A Vibrant Insurance Industry

Exploring trends in Chinese insurance regulation Hans Wagner

China is well known internationally for a variety of different attributes, including its long history, historical monuments such as the Great Wall, its outstanding and varied regional cuisines, its large population and its growing share of the global economy. From 1979 to 2010, China’s annual gross domestic product (GDP) growth was 9.91 percent. Since 2010, growth each year has trended down, from 10.6 percent to 6.7 percent in 2016. China passed Japan in 2009 and is the world’s second-largest economy behind the United States. The digital economy has been especially rapid in its growth, with more than 20 percent annual growth since 2009 and about 47 percent of global retail e-commerce sales.

In this environment, the growth and change of the insurance market is also striking. Gross premium exceeded RMB 3 trillion (USD 455 billion) in 2016, with annualized growth of more than 20 percent since 2013. Life is the largest market segment, but health is the fastest growing. It is estimated that during 2016, the insurance premium growth in China represented 47 percent of the global growth in insurance premiums (see Figure 1). With the local economy still growing and much lower penetration rates than more developed markets, China’s insurance industry still sees great opportunities for further growth.

Figure 1: China Market Premiums

Source: Chinese Insurance Regulatory Commission

This article provides an overview of China’s insurance regulatory regime, news of recent developments and views on possible future developments. The author works primarily in life and health insurance, but some coverage of property and casualty (P&C) is provided.

Regulatory System Overview

Regulation of the insurance industry in China is the responsibility of the Chinese Insurance Regulatory Commission (CIRC). CIRC has sweeping powers to regulate all aspects of the industry. CIRC is a national regulator, but it has 31 provincial branches that sometimes issue supplementary local regulations and form local interpretations of national rules. Inside the CIRC are departments regulating finance, actuarial, investments, foreign insurers and other matters. Foreign insurers are subject to specific regulations—for example, ownership share limits and special rules for adding new provincial branches. CIRC is under the direct supervision of the State Council, which is the chief administrative authority of the People’s Republic of China. The State Council is essentially the top of China’s executive branch.

More broadly, the economy and finance industry is under the direction of the Ministry of Finance (MoF). The MoF is also under the direct supervision of the State Council. For the insurance industry, the most relevant roles of the MoF are in setting accounting rules and tax rules. The New Chinese Accounting Standards (NCAS) issued in 2006 are broadly aligned with International Financial Reporting Standards (IFRS), while implementation is adjusted to Chinese characteristics (e.g., held-to-maturity accounting classification of assets is still in widespread use). A schedule for incorporating IFRS 9 was announced in April 2017. For NCAS, CIRC gives advice to MoF but does not set rules for insurance liability valuation. CIRC directly controls the valuation basis for solvency measurement.

At the same ministerial level as the MoF is China’s central bank, the People’s Bank of China (PBoC). The PBoC has the key role in monetary policy and setting interest rates, along with regulating the money supply. The PBoC is also in charge of anti-money laundering activities, which for insurers have implications for policy issue and service.

Also quite relevant for publicly listed insurers is the Chinese Securities Regulatory Commission (CSRC), which is the main regulator for securities markets in China, similar in function to the Securities and Exchange Commission (SEC) in the United States. Bank distribution is a significant portion of the total market, so the Chinese Banking Regulatory Commission (CBRC) also has relevance for many insurers. CBRC rules, for example, allow each banking outlet to cooperate with a maximum of three life insurance companies and forbid life insurance sales personnel from operating directly within bank outlets. As with CIRC rules, the interpretation of CBRC rules sometimes varies among different provinces.

No summary of the Chinese regulatory landscape is complete without mentioning the leading role of the Chinese Communist Party (CCP). While the governing and regulatory bodies are independent of the CCP, high-ranking government officials are usually also high-ranking party members. Individuals often rotate among roles in industry, government and the party, as well as between provincial and central roles. Party initiatives, such as the anti-corruption campaign of recent years, can make an impact. The chairman of CIRC, Xiang Junbo, who previously was chairman of one of the “big four” state-owned banks and had been vice governor of the PBoC, was placed under investigation in April 2017 by the CCP for “serious violations of discipline.” Shortly thereafter, he was removed from the CIRC organization chart on its website.

Recent Insurance Regulatory Developments

In August 2014, the State Council released a milestone paper titled “Several Opinions on Accelerating the Development of the Modern Insurance Service Industry.” This marked the first time that the State Council had specifically addressed the role of the insurance industry in assisting China’s development. In addition to setting out a broad agenda of modernization and reform for the industry, there are concrete insurance penetration and density goals for 2020 that would represent approximately 16 percent annual growth for the industry. This paper reinforced several previously existing regulatory thrusts, giving them much greater weight with the endorsement of China’s highest executive body.

The inclusion of explicit and ambitious growth targets in this paper, coupled with drives for modernization and reform, provide an indication of the balancing act required of the CIRC. There is a desire for a large insurance industry, and simultaneously a desire for a strong industry contributing to society. China’s growth history includes examples of high growth that was not sustainable or had unhealthy underpinnings, so regulators must strike the right balance in encouraging growth while ensuring solidity.

The full scope of all of the regulatory changes is beyond the scope of this article, but a summary of the key regulatory changes from CIRC and other regulators can be grouped into five main areas:

  • Modernize and open up regulation to give market forces more scope.
  • Improve customer services and sales practices.
  • Improve capital management and industry stability mainly through solvency reform.
  • Restrain market excesses and encourage the insurance market to focus on protection function.
  • Improve corporate governance.

Allowing More Market Forces

Historically, like many developing insurance markets, CIRC kept close control of policy pricing both in life insurance and P&C. The liberalization of interest rates allowed in pricing has been progressively applied to different life product types between 2013 and 2015. While old regulations had a strict cap on the interest rates used in determining policy premiums, new regulations remove the cap but still require that products using rates higher than 3.5 percent for nonparticipating and 3.0 percent for participating receive permission from CIRC.

For P&C, the first emphasis of pricing liberalization has been on auto insurance, which is the dominant product. A pilot of pricing liberalization was rolled out to six provinces in April 2015, followed by national liberalization in July 2016. Commercial insurance rates are still controlled, but further liberalization is expected.

In addition to liberalizing the pricing standards for insurance, CIRC also has greatly expanded the list of permitted investments, allowing insurers to improve their investment returns, create better diversification of risk and tools for risk management, and encourage insurance companies’ investments to help overall economic growth. In 2010 and 2012, CIRC began permitting investments in equity and real estate. Following the “Several Opinions” paper in 2014, CIRC also allowed venture capital and private equity investments. Insurers are required to meet various qualifications before investing directly in nonstandard asset classes.

Improving Customer Services and Sales Practices

One of the overriding goals of the CCP is to maintain social order. Accordingly, customer satisfaction is of prime importance, especially if potential dissatisfaction could rise from an individual case to the level of mass complaints. So it is no surprise that a number of initiatives have focused on both the insurance sales and servicing processes to protect consumers.

CIRC has issued controls both at a detailed operational level and with a broader top-down approach. These include regulations on what can be included in sales illustrations, a mandated “welcome call” after all life insurance sales, special protection for older consumers in some provinces and other initiatives. Since 2012, a series of scorecards has been developed for various aspects of sales and service quality.

With the importance of e-commerce in China and the potential for digital insurance operations, CIRC has encouraged innovation. However, a number of nontraditional players entering the areas of insurance—particularly wealth management products—have not pursued sustainable strategies. Some of these have exploited inconsistencies in approach among different Chinese regulators, and there are renewed efforts to rein these in. Guo Shuqing, head of CBRC since February 2017, has emphasized the need for coordination among regulators and ensuring consumers have appropriate protection through regulation.

Another area in which CIRC has liberalized the market, but also placed more responsibility on companies, is agent licensing. Old requirements for agents passing a regulatory exam have been eliminated, but companies are expected to ensure their agents are appropriately trained and are responsible for their behavior.

Improving Capital Management and Stability

Perhaps the recent Chinese regulatory innovation that is best known abroad is the Chinese Risk-Oriented Solvency System (C-ROSS). A more complete description can be found in The Actuary’s February/March 2014 issue, but in brief, C-ROSS is structured with the multiple-pillar framework that is common to modern global solvency regulation and very much resembles the European Solvency II framework, but it limits required capital measurement to a standard formula. However, C-ROSS includes many features designed specifically to China or that are more appropriate to developing markets as opposed to Europe’s mature industry. Its Pillar 1 measurement framework of available and required capital came into full effect at the beginning of 2016.

Pillar 2 qualitative requirements were implemented during 2016, with both the Integrated Risk Rating (IRR) and the Solvency Aligned Risk Management Requirements and Assessment (SARMRA) being completed for all companies. The IRR attempts to combine the quantitative assessment from Pillar 1 with monitoring of other indicators plus examinations of each company’s operational, strategic, reputational and liquidity risks. SARMRA on-site inspection teams from CIRC provincial offices reviewed the completeness and effectiveness of risk management. Quantitative scores were then assigned, with companies scoring below 80 increasing required capital and those with scores higher than 80 reducing required capital.

With the adoption of the new capital standard, China also has moved to updating its embedded value (EV) reporting. EV reporting is required as a regulatory filing, though many investment analysts also use it as a metric. The Chinese Actuarial Association (CAA) was charged by CIRC with the task of updating the Chinese EV standard to reflect the new capital standard.

One of the less-healthy aspects of insurer growth in China has been a variety of companies wishing to apply variations of what they see as the “Buffett model” of using insurance as a cash cow for other corporate investment goals. The local adaptation has not always included the principles of avoiding hostile takeovers, running a sound insurance company and maintaining a solid, consolidated balance sheet supporting opportunistic risk-taking. Liu Shiyu, the head of CSRC, in December 2016 described some leveraged takeover players as “barbarians” and “robbers.” A number of companies recently have had product and investment restrictions placed upon them and executives banned from the industry.

Focusing on Protection Function of Insurance, Eliminate Excesses

One of the key focuses of the “Several Opinions” paper is to support the growth of the protective element of insurance in China, notably in health and pensions, but also for agricultural insurance and other areas. A large portion of the premium income historically has been from savings-oriented policies that customers expect to hold for a short term (anywhere from just a few months to a few years). In 2015, such products were 27 percent of total life insurance premiums, but CIRC has taken several steps to curb the sales of these products in recent years. Progress has been uneven, as CIRC has faced pressure to help companies deal with cash-flow issues from prior sales, as well as maintaining overall industry growth goals. Products with an expected duration of less than one year have been banned, and progressively tighter limits are coming into force for products with an expected duration between one and five years.

A September 2016 regulations package also included updates across all life insurance products. These rules covered several areas, including mandating higher minimum death benefits (existing rules in China have death benefits that are more significant than in some European markets, but are much less than what is required to be tax-qualified life insurance in the United States), clarifying the responsibilities of the chief actuary for the reasonableness of assumptions and requiring new products to have a positive EV margin. Restrictions were placed on universal life products, which in China often are more akin to shells for short-term savings.

There have been carrots provided for transition, as well as sticks. 2016 saw the launch of a tax-advantaged health insurance scheme, although so far sales have been small. There also have been some pilots of tax-advantaged pension plans, as well as other pilot programs such as a micro-loan warranty pilot in Shanxi province in 2015.

China also has updated its official mortality tables, including for the first time a specific table for annuities developed from annuity mortality experience rather than adjusted from life insurance experience.

Improving Corporate Governance

In 2015, in response to State Council requests to reinforce internal control and prevent financial risks, CIRC launched the “Two Reinforcements and Two Restraints” review. This consisted of extensive self-assessments by insurance companies and their branches to identify areas of failed controls. With the first round producing inadequate reporting in some cases, CIRC has followed up with on-site inspections and additional rounds of company self-inspections. Work in this area continues.

During 2017, CIRC launched provincial team on-site inspections of insurance company governance, similar to the SARMRA reviews where each province inspects companies that are not headquartered in that province.

The expanded responsibilities of the chief actuary and the company general manager under the September 2016 regulations also have the intention of strengthening governance.

Other Initiatives
Beyond the changes for mainland China’s insurance industry, it is worth noting a change related to Hong Kong. Due to various factors, a major percentage of Hong Kong life and health insurance sales come from mainland Chinese visitors. China still has controls on conversion of RMB into foreign currency, and these purchases were seen as a potential loophole in those controls. There have been several stages tightening restrictions in 2016 and 2017.

On a somewhat related note, after a period when Chinese insurers aggressively looked abroad for insurance acquisitions and other investment opportunities, offshore investing recently has been discouraged through various means, but some opportunities are still being explored.

Possible Future Trends

Various further regulatory refinements are likely as China’s economy and insurance industry continue to evolve and modernize. Balancing healthy growth with strengthening the core will be a continued theme. Another balancing act is between investor interests and consumer interests, along with the competing consumer interests of low prices and strong solvency. Required cash values for life products currently provide good liquidity for consumers, but providing this liquidity has an economic cost and is one reason that Hong Kong long-term products are priced attractively; perhaps the balance of liquidity and cost will shift. CIRC is working to improve the regulation of asset-liability management. There is continued interest in encouraging the insurance industry to invest in areas supporting the general economy, especially health care and an aging population. (China has a rapidly aging population following decades of improved longevity coupled with the one-child policy, which was driven by a desire to avoid a rapidly growing population straining limited resources.) Depending on movements in the broader capital account, overseas investments may again become more fashionable for Chinese insurers.

It is likely the regulators will accelerate efforts to close loopholes and inconsistencies among different regimes. On the other hand, it is rumored that a number of large domestic insurers have lobbied for a more segmented approach that recognizes the different nature of business at large companies compared to smaller companies. Foreign insurers are hoping for some relaxation of restrictions on their activities. As e-commerce continues to grow, and with the government’s interest in using digital advances as an economic accelerator, regulators likely will need to adapt to new players and plays in insurance.

Conclusion

China remains a dynamic economy and insurance market with exciting challenges. The regulatory framework is developing based on careful review of international practices, with adaptation to China’s needs. While the percentage growth in premiums may be slowing, the pace of change for the industry likely will not be!

Hans Wagner, FSA, is the chief actuary and chief risk officer of ICBC-AXA Life in Shanghai. He is also a member of the SOA China Committee.

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The views expressed in this article are the author’s and not those of his employer or its shareholders.