All Eyes on China.

Before international insurers can gain entry to China's insurance market, they'll have to jump through regulatory and cultural hoops.

With China's imminent entry into the World Trade Organization, there is much speculation and anticipation as to how this country's stringently regulated insurance market will be relaxed to permit the entry of foreign insurers. At stake for both property/casualty investors and China is a potentially immense economic opportunity, and for the latter there are prospective gains in technology, work-force skills and educational programs. But few foresee this process of deregulation and foreign entry as uncomplicated. There are many obstacles and risks facing eager insurers, not only from the communist government but also from the ingrained attitudes of the Chinese public.

Sizable Investments Anticipated

To date, China has granted only 14 licenses to foreign insurers, who are restricted to selling policies in the Guangzhou and Shanghai areas. But the Chinese government has expressed interest in further opening its insurance market, especially since the preconditions to WTO membership include lifting the geographical restrictions and increasing the number of admitted insurers. Financial analysts have estimated that about $15 billion in capital will be needed to fund the market developments that are expected over the next five years, meaning that China will find it difficult to turn away foreign dollars. Additional benefits also will accrue to the Chinese government and economy--tax revenues and other operating fees that will add to the already sizable investments anticipated.

Aside from WTO membership and financial incentives, China also stands to gain from the introduction of improved, cutting-edge technology and other work skills that will accompany foreign insurers. As China positions itself to further advance as a major global economic player, it will need to bring its work force up to date on marketing, management and technological developments. The accumulated expertise and resources of foreign companies will prove a substantial asset in satisfying these needs.

In addition to bringing new jobs and creating advanced job opportunities, foreign property/casualty insurers will play a role in further educating the Chinese government and public about insurance. Several U.S. companies already have taken steps to enhance insurance knowledge. New York Life International maintains a Web site in Chinese and provides training materials specifically tailored to its Chinese representatives. The company also provides interested officials with a Chinese-English glossary of insurance terms. In addition, Liberty Mutual has held conferences in China to promote and improve the country's safety and health culture. Moreover, as the Chinese begin to accumulate personal wealth and property, interest in insurance as a protective measure is expected to grow.

The most obvious opportunity for foreign insurers is China's immense, largely untapped market. China has an extremely underserved insurance market compared with the United States (see "China vs. United States," Page 67). It is estimated that the Chinese insurance market is currently worth $8 billion, with an estimated annual growth rate of 20%. This means that a mere 1% of the market share in China would be greater than 5% of the U.S. market.

In addition to the enormous potential market, expansion into China serves at least two other purposes for foreign property/casualty insurers: the chance to extend their globalization goals and to further spread risk. For competitive reasons and because of the inherent risks of fluctuating regional economies, insurers continue to look for international partners and start-up opportunities. Specific to China, there are possibilities for a symbiotic joint venture. In addition to pursuing initial public offerings on overseas stock markets, several Chinese insurers, most prominently China Ping An Insurance Co., have expressed interest in seeking a partnership with a foreign insurer. This could be the means of access to a new market for both Chinese and foreign insurers.

Getting a Foot in the Door

All insurers who want to do business in China will need to be approved by the China Insurance Regulatory Commission. The commission recently issued a decree concerning the regulation of insurance entities, which took effect March 1. In addition to these guidelines, there are stipulated principles specifically concerning the establishment of an insurance company:

* The company must observe insurance laws, regulations and administrative rules.

* The company must be beneficial to the stability of China's insurance market and financial system.

* Insurance business and banking and securities business should be operated separately; property insurance and life insurance business should be operated separately.

* There should be reasonable distribution and fair competition.

While some of these guidelines will require further clarification--in particular, the second and fourth principles--there are some concrete requirements that the regulatory commission has established. First, all insurers must provide a minimum paid-in capital of 500 million yuan (about $60.4 million) to conduct business at the national level, or 200 million yuan ($24.2 million) to conduct business at the regional level. Further, in following with the specifications set for foreign life insurance companies, it is expected that the senior management of property/casualty insurers will have to meet qualifications stated by the regulatory commission. (There currently are no requirements regarding the number of actuaries.)

Just as important as the official rules and regulations are the connections that must be made for an insurer to improve its chances of being approved for entry. In Chinese society, having the right connections is a means of survival. In the case of foreign insurers, having an advantageous connection often amounts to "donations" being made for the training and education of Chinese personnel, the establishment of educational cooperative exchanges and the development of educational centers. This often is viewed as an opportunity for destitute government officials to skim the cream off funds from wealthy investors. Top government officials have long vowed to clean up this corrupted system, but until concrete changes are made, foreign insurers will have to play this game.

Risks and Barriers

The adage taught in basic finance--"the greater is the expected profit, the greater will be the risk"--is especially true in the case of China's insurance market. Although there is great potential for financial gain, foreign insurers must be aware of and prepared for a variety of risk factors that can combine to derail any start-up effort. Among the more significant risks are:

* Political and regulatory risks. Although the Chinese government has established the regulatory commission as the insurance industry's governing body, there is no clear indication yet of how tightly the industry will be regulated. And it remains to be seen how the authorities will oversee the expansion in number of foreign investors and the relaxation of geographical boundaries.

A related concern is the fact that China has virtually no property/casualty insurance history. This is because the Chinese historically have not been given the right to own private property. To further complicate matters, the few judicial rulings that have been passed on property/casualty issues have been erratic. All of this could lead to an extremely unpredictable liability insurance cycle, since pricing, liability estimates and other economic considerations are dependent on a fully developed tort system.

* Exchange-rate risk. Currently, foreign currencies are not allowed in China. Therefore, all business carried out in China must be in yuan. This gives rise to an exchange-rate risk, a common problem facing insurers who conduct business abroad. The yuan is even more complicated, because it is only partially convertible and not completely tied to a flexible exchange system.

* Natural catastrophes. The majority of China's more than 1 billion residents reside close to the country's two major rivers, the Yantze (Chang Jiang) and the Huang He. These rivers historically have been the cause of multiple severe floods that affected millions of people. In addition, China is prone to earthquakes, windstorms, hail, typhoons (along the southern and eastern coast, i.e., Guangzhou) and volcanic eruptions (four volcanic fields in western China and six in the eastern portion of China that borders orea).

* Cultural barriers. The Chinese highly value relationships, even if certain of these relationships may be viewed by Americans as merely contractual obligations. Because of this respect for relationships, it is uncommon that lawsuits are brought against another, whether business or personal. This behavior goes against the need for liability insurance to have an established, highly developed tort system. It remains to be seen how China's gradual relaxation of its economic and social systems will affect the perceptions and behaviors of its citizens.

Another cultural disparity is the inclination of Chinese toward saving. This is a long-held ethic in China, one that could lead to the public's view of insurance as atrophy. In a nation historically observant of superstitions, purchasing insurance may be considered as cursing oneself and asking for misfortune. But as China continues to move away from tradition and the rigors of communism and as it steps closer to capitalism, individuals have begun to accumulate property and gain some individual rights that, with time, should lead to changes in perspective. Eventually, significant ownership will generate an interest to protect property and to avoid unwarranted liabilities. How quickly this shift occurs will be partially dependent on how persuasive foreign insurers are in marketing insurance as essential and not superfluous.

China's property/casualty insurance market contains enormous potential profit, with both China and foreign insurers standing to reap the expected rewards of deregulation. Even with the country's stringent and often ambiguous laws, its lack of an established tort system and myriad cultural barriers, foreign companies continue to exhibit a great sense of eagerness to take the plunge. These interested parties have obvious reasons to look ahead, but they should also consider the present to derive lessons that could prove helpful in their attempts to enter the Chinese market. Other countries with emerging free markets--notably Russia, Brazil and Vietnam--have shown that market economies can have severe side effects, which may override any gains made. The ensuing decade will tell if China can avoid such side effects and apply the lessons of history in a manner that maximizes the potential for growth and profit.

Julia Chu is an associate actuary at Milliman & Robertson in New York.