions. As a country with the most severely aged population in the world, Japan has also established a pension system that will provide “insurance for all and pension for all”. Japan’s pension system still mainly relies on the first pillar and the second pillar. Its third pillar is smaller in size but developing quickly. Canada also has a “three-pillar” pension system. Its first pillar is the Canada Pension Plan (CPP), which is operated under a fully marketized mechanism and has obtained considerable investment returns from the capital market. Table 3.1 shows the three pillar pension systems in different countries and regions.

China’s pension reform has always been an important part of its economic reform. As insurance companies are major players in the implementation of the second pillar and the third pillar, I have witnessed the entire reform process firsthand. Before the pension reform in 1991, only a very limited population was covered by the pension system. Because of the urban‒rural dual structure of China’s economy, there was hardly an endowment insurance system in the vast rural areas. The coverage of urban endowment insurance, back then known as labor insurance, was also very limited. It covered only urban employees of state organs, public institutions, and some enterprises and a few self-employed workers in urban areas. Organizations that joined the urban endowment program were responsible for the welfare of their employees, and the protection was somewhat comprehensive. In 1991, China began its pension reform and established a nationwide basic endowment insurance plan for the urban working group (the first pillar). In the twenty-first century, China successively introduced enterprise annuity and occupational annuity policies (the second pillar) and began the pilot of an individual tax-deferred third pillar pension plan, in 2018.

We observed that compared with developed countries, there are many challenges in China’s pension system. First, China’s total pension reserve is insufficient. In 2018, the total proportion of China’s three-pillar pension reserve only accounted for 8% of its GPD, far lower than the OECD average of 49.7% and 146% of the US (see Fig. 3.1). Second, China’s three-pillar pension system is extremely unbalanced in structure. Its overly dominant first pillar accounts for more than 3/4 of the entire pension system, while its second and third pillars are developing in serious tardiness. The third pillar of China’s pension system was essentially nonexistent for a long time and is in urgent need of fast development.

Corresponding with the slow development of China’s pension system is its consistently high savings rate. One opinion is that the long period of inadequate social security has affected Chinese people’s saving habits: to cope with future uncertainties, residents regard savings as safety nets for their family and themselves. According to the World Bank, China has one of the highest savings rates and per capita savings in the world. Its savings rate peaked at 52% of GDP in 2008, and although it had fallen since then, it was still at a high of 44% in 2019. China’s high savings contributed sufficient funds for its rapid economic development, but also restricted consumption. When interest rates are low, the return on savings decreases, and residents’ financial benefits are harmed in a way. Different from individual savings behavior, the future third pillar personal pension plan enjoys clear national policy preferences and provides abundant investment choices. It will be conducive to the conversion of residents’ savings into investment.

With the advent of the Era of Longevity, pension systems will face unprecedented challenges. Many countries around the world, including China, adopted a “pay-as-you-go” first pillar scheme, i.e., the public pension. The so-called pay-as-you-go scheme is that the pension contribution from the working generation will be paid to retired people in the same time period. As long as the gap between the amount of pension contribution paid and the amount of pension benefits withdrawn is not too large, such a scheme can still be subsidized by the government. This scheme works well in societies where the population age structure is pyramid-shaped because there are large numbers of young and middle-aged workers making contributions to support a smaller number of retirees. However, in the Era of Longevity, with fewer contributors and more pensioners, the pay-as-you-go scheme will be unsustainable. The government could keep filling in the gap by borrowing, but that would be a bottomless pit. If the government cannot afford to keep the pension system running, the burden of providing for the elderly will eventually be transferred to individuals.

The Japanese pension scheme is a classic example of a pay-as-you-go scheme that the government could no longer sustain. The Japanese government, under the pressure of a heavy fiscal burden and an aged population, had to adjust its pension policy and transfer the pressure onto participants. The pension reforms introduced in 2004 included reducing pension benefits, increasing the pension eligibility age and raising pension contributions. In 2016, the Japanese government changed the pension payment standard adjustment protocols: instead of being adjusted by changes in general prices of goods, the payment standard was to be adjusted by changes in the average social wage. Due to the long-term sluggish wage growth in Japan, the pension benefits were already decreasing. Japan’s 2016 adjustment made matters worse by increasing the financial pressure of retirees and caused public dissatisfaction with the pension system.

What happened with Japan is a wake-up call that future governmental public pensions may not be adequate after all. The pension replacement rate² is commonly used worldwide as an indicator to measure whether pension benefits are adequate. The standard pension replacement rate is the ratio of an individual’s retirement pension to his or her preretirement income, which, in plain English, lets people know if they are going to have enough money to spend when they are still alive. In the Era of Longevity, the pension replacement rate will continue to decline, which needs our attention.

According to the International Labor Organization’s Convention Concerning Minimum Standards of Social Security in 1994, a pension replacement rate of 55% is the minimum for maintaining retirees’ life standards. If the pension replacement rate falls below this threshold, the living standards of retirees will be seriously reduced. According to the Japanese government’s 2019 pension estimates report, the monthly pension replacement rate for each Japanese couple is expected to continue to decline in the future. The Japanese government’s projected pension replacement rate in 2019 was 61.7% and would fall to approximately 51% by 2040. According to the OECD’s Pensions at a Glance report released in 2019, in OECD countries, the pension replacement rate for those born in 1996 was 5.8% points lower than that for those born in 1940. In China, the target replacement rate of pensions is not clearly stipulated. According to the research data of Professor Zheng Bingwen of the Chinese Academy of Social Sciences, China’s replacement rate of the basic endowment insurance for employees dropped from 87% in 1998 to 50% in 2011, and the average replacement rate of social pension was stabilized at approximately 45% in the seven to eight years after 2011.

Therefore, to adapt to a changing future and to compensate for the decline in public pension replacement rates, societies and individuals should plan ahead and seek changes for solutions. For governments, speeding up the development of the third pillar pension plans through policy incentives can cushion the decline of the replacement rate. For individuals, the accumulation of wealth and establishing wealth management awareness can help maintain and increase the value of personal assets and compensate for the decline in living standards caused by the declining pension replacement rate.

For individuals, there is a high possibility that after retiring we will need to rely more on ourselves for financial support in the future, and we need to be well prepared both in awareness and in finance. As China has a history of a planned economy in the past, urban residents still have high expectations for the government to provide pensions. However, the real cases and experience in the Era of Longevity made it clear that governments would possibly only assume the most basic responsibility in pension and that it would be unrealistic to rely completely on the government for adequate pension or expect a high pension replacement rate to be maintained. In the future, governments will still provide the most basic social security and favorable policies. However, the diverse needs people have for a better retirement life will be met more by the participation of individuals and marketized institutions.

The gradual decline in the replacement rate for government-provided public pensions is a wake-up call, urging us to look for financial solutions best suited for the Era of Longevity from the entire wealth management industry. The three-pillar pension reserves are supported by national policies. In addition to these preferential reserves, the wealth that people spontaneously reserve for pension and health needs has a larger volume and a broader market. We need to keep in mind that, the wealth reserves accumulated spontaneously by individuals are the most crucial no matter what reforms pension and social security systems would go through in the future. This indicates that the size of the personal wealth management market will continue to grow. In the history of human development, industrialization created enormous social wealth, with which the middle class rose, and their strong demands for wealth management in turn boosted the development and prosperity of the financial industry. The Era of Longevity follows the Industrial Age, and wealth management will be in greater demand than ever before. It is inevitable that an Era of Wealth will come hand in hand with the Era of Longevity, and this time it will be an Era of Wealth for all.

China’s wealth management market is far from mature. Chinese people dwell heavily on past experiences and believe “if you do not buy a house, what else should you buy?”. A comparison between China and the US shows that the wealth of Chinese residents is overly concentrated in real estate. In the US, where the financial market is highly developed, people tend to allocate their assets in multiple types of financial investments, such as the stock market, funds and insurance (see Table 3.2). China’s real estate market was considered a “invincible myth” in the past 20 years, and investing in real estate has become a belief of many Chinese families. According to the Chinese Urban Household Wealth Health Report in 2018, property assets accounted for nearly 80% of household wealth in Chinese families, much higher than the 35% of the United States. Surveys by the People’s Bank of China, which is the central bank of China, also pointed out that 40% of Chinese households own at least two homes. The excessively high ratio of real estate assets severely squeezed the space for the allocation of financial assets. In Chinese people’s financial assets, the allocation of products is relatively simple: they are concentrated in cash and savings, especially in rural areas.

An age of wealth management for all also means that the structure of wealth and ways of wealth management have changed. First, investing in real estate is not as attractive as it used to be. The skyrocketing growth of China’s real estate market was a result of industrialization and urbanization. However, with the peak of the First Demographic Dividend, rigid housing demands have declined, which means the economy can no longer rely on the stimulus from real estate as much as before, and the increase in housing prices will return to a reasonable range. Second, bank financial products that are risk-free, high-yield, principal-and-interest-guaranteed will also become historic. In the past, banks could provide risk-free financial products with a yield rate of 6–8%, but the reason for that was still the real estate mortgage loans: the rising real estate prices ensured a continuous supply of such financial products. When the real estate market quiets down, such wealth management products will no longer exist. Last, we think the future will be the era of stocks and equities. When economic development no longer relies on real estate but on the businesses of excellent enterprises, our financing system will gradually transition from indirect financing, such as bank loans, to direct financing, with equity being a classic example. At the same time, with China’s financial market quickly growing more open and mature, individual investors are also becoming more rational and experienced. With the changes in the financing structure and product returns, the wealth structure of Chinese residents will become more dispersed and diversified.

In the future, the declining interest rate will put greater pressure on the asset preservation and appreciation. A reasonable allocation of equity products can help people better preserve and appreciate their assets. For example, in the US, IRA accounts owners allocate their pension to a large number of mutual funds and stocks, achieving good returns no less than that of the S&P 500 index. In sharp contrast, the German Riester pension plan focuses its allocation on a large number of fixed income assets, and its guaranteed return has been on a constant decline.

What we observed were not only changes in investor behaviors but also changes in China’s financial sector. The financial industry has gained a deep understanding of the importance of developing the pension wealth management market, and financial institutions started launching products and services that accommodate various needs of consumers. Their innovation tries to solve the financial problems of pension while maintaining industrial features, and that was how China’s pension finance came into being. Pension finance is the general term of financial activities centering on various pension needs of social members, aiming at a rational allocation of wealth for customers’ full life cycle to improve quality of life at old age. Pension financial products provided by different financial institutions vary in features, and what insurance companies have to offer has unique advantages in risk diversification and long-term fund management. The commercial endowment products provided by insurance companies are an important supplement to social security and can provide protection against risks that policy holders may encounter when they get old. Among these commercial endowment products, annuity products are safe and stable and provide full compound interest. Policy holders of annuity products can receive insurance benefits for a long period or even for life. Pension products launched by banks are mainly pension savings products and pension financial products. As banks have many outlets and high public credibility, their products have great advantages in business development. Target date pension fund products launched by fund companies are developed to meet various customer needs: these types of products are equity investment fund products where portfolios of investments could be constantly adjusted based on different ages and risk preferences of customers. They are very flexible and accommodates differentiated pension investment needs. They provide a good management channel for those who look for stable gains from their pension investments. Pension trust products provided by trust institutions are especially favored by high-net-worth customers, because they protect the independence of trust property and could be renewed automatically upon customers’ choosing. They not only guarantee the safety of pension property but also solve the problems for the elderly who are unable or unwilling to manage property by themselves.

In these endeavors, financial institutions also launched quite a few new products (see Table 3.3), such as reverse mortgage products. A reverse mortgage product refers to a product where homeowners mortgage their houses to insurance companies or banks, and the insurance companies or banks pay cash to homeowners. Through reverse mortgages, older homeowners could secure their living expenses with guaranteed access to their home equity, increase their cash flow, and improve their quality of life. This kind of product is relatively mature outside of China and is still in early development in China. With such a high home ownership rate in China, many older people are “rich in homes but poor in cash”. Reverse mortgage products can turn older people’s fixed assets into cash flow, effectively relieving the economic pressure of the elderly and their children while increasing their consumption ability.

Many product innovations are explored by the financial sector outside the three-pillar pension framework, which is often supported by national policies. From the perspective of the industry, it is important that commercial innovations should be incorporated to solve pension problems. As the “third pillar to be”, these products could be well included in national policies to become products within the three-pillar system in the future. It will help them better serve the financial needs of elderly individuals.

In previous chapters, we talked about funding for retirement and that the key is making up for the income gap after retirement. Medical and healthcare costs, a very important component of personal expenditure for both young and older people, rise drastically with age. Funding for health is a more complicated topic. The risks pension systems take into account are the risks of life expectancy but not risks of individual disease or disability, which are unevenly distributed among large groups of people in society. Due to genetic and environmental factors, some people are at higher health risks; therefore, the ways societies raise funds for health risks will be different. To solve the health financing problem in a targeted approach, a risk-sharing mechanism should be established so that the risk is shared among the government, various organizations and different groups of people.

To take an overview of classic health funding systems across the world, Germany and the UK took the lead in establishing a government-led risk-sharing mechanism that covers the entire population to address the challenges posed by diseases and loss of capacity. Similar to the birth of the earliest pension system, it was the same “Blood and Iron” chancellor Otto von Bismarck, who set up the first disease fund. It was the first attempt to fund for health costs from the whole society based on contributions made by employers and employees. This model is also known as the “Bismarck model”. Under the requirement of national compulsory coverage, nearly 90% of Germans received health protection through disease funds, while the rest were requested to purchase commercial health insurance. A two-track insurance system was formed in Germany. Another major health funding system was born in the UK after World War II. In 1942, William Beveridge, a famous British economist, issued a reform plan and delivered a health fund system in which a universal medical care would be directly supported by the UK’s national finance and taxation. Therefore, this model was called the “Beveridge Model”. Unlike Germany, the Beveridge Model did use employment as beneficiary eligibility qualification. Most public health funding systems in the world drew experience from both the German and British schemes, and in recent decades, the dual-channeled funding model of “tax + employment contribution” has been gradually adopted.

Let us look at the other side of the Atlantic Ocean. In the US, the overall social security system was a late starter. Its health funding has evolved to become a system based on commercial insurance with separate risk-sharing mechanisms of different groups. During World War II, when wage growth stagnated, the US government encouraged large enterprises to provide their employees packages of remuneration and welfare with medical insurance included, which stimulated the employer-based group health insurance model to flourish. In addition to corporate insurance, two governmental programs, Medicaid and Medicare, were established in 1965 to serve low-income groups and elderly individuals. These two groups make up one-third of the US population and are in most need of medical insurance. Since then, there have been several attempts in the US to reform this decentralized health funding system, and Obamacare, which we often heard about in the news, was a continuation of this direction. The Affordable Care Act was signed into law by President Obama in 2010. It increased the coverage rate and reduced the financing burden of commercial insurance policyholders, but it eventually failed to break through the framework of parallel operation of multiple funding mechanisms.

The essence of health funding is to accumulate funds and share risks. Therefore, funding and contribution organized by the government are often compulsory. However, for commercial insurance institutions, the funding comes from customers who choose to purchase commercial health insurance. In Europe, for example, although social insurance is mandatory in some countries, some people would still purchase commercial health insurance as a supplement, often to obtain more, better and timely medical care services.

Under the grand goal of the “Healthy China Initiative”, China is promoting a multilevel medical security system. Government-led basic medical insurance aims at “full coverage of basic insurance”. On that basis, the proportion of medical expenses paid by individuals is still relatively high, and in many cases, the out-of-pocket expenses account for 30–40% of the total medical expenses. To increase funding channels, the Chinese government has been working with all kinds of commercial enterprises to launch pilots of critical disease insurance systems and long-term care insurance systems in recent years. Innovative products such as regional inclusive insurance products and the popular “Million” supplemental medical insurance products were both efforts in providing health funding security on more levels.

Regardless of which funding mechanism is adopted to deal with health risks, the rapidly rising medical costs have been sending out warning that human’s current social ability may not be enough to deal with health risks. The Era of Longevity will face the risk of insufficient health funding. Empirical data show that in the past few decades, the increase in medical expenses has been significantly faster than the growth in per capita GDP. With fiscal expenditure and personal expenditure on a constant rise, health expenditure is very much likely to become a heavy burden on society in the long run. Neither Bismarck nor Beveridge could have anticipated such drastic changes in population age structure. An increase in the aged population and the fact that more people will have to live with diseases for a long time will significantly increase health risks all around the world. Funding solutions from the last era is apparently far less than sufficient to cope with health funding challenges in the new era.

What can be done about it? Expenditure-wise, measures should be taken to control health costs, which means that governments should try to curb the growth rate of health expenditure through systematic reforms of the public healthcare system. Funding-wise, it is necessary to increase the initial accumulation of health funding and improve the ROI rate through marketized operations as much as possible. Germany has been actively dealing with long-term health funding risks by putting a mandatory requirement on commercial insurance companies included in the national medical insurance system. These insurance companies are requested to invest 10% of their policy premium into the capital market for long-term management. By doing so, Germany has built a designated reserve of funds to cope with long-term risks, and the total amount of reserve had reached 260 billion Euros by 2018. Before the outbreak of COVID-19 in 2020, the assets of the US government healthcare plan totaled more than 500 billion US dollars, out of which more than 300 billion US dollars were put to marketized operations to cope with the pressure of healthcare costs after the post World War II generation of baby boomers retired.

Despite the proactive countermeasures in place, the US Congressional Budget Office still made a projection that the Medicare hospitalization fund would run out by 2024, affecting hospital costs for 50 million senior citizens. In the context of the changing age structure of the population, existing efforts to increase income and reduce costs may not be enough to cope with health risks in the Era of Longevity. While the United States is already grappling with health funding solutions after the retirement of baby boomers, countries around the world that are moving toward the Era of Longevity must also confront and reflect on the enormous challenges that future health expenditures pose to health funding today.

In the era of longevity, the funds people save for their retirement life and health care are highly likely to be insufficient. Hence how to accumulate wealth in a scientific way has become an important topic. In the following section, we will extend the time span and discuss some simple yet profound laws in wealth accumulation from a life cycle perspective, laws that should be followed whether it is to build up personal or social wealth. Accumulating wealth is akin to storing water in a tank. The volume of the water depends on the length, width and height of the tank, while the size of wealth also depends on three factors: the term of investment, the amount of principal and the rate of return. Therefore, there are three approaches to accumulate more wealth for retirement in the era of longevity. One is extending the period of investment, one is increasing the amount of principal by investing in human capital in the second demographic dividend stage, and another one is boosting additional earnings by compounding.

The most straightforward way to extend the period of wealth accumulation is by either starting saving early or delaying retirement. The longer life expectancy is after retirement, the more time there is to accumulate wealth. People wish to retire on time as they schedule must plan ahead for retirement life. Financial planning is not optional or only for the middle-aged people but is essential for every career freshman. Public health studies have shown that the physical fitness of the older population has greatly improved compared with that of their preceding generation at the same age. A 60-year-old in the past is in the same health condition as a 70-year-old or even 80-year-old today, thereby paving the way for older persons to extend their working years. A prolonged working life of the workforce extends the period of wealth accumulation for retirement and thus a bigger size of wealth. In fact, many countries with significantly aged populations have delayed the statutory retirement age as one of the responses to an aging society (see Tables 3.4). In the West, most people retire in their 60s. Japan has recently introduced a law to prepare its society for retiring at age 70 by encouraging businesses to offer job opportunities for people who are willing to work until they are 70 years old. While we think delaying retirement is necessary, we believe that it should be implemented step by step, with an awareness of the differences among enterprises and industries, and based on the retiree’s willingness. In the era of longevity, older persons might retire, then rejoin the labor market and retire again to replenish their wealth flexibly.

Compounding is a way to realize exponential growth. Many people come across the term when they follow on Warren Buffet’s successful investment stories. Buffet once used the “snowball” metaphor to describe tremendous wealth reaped from long-term compounding. In fact, the essence of compounding is that quantitative change accumulates to a critical mass and leads to a qualitative leap. It is the power of long-term accumulation. A rule of thumb to estimate compounding is Rule of 72.

Assuming that the average yearly return rate on pension is 8%, the investment will basically take 9 years (dividing 72 by 8) to double; if 6%, then 12 years to double. There are three preconditions for compounding to come into play: a long period, above-average return rate and no fluctuations in return rate. Only when the term of investment is long enough, can compounding generate huge returns.

Let us make a hypothetical example with an investment that returns at 5% annually for 50 years. Nearly 43% of the returns are created in the last decade (see Fig. 3.2), while returns generated in the first decade only account for 6%. It shows that very little return could be reaped over a short-term investment and that the higher the rate of return is, the greater share returns in the later period take up in the total. Let us take a closer look at the results of the investment over a longer time span: after 30 years, the balance is 4.3 times the size of the principal; after 50 years, 11.5 times; 70 years, 30.4 times. This is exactly why I call compounding a friend of time. Over 30 years, compounding could significantly boost returns; over 50 years, compounding could grow from a bud to blossom; over 70 years, the power of compounding could be as great as God.

Certain investment income must be guaranteed for compounding to play its role. Even if the term of investment is long enough, with a low rate of return, compounding still cannot exert its magic. In the era of longevity, the time span to accumulate wealth for retirement could be ensured, so the impact of the return rate becomes more significant. The amount of wealth accumulated for retirement depends heavily on investment returns. Assuming that two young men, both with a strong sense of saving for the future, start to put aside 10,000 yuan every year for retirement life at age 30. One of them, not very good at wealth management, puts the money in a bank to enjoy a 2% return rate annually, while the other, having greater wealth management savvy, builds a diversified portfolio with funds, insurance and other financial products and reaps a 6% annual return. Forty years later, when these two young men become grandfathers, the one who is poor with wealth management would have a balance of 600,000 yuan, while the other would have assets worth more than 1.6 million yuan. The latter, with a nearly threefold asset size of that of the former, could provide for a much more comfortable and enviable retirement life.

Another point of note is that the returns must not fluctuate in the process of wealth accumulation, otherwise, the magic of compounding would be compromised. Let us assume that the two young men both enjoy a 6% rate of return annually on average. One of them has a stable investment performance, returning 6% every year, while the other, has a good year peaking at 27%, followed by a 15% loss, and this goes on for 50 years (the mathematical average return is 6%). Due to sharp swings in returns, the latter would end up with a 1.4 million yuan worth of assets, nearly half the size of the wealth created by a stable 6% annual return rate.

Comprehending the idea of “length, width and height” is not difficult at all, but it is hard to follow it through in investment practice. In the era of longevity, “length” is easy to achieve because the term of investment naturally extends as a result of longer life expectancy, and “width” is not hard as we already see the second demographic dividend reveal. “Height”, however, is much more challenging, as compounding could be hindered by low interest rates.

In the past decade, major developed economies have all been in low interest rate environments. Since the 1980s, fading dividends from technological progress and the changing age structure of the population have slowed economies. A dim outlook for potential growth was the main reason behind the long-term interest rate drop worldwide. In addition, governments have been overly reliant on monetary policies to intervene in the economy and capital market and have continued to increase money supply, which further drives down interest rates. Take the 10-year Treasury bond yield as an example. In the United States, since it plummeted below 10% in the 1990s, the yield has seen ups and downs but continued to slope downwards and remained at a low level since the financial crisis in 2008. In Japan, the declining trend could be observed even more clearly, as the interest rate has been negative for almost every year since 2015. In an environment where there is a persistently low or even large-scale negative interest rate, it is quite challenging to preserve, let alone increase wealth.

In China’s case, its interest rate, compared with that of other major economies, remains at a high level but will decline slowly over the long run. Facing common challenges such as a heavily aged population, sustained low fertility rate, slow-paced technological progress and declining growth rate projections, China will see its interest rate go downwards as a long-term trend. That being said, the interest rate is unlikely to take a dive. It will be low only as relative to its past high levels, but once down, it would be very hard to climb back.

Equity assets, overseas investment and alternative investment could help to mitigate the impact of a low interest rate environment. In the era of longevity, longer life expectancy extends the term of investment, and a prolonged investment term often increases investors’ risk appetite. Therefore, adjustments could be made to the investment portfolio to increase the allocation of riskier assets such as equities, in particular, stocks with stable earnings, low valuation, high dividend rate, managed by excellent teams and rising above economic cycles. These assets could help better achieve long-term investment goals. Increasing the allocation of overseas investment and alternative investments also helps. For example, institutional investors, insurance companies in Japan and the UK increased their investment overseas during low interest rate periods. By investing overseas into high-yielding assets, they are able to counteract unfavorable performance in the domestic market. For the purpose of risk diversification, alternative investments with low correlations to capital markets or economic fundamentals, such as gold and arts, are also worth considering as tools to cope with low interest rate environments.

In the previous sections, we focus on the challenge of retirement savings in the era of longevity, confronting nations as well as each individual. The problem is so pressing that it requires extensive and close attention from all age groups. Now, we shift the focus to the older population. The era of longevity is characterized by an increasing number of older persons, especially the oldest old. This specific age group has its uniqueness in terms of its financial status and needs. Those unique status and needs, although yet to become common problems across societies, have been emerging in superaged countries such as Japan. While retirement finance emphasizes making financial arrangements from a life-cycle perspective, elderly finance focuses on unique financial problems of the oldest old. By envisaging ways to deal with those problems, we wish to provide some ideas for financial institutions to better serve elderly individuals.

A special project recording team at Japan’s broadcaster NHK (Japan Broadcasting Association) once made a documentary called “Old Bankruptcy”, which documented many tragic cases beyond our imagination. The documentary revolves around the theme of money. The elderly in the documentary, all having worked diligently and made saving plans for retirement, had no idea that unanticipated long life, coupled with economic recession, would make their retirement life so financially tight, hard and lonely to the point that they even feel deprived of desire to live. Longevity, often considered a symbol of happy societies, could also be the last straw that crushes old life. We must realize in sober truth that prolonged life or long-term illness could increase the risk of wealth depletion, which is called longevity risk. A more straightforward language to explain it is “a man lives, with no money left”. When we talk about the pension replacement rate falling in previous sections, we refer to the insufficiency of public pension funds. When people are in their oldest old years, the expenses on medical treatment and health care increase steeply, and money becomes a huge concern. The term longevity risk is first used in actuarial science to refer to the risk resulting from chances that actual life exceeds life expectancy. For individuals, longevity risk is the risk of wealth depletion when their lifespan cannot be accurately predicted and they end up living longer than expected with no money at their disposal. (see Fig. 3.3).

Longevity risk could spill over and become a social risk. Asset depletion is most likely to happen to the oldest old. The cohort is highly likely to have been living with illnesses for a long time and has little chance to be reemployed to earn income, but burdened with high medical care bills. When the assets of the oldest old population are exhausted, normally, family members share the expenses of living and medical care to provide support. However, in a low fertility rate society, the burden on children to support their parents becomes heavier. Some families that are not so well off would be hit harder or even plunge into poverty. Inequality among families builds up, which will inevitably lead to inequality across society. As the number of long-lived but bankrupt older persons increases, there could be collective longevity risk, which could destabilize the social security system and undermine the sound and stable development of society. Therefore, in a longevity society, if there are no effective countermeasures, personal longevity risk could escalate and lead to systemic risks.

Among all countries, China should pay more attention to longevity risk. A significant difference between China and developed countries in terms of population aging is that China has yet to become rich before it becomes old. In developed countries, when the proportion of the population aged 65 and over hits 7%, the GDP per capita is approximately $10,000, while in China, the GDP per capita was only approximately $1200 when the same happened in 2000. In 2019, when China’s GDP per capita finally exceeded $10,000, the proportion of the population aged 65 and over has reached an astonishing 12.6%. When Japan and South Korea had the same level of population aging, their GDP per capita reached $31,000 and $27,000, respectively. “Getting old before getting rich” not only puts huge pressure on society but also increases the chances of old-age poverty.

The financial behavior of older persons is unique due to the physical and cognitive decline associated with aging and their socioeconomic status. Older persons might have amassed a huge amount of wealth and wish to maintain their financial independence, and their desire to preserve or even to increase the value of their existing assets grows. They have low risk appetites and sometimes cannot manage their wealth well as a result of cognitive decline. When the era of longevity dawns, the behavior of this particular age group will have an ever-growing impact on the financial market, which requires us to effectively analyze and understand their financial behavior.

Survey data across nations have clearly demonstrated that the older population holds a huge amount of wealth. One case in point is Japan. Despite many cases of old-age bankruptcy, the older population in Japan remains the “wealthiest” age group at the macro level. A report released by the Tokyo metropolitan government in 2017 stated that 70% of Japan’s 1800-trillion-yen household financial assets are held by those aged over 60. In the UK, a survey released by Savills, the global property consultancy firm in 2018 reported that 40% of the UK’s national wealth is in the hands of the 65 plus retirees. Under such circumstances, for the middle class and the high net worth individuals around the globe, it is very important to think about how to pass on the wealth safe and sound in their old age.

Older persons have low risk appetites, which could affect the risk preference of the market. Residents’ retirement investment risk preference curve follows an inverted U shape as their age increases, which is in line with the patterns of life cycle development. Young people who just enter the workplace earn relatively less income, but they are under the pressure of buying a house, children’s education and other expenses; therefore, they have a low risk appetite. As they grow older, their income increases and expenditure pressure decreases, so their risk appetites grow. After they retire, the income and their risk appetites see a drop again. Older persons are typical risk-averse investors who prefer choosing low-yielding and safe investments such as deposit or fixed-income products. When older persons with low risk preference become the investor majority, the risk preference of the entire market will be lower, thereby contributing to a low-interest-rate economic and social environment.

Older persons are also more vulnerable to financial fraud due to insufficient financial literacy. In fact, financial literacy in all age categories, including older persons, has yet to be improved. The rating agency Standard & Poor conducted a global survey on financial literacy in 2015 and rated the financial literacy score of Chinese far below the global average, as the survey found that 72% of Chinese adults do not comprehend important financial terms such as risk diversification, inflation and compounding. This result is astonishing. According to the survey, three quarters of Asian adults and two-thirds of adults globally are financially illiterate. As they age, their lack of necessary financial literacy poses a great challenge to managing their assets. Moreover, with limited access to financial information and due to a lack of sound judgment, older persons might be exploited by financial predators and fall victim to various financial frauds. All these would jeopardize the financial security of the older population.

As their decision-making ability declines, older persons might end up putting their assets in a frozen state. As they age, cognitive functions decline gradually, disrupting their normal life. However, making financial transactions such as making or taking a deposit, securities investment or purchasing insurance products requires the party to be able to make sensible judgments independently. When older persons cannot carry out asset allocation or wealth management, their assets might slump into a frozen state, stalling economic development. The Annual Report on the Aging Society released in 2016 by the Japanese government shows that the number of 65-plus persons with dementia is rapidly growing, and by 2030, dementia patients will account for 7% of the total population. The size of the financial assets held by them is growing as well. According to a report by the Japan Economic Newspaper, it is estimated that the assets held by older persons with dementia will increase to 215 trillion Japanese yen in 2030, equivalent to 40% of Japan’s total GDP. If that large size of assets ends up in a frozen state, economic development would take a huge toll, and it is not conducive to the effective allocation of resources. Therefore, innovations in both regulations and financial products must be made to unfreeze the funds and put them to work.

Older persons will be heavily reliant on regulation assurance and services provided by institutional investors in their financial decision-making. In regard to providing financial services for elderly individuals, Japan’s impeccable service is the embodiment of the “customer-oriented” culture. For example, the Japan Securities Dealers Association has specifically issued a guideline on sales of financial products targeted at elderly customers, formulating the definition of “elderly customers”, the range of products and the procedures. Its members must follow the rules when they solicit sales. Nippon Life launched the GranAge pension scheme, which aims to provide packaged services for older persons since they are in their 50s to when their life ends, including ID authentication, life support, voluntary guardianship, funerals and benefit payouts in their active years.

To deal with senile dementia, the Japanese government has joined hands with financial institutions to prevent asset freeze and guarantee daily life activities and medical care for the patients. Mizuho Bank launched a Dementia Support Trust, a product that allows customers to set up a trust as preparation for the possible attack of the disease, and if the customer is diagnosed, the money could be used to cover living and medical expenses. When the patient is diagnosed with dementia by a doctor, upon the submit of the diagnosis, the patient’s expenditure would be restricted, and an agent such as a family member would manage the assets on behalf of the patient. The bank would check the payment made by the agent in case the trust money is misused.

Technology is also increasingly enabling financial services for older persons. As an increasing number of senior citizens access the internet, financial institutions are able to provide targeted products and services. Institutions could educate middle-aged and older persons on asset management skills and offer products through websites, online banking, apps and third-party platforms, among other internet channels. The application of big data made personalized services possible to meet customer needs. With massive customer preference information at hand, financial institutions could design tailor-made solutions to meet customers’ needs for personalized and diverse wealth management products. Health technology is aiding older citizens suffering from mobility or memory impairment, and it is also assisting older persons with severe chronic diseases in making sound investment decisions and handling their own financial needs. Smart robot investment consultants are booming, and by analyzing the investment preference of different individuals with big data and artificial intelligence, they are providing professional help to the elderly in investment decision-making and investment actions.

More people have come to realize that elderly finance is an industry that is interdisciplinary and cross-field, and the financial sector alone cannot respond to the changing needs of elderly individuals. Not just professional institutions, every firm in the business of retirement finance should develop a better understanding of the elderly’s behavior, health, psychology and demand. That is why it is increasingly important for firms in the financial sector to interact and for financial and nonfinancial sectors to interact and coordinate efforts. For example, designing a product that combines the merits of both insurance and trust to better serve the elderly’s need to pass on their wealth. Financial institutions could work with elderly nursing communities to launch tailor-made products or products that offer both benefit payouts and elderly care services to cater to the elder’s demands. It requires cooperation and intensive study from multiple industries to offer products and services that the elderly truly need. We expect that an increasing number of enterprises will realize the importance of elderly finance and take action as soon as possible.

The era of longevity is the era of health and wealth. In some sense, longevity, health and wealth arrive at the same time, but they do not necessarily come hand in hand. Adequate wealth ensures better elderly care and medical services, which in turn promotes longer and healthier life expectancy. However, for each individual, the level of wealth is not always sufficient to fund their payment demands in a long life. There is a risk of wealth depletion in older age. To illustrate this, economists have drawn the curve of labor income and consumption over the lifetime based on empirical data from developed countries such as Japan and the United States. The two curves intersect and create a hat shape (see Fig. 3.4). The income curve shaped a typical inverted U, peaking at the age of 40–50. The consumption curve stays much flatter, as spending on education is higher during youth and it slowly rises over age until peaking at older ages as the demands for care and health grow. At older ages, the deficit gap between income and consumption can be clearly observed, and it widens as life expectancy extends. One common challenge in the era of wealth is to fill or narrow the deficit gap during older ages with accumulated assets and investment income in younger days.

We noticed the imbalance between income and consumption over the lifetime long ago, and made business designs accordingly. We believe the operation of professional investment institutions could provide preconditions for individuals to make their optimal financing arrangements.

Let us first set up an ideal financing model for a long-living life. With this purely theoretical model, I will elaborate how to solve the problem of fund deficit in old age with long-hill theory and compounding. Let us assume there is a middle-aged 40-year-old man who decides to accumulate assets by an automatic investment plan and spend down the investment in older ages. He could choose to start the withdrawal at any time, say at 70 or 80 years old. During the decades between the initial investment and the date when he starts to withdraw money, a professional investment institution has been delivering stable and excellent yields. Referencing the average annual return rate of the US stock market at nearly 7% and the bond market at 3% over the past 20 years, we assume that our model could deliver an average annual return rate of 5% by asset allocation.

If other conditions remain constant, the age when the withdrawal starts would have a huge impact on the size of the balance. Figure 3.5 details the balance in different scenarios in an automatic investment plan. If the man invests 200,000 yuan every year for 10 years, starting from 40 years old, and after several decades of accumulation, he would have a 3–6 times size of assets of the 2 million yuan principal, depending on the age that the withdrawal begins. The later the withdrawal begins, the larger the assets size is, and the better results compounding is able to produce.

As shown by the three scenarios in the figure, as soon as the withdrawal begins, assets that have been accumulated would start to shrink to some extent, resulting from that investment income in that year cannot cover the expenses and additional money must be withdrawn from the pool. If the withdrawal starts at 70 years old, the investment income generated in that year is only able to cover 75% of the expenditure. As the coverage ratio further drops, the shortfall could only be compensated by withdrawing from the accumulation. It is also shown that the later the withdrawal starts, the slower pace the assets shrinks. This is largely due to the effect of compounding. Although withdrawals are made every year, the assets left untouched are still producing returns. If the withdrawal starts at 75, the accumulated assets by then could be sustained until the age of 100. This leads to our conclusion on the advantages of establishing a financing model for a long-living life. For one, it could support life after retirement and improve life quality; for the other, it could help preserve or even increase the value of assets through compounding and slow down the drain on assets.

If the expenditure in old age is partly covered by the financing model and partly covered by other funds such as state pension or employer pension schemes, less money would be taken out and more left to accumulate. If there are other sources of support for old life, the amount of principal invested could be reduced to ease financial pressure during youth, or the withdrawal could start at earlier ages, and neither would affect the achievement of the investment goals.

Let us try extending the period of accumulation even longer to see how compounding works. As demonstrated by Fig. 3.6, if the investment is a designated old-life future plan some wise parents make for their children, the amount of principal invested does not have to be a huge sum. Say, it is half of what the middle-age invested, which is 100,000 yuan annually, for ten consecutive years. If the investment is made when the child is 10 years old, he or she starts to withdraw money at senior ages. In the time frame of nearly half a century, the size of the investment would grow exponentially. The balance would be 15–25 times the size of the initial 1 million yuan principal, varying based on different ages when the withdrawal starts. The difference between the two investment plans, one that starts at age 40 and the other that starts at age 10, is that in the latter case, assets would not shrink as soon as the withdrawal begins at age 80; instead, the turning point would be at approximately the age of 95. This is because the annual returns generated by the investment accumulated throughout 10–80 alone would be sufficient to cover the consumption, and the withdrawal would only slow down the speed of money accumulation. It is only when the investment income falls short of rising expenses due to inflation at the age of 95 that the total assets size finally starts to shrink. This example shows that the earlier investment starts and the later the withdrawal happens, or to say, the longer the term of investment is, the more rewards could be reaped through compounding. The larger the amount of assets accumulated before the first withdrawal, the more slowly it would dwindle after the withdrawal, and the more financially prepared we would be to provide for a quality retirement life.

The demonstration above helps us to better understand how to meet the need for a good old life through long-term accumulation. Of course, reality is far more complicated than our assumptions. For one, the rate of return in the real market swings. As we mentioned, a stable rate of return is the foundation for compounding to play its role, and return rate swings affect long-term investment income. In addition, professional investment institutions charge a certain amount of management fees, so the cost must be factored in when making an investment. Other assumptions in the model could also change in real life, and it is just a simple model for demonstration purposes.

Generally, there are three takeaways from the ideal financing model for a long life. First, the model demonstrates the advantage of long-term investment, which is what I call the long-hill theory. The example of starting investment at the age of 10 and withdrawing at old age vindicates the theory. In that case, the principal is only half of what is invested in the case of starting the investment at 40, but the total assets accumulated are much larger. Second, institutional investors are able to make professional investment decisions to deliver an excellent rate of return, which is also what Taikang has been striving for. Last, the investment model is able to produce enough money for old life, effectively reducing the risk of asset depletion in older ages. Apart from that, the investment continues to produce income even when money is pulled out, so there might even be some money left to pass on to the children.

What would happen if we change the “length, width and height” in the model, which is the investment term, principal and rate of return? The following table demonstrates the balance at 95 years old with the ideal financing model in different scenarios. Supposing that the withdrawal begins at the age of 75 (there is only accumulation with no withdrawal before that) and rises along with inflation and that the money left still produces income. Based on the abovementioned assumptions, we could calculate how much money could be accumulated when the investor reaches 95 years old, with different rates of return and different amounts of principal, as shown in Table 3.5. It is clear that the higher the rate of return is, the longer the investment term is and the higher the amount of principal is invested, the more assets there would be at the investor’s disposal to support life at age 95. In contrast, under the assumption of a low rate of return, a small amount of principal and a fairly short term, the investment might not break even or even end up with a negative balance. Length, width and height of investment are the three basic dimensions of building an ideal financing model over time, and everyone could decide on a plan based on their ultimate investment goal.

In addition, by dividing the balance of funds at age 95 by the total assets volume accumulated at age 75 when there is no withdrawal, we could have a picture of money consumption based on the steepness of the post-withdrawal curve. It is shown that in some cases, the value is greater than 1, which means that the balance at the age of 95 is even larger than that at 75, indicating that although the withdrawal lasts for 20 years until 95, the investment income during this period is sufficient to cover the consumption, and the balance is still gaining. Interestingly, with high yields and long investment terms, by the age of 95, the total assets generated by the 1 million yuan investment plan that starts at 10 are larger than those of the 2 million yuan investment plan starting at 40.

Based on the ratio of balance at 95 and balance at 75 in the two investment plans, the 1-million-yuan plan generates a higher number. The plan also sees a steep asset accumulation curve during the decumulation process. Both prove that the income produced by long-term compounding is staggering.

In addition to daily life expenses, the older population faces higher health risks; therefore, they should start planning ahead to save on medical expenses and nursing and rehabilitation services. The health risks create more demands for cash in tail events. The demands could be satisfied by more sophisticated financing products such as health insurance and care insurance. The topic has been covered in previous chapters. To take an overview of financing from the life-cycle perspective, it should be a package of a wide range of wealth management plans and insurance products so that the cash flow can be adjusted to adapt to needs in different stages.

Long-term handsome and stable yields are the cornerstone of the financing model for a long-lived life. Since financial products could compound returns, the earlier the investment is made, the longer the period is for the investment to produce interest and to compound, increasing the efficiency of wealth accumulation exponentially. It could help people improve the living standards of their retirement life and solve the problem of insufficient funds for elderly care and medical services in the upcoming centenarian era. Therefore, for investment institutions, it is crucial to implement the principle of life-cycle wealth management in their product design.

Let us wake up from the ideal model and return to the real world, where financial products are far from perfect, but compounding still applies. The theoretical financing model for a long-lived life could be a prototype for product design in real life, although one must be careful not to confuse the two. As a financial institution dedicated to catering to the client’s needs over their life cycle, Taikang seeks to tap into the potential of compounding for clients by designing products with a view to long-term accumulation. A qualitative leap would naturally follow when quantitative changes build and reach a certain mass. To solve the financing challenge for a long-living life, business innovation and cross-sector solutions are needed since pure financial products play a limited role.

Taikang creatively combines long-term annuity products with the benefit of checking in its longevity communities, a solution that incorporates intangible insurance and tangible medical and caring services. Clients could enjoy insurance and wealth management services, reap the benefits of compounding delivered by our excellent investment performance and save up sufficient money for retirement when they are still young. When they get older, the insurance premiums accumulated could fund a quality retirement life in a longevity community or other arrangements as they please. Different from traditional solutions, what Taikang offers is an innovative financing solution that addresses the challenge of wealth accumulation in the longevity era, a solution that aims at maximizing the benefits for clients in their entire life span or even longer. Taikang offers professional investment capability empowerment and high-quality elderly care services in longevity communities. What the clients purchase is not just financial products but also a future lifestyle. It is a revolution in elderly care.

As mentioned above, among the three pillars of pensions, the third is private pension, which are often encouraged by national tax incentives. Taikang encourages clients to find an optimal financing model and provides incentives for people to accumulate wealth for older ages by offering a myriad of medical, caring, rehabilitative and end-of-life care and services that cover a full life cycle. If the lifestyle of living in a longevity community incentivizes people, these for-profit products to some extent play the role of the third pillar. Taikang will further innovate in the future, extending beyond elderly care to provide medical and nursing services. We will expand the business to the health sector, where Taikang will combine annuity with health insurance and nursing insurance among other insurance products that cover the needs of both elderly care and health care over the life cycle to respond to more complicated events, especially tail events that require more cash consumption.

In the era of longevity, as the older population continues to expand, financial services for the elderly will be the blue ocean. The industry is unique in that it requires traditional financial services, yet there must also be meticulous care and a people-oriented culture. Taikang has launched in its longevity communities products tailored for elderly individuals, exclusive asset management and financial services to help the elderly better manage and pass on their wealth. Sufficient and secured wealth gives the elderly a sense of happiness and reassurance, and that is where Taikang sees the value and meaning of its cause.