China market report- Land of opportunity and challenge

The insurance market Munich Re has predicted that China will be the second biggest insurance market in the world, in terms of gross written premiums, by 2020. The insurance market is still developing and already has a number of insurers, although, as a report, 'Entering new insurance markets', by Clyde & Co explains, the Chinese insurance market is still largely dominated by domestic players like the People's Insurance Company of China. "While recent amendments to the Insurance Law of China (promulgated in 1995 and amended in 2002 and 2009) have encouraged more foreign insurance companies to operate in China, they currently only represent a small market share, hovering around 5% between 2008 and 2010," said the report. Indeed, for property & casualty insurance, it is just 1%.hideZurich Insurance Company recently stated: "The Chinese insurance market is a very dynamic market, presenting growth opportunity for foreign and domestic insurance companies. Because insurance is such a strategic industry, the Chinese government has opened the insurance industry to foreign investment and assistance while carefully monitoring the speed and scope of its still nascent insurance industry's growth versus society's demand for insurance services." However, the Chinese insurance market is in a state of transition. After a period of rapid expansion, the market must now adjust for sustainable and healthy growth, according to a recent report from A.M. Best Co. "Since enhancing risk management and market discipline in recent years, China's regulator has gradually rolled out plans for solvency reform, less restrictive investment rules, the opening of compulsory motor insurance to foreign players and the partial liberalisation of commercial motor rates," stated the report. "These developments are paving the way for more sophisticated underwriting practices and offsetting market issues brought on by the previous fast expansion. At the same time, regulatory requirements, business growth, competition, and enhancements to operational, underwriting and distribution systems are all driving the continuing demand to increase capital," continued A.M. Best. The report goes on to say that the challenge for foreign players will be to expand their current small market share 'despite an inadequate network of branch offices, limited distribution channels and the inability to fully utilise underwriting and pricing capability under the current regulations."' The credit rating agency concludes on this point: "Foreign insurers have only ever maintained about a 1% share of China's non-life market since entering more than 10 years ago." The insurance regulations Unlicensed insurers are prohibited from doing insurance business in China, and non-admitted insurance is only allowed for international marine and aviation risks. Direct insurance business written by unlicensed insurers is known as 'underground insurance' and is strictly prohibited in China. Anna Elshafei, a consultant in Hogan Lovells' Shanghai office, explained that certain measures and policies are in place to discourage 'underground insurance'. For example, China's foreign currency controls make it difficult for Chinese insureds to receive claims payments from overseas insurers. Foreign currency payment receipts must be supported by valid contracts that show a lawful and genuine underlying transaction. She pointed out that a policy agreement that provides for offshore coverage of risks in China would not be a lawful contract. "Without sight of a valid and lawful contract, Chinese banks are not permitted to receive foreign currency and exchange it into Renminbi for payees," she said. "We understand that, in practice, smaller claims payments may be able to pass through this filtering process but this is technically not lawful," added Ms Elshafei. Jason Beelders, Vice President, Head of Global Markets Risk Practice, Chartis Europe, added: "It is not mandatory for local claims to be paid in-country but claims payment and overseas reimbursement are paid in the same currency denominated in the local policy to comply with foreign exchange control regulations." Another discouragement that Ms Elshafei highlighted is that in 2004, the regulator, the China Insurance Regulatory Commission (CIRC), issued a rule stating that persons and entities in China who assist unlicensed insurers to market, sell or administer insurance business in China would be 'named and shamed'. According to Article 160 of the PRC Insurance Law, they may also be subject to the confiscation of any 'illegal income' and fined between and to five times the illegal income. Where there is no income or the income is less than Renminbi 50,000, the fine would be between Renminbi 50,000 and 300,000. In the most serious cases, criminal liability may be imposed. Ms Elshafei said it is lawful, although not encouraged, for insurers in China to purchase reinsurance from overseas (non-CIRC regulated) reinsurers provided certain requirements are met. "CIRC tends to take the view that Chinese parties who purchase insurance offshore are 'on their own'. That is, they cannot expect CIRC to protect their lawful interests in transactions with non-China admitted insurers," she said. Even when using admitted insurers, there are some special requirements, in addition to the currency restrictions, such as 'cash before cover.' Jason Beelders explained that the CIRC in Beijing has issued instructions to all of the provinces requiring them to adopt Cash Before Cover (CBC) rules. So far three provinces have drafted and issued rules: - Guangdong: the CBC rule came into effect August 1, 2010 and applies to all products. Premiums due from non-individual policyholders must be paid from the policyholder's bank account directly, not through intermediaries. - Shenzhen: the CBC rule came into effect Dec 1, 2010 and applies to business with individual policyholders, and business with non-individual policyholders with premium at or less than RMB100K (US$15K) - Jiangsu: The CBC Rule came into effect January 1, 2011 for all non-Auto general insurance. Global programmes Anna Elshafei said it is possible for an international insurer to include China risks in a global programme by way of a local policy issued by its licenced China subsidiary or under an arrangement with a licensed entity in China. "Offshore insurers who cover China risks by way of 'underground insurance' will likely encounter difficulties both in receiving premium payments from China and in remitting claims payments into China due to China's foreign exchange controls," she said. She added that, assuming premium payments can be remitted overseas, they should be subject to business tax at 5% plus surcharges, which should be withheld by the PRC entity. And where cover under a global programme is provided by a Chinese subsidiary, the subsidiary would be subject to business tax at 5.0% plus surcharges and enterprise income tax at 25% of profit earned. Compulsory cessions were abolished in China in 2005, but between December 2005 and July 2010, insurers in China were required to give priority to China-domiciled reinsurers when arranging reinsurance. This rule was abolished in 2010. However, said Ms Elshafei, because of pressure from the local reinsurers, including the international reinsurers that have formed China branches and subsidiaries, the CIRC has issued a rule which requires that, in the event that a PRC direct insurer cedes risks to an overseas reinsurer, even if the solvency ratio of the overseas reinsurer has met the requirements of its home country regulator, the ceding company can only recognise 90% of the book value of the corresponding reserves for the reinsurance receivable as its admitted assets. By comparison, if the same risk is ceded to a China-domiciled reinsurer, and the solvency adequacy ratio of such reinsurer is 100% or above, then the ceding company can recognise 100% of the book value of the corresponding reserves for reinsurance receivable as its admitted assets. Ms Elshafei pointed out that the practical effect of this rule is that it is more capital-efficient for insurers in China to cede to local reinsurers than to overseas reinsurers. Regulatory compliance In common with markets around the world, regulators in China are increasingly focusing on compliance. Ms Elshafei said the CIRC is definitely taking a tougher stance on compliance, especially in the fields of financial data misrepresentation, sales practices and solvency. "The CIRC is quite prepared to impose penalties on foreign-invested insurers and several foreign-invested insurers have been penalised for various reasons. In particular, the CIRC has stepped up its supervision of insurers' solvency levels," she said. "During earlier periods of rapid growth in the industry, the regulator seemed reluctant to take action against insolvent or effectively insolvent insurers for fear of slowing down the market," added Ms Elshafei. However, she explained, the financial crisis in 2008 highlighted the seriousness of the problem and the CIRC took action. In 2009, for example, it put China United, one of the largest P&C insurers, into receivership. Following this, many insurers increased their registered capital to improve their solvency rates. As to the future of regulation in China, Ms Elshafei explained that a global insurance programme is a relatively new concept in China and no current rules specifically address this type of business. "Our enquiries with the CIRC suggest that no new rules are planned at the moment. We assume that this is essentially because a global policy under which a foreign insurer directly covers risks in China would be seen as unlawful 'underground insurance'," he suggested. Nevertheless, she stressed that risk and insurance managers with operations in China need to keep up with the fast evolving insurance regulatory regime. According to CIRC's 2011 yearbook, at the end of last year there were roughly 1,100 currently effective regulations and rules in the insurance space. "The CIRC issues new regulations and rules on what sometimes seems a daily basis. Insurers in China need to constantly monitor developments of regulations coming out of CIRC and other authorities," she said. Ms Elshafei added: "Our experience suggests that the CIRC is an authority with a long memory. Overseas insurers who cover risks in China on an 'underground insurance' basis may manage to 'fly under the radar' of the CIRC to a certain extent. However, should they wish at a later stage to establish an entity in China, they may find that CIRC will exercise its discretion to deny or delay their establishment application."

China market report- Land of opportunity and challenge

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