Open for business: ever so slowly, China's market takes shape as regulatory rules solidify.

China, that huge potential market waiting to be tapped by the world's insurers, presents a fast-changing challenge to the legal experts of the insurance business. Since its accession to the World Trade Organization toward the end of 2001, the People's Republic has been a favorite destination for insurance businesses seeking new overseas outlets. The government in Beijing has been eager to oblige, clearing some of its more arcane regulatory hurdles and inviting foreign participants to take a piece of the action.

While the market is opening at a breathtaking pace, lingering doubts about the ability of China's legal and regulatory environment to keep pace remain for foreign participants.

"The China Insurance Regulatory Commission has taken positive steps in both meeting China's obligations under WTO, and reducing the burdens of administrative bureaucracy that have unreasonably straddled the industry players," said James M. Zimmerman, chief representative and partner in the Beijing office of international law firm Squire Sanders & Dempsey LLP. "These are positive moves to simplify the CIRC's once-complicated regulatory system," said Zimmerman. "The market is freer, and insurance premium rates and policy clauses do not have to be fixed by regulators."

Setting Their Own Pace

Although the government has been diligent in sticking to its WTO commitments to open its markets, foreign insurance participants have been frustrated that Beijing has not been willing to accelerate the market's liberalization, according to Huhnsik Chung, a partner in the insurance and reinsurance department of the law firm Edwards & Angell LLE "This strict adherence to the WTO commitments has to some extent been frustrating for foreign participants who had hoped for a more accelerated and fluid opening," he said.

"Foreign insurers have criticized China's practice of delaying announcements of market-opening policies until the last minute, rather than providing lead-time announcements," said Chung. "There has been a perception that China is stalling and unwilling to open up the market. To the CIRC's credit, it had been amending the regulatory environment to meet the WTO commitments."

The CIRC took over from the People's Bank of China--the country's central bank--the role of regulating the insurance industry in 1998. Since then, and especially since WTO accession, the commission bad moved to lessen its micro-management and bureaucratic control of insurance operations, putting more emphasis on solvency based on benchmarks, said Zimmerman. To that end, the CIRC abolished 58 administrative requirements, including the need for examination and approval of an insurer's qualifications for investment in securities investment funds, and an "investment proportion" designation for insurance company investment in securities funds.

But Zimmerman adds that work is needed to clarify the insurance regulatory system. There is a need for more detailed regulations on penalties, insurance clauses and rates, for example.

Recent developments include revised rules issued by the CIRC in 2002 and 2003, designed to "better meet the needs of the growing insurance industry," said Chung. Of most significance was the adoption of the People's Republic of China Insurance Law late in 2002, which followed a reinsurance provision adopted earlier that year, he said. The CIRC also released solvency rules early last year, which replaced a set of rules dating from 2001. Other draft regulations were released for comment in 2003.

Foreign insurers appear to have difficulty dealing with China's cautious approach to regulation, said Chung. That approach emphasizes a company's size and how long it has been in business, more than actual performance. A foreign insurer must have at least a 30-year history, must have had a representative office in China for at least two years, and must have total assets of at least $5 billion to get a license. Smaller and younger insurers need not apply.

Expensive Investment

Another problem for foreign insurers is high capital requirements, said Chung. Under draft revised insurance regulations, which seek to equalize national and regional insurers, and Chinese and foreign insurers in terms of capitalization requirements, the minimum capital required for establishing a foreign-funded insurer would be $24 million, of which 20% must be placed in a guarantee fund maintained by a Chinese bank. Another $2.4 million is required for each new branch established by a foreign insurer.

The licensing process, which takes about two years, also is seen by many foreigners as unduly burdensome, said Chung. The CIRC must rule on a preliminary application within six months. If it is approved, an official application is issued to the company. The applicant has one year and three months to complete that stage, after which registration would take place, if approved.

In another area--investments--regulations are prohibitive, but change may be coming. "Regulations which limit the investment holding of insurers have been problematic for foreign insurers, as the funds had to be held in bank deposits, approved bonds and securities funds," said Chung. "Draft revised insurance company regulations, which have yet to be adopted, would allow investment outside the territory of China. Precisely what the insurers will be allowed to invest in remains to be seen."

Those draft regulation revisions also promise more freedom in drafting terms and conditions, and setting rates, said Chung.

Checking It Out

Optimism about the regulatory aspect of China's insurance market can be taken from signs the government is willing to look beyond its border for models, said Zimmerman. Chinese authorities are apparently aware that they need to learn more about how the industry works in other venues. "Various government agencies and the Supreme People's Court have sought out the assistance of the foreign legal and business communities," he said.

Over the past two months, the legal committee of the American Chamber of Commerce--which Zimmerman chairs--has prepared "detailed commentaries" on a number of draft laws and regulations for China, he said. "The government has asked for our comments and we have given them to them; they have taken our suggestions into consideration. The CIRC has done the same. This is an extraordinary opportunity for foreign investors to participate in the law-drafting process."

Julian James, director of worldwide markets for Lloyd's of London, also sees China's insurance regulators are looking at practices in other countries, in an effort to see what works and what might work in China. "They have been to London on a number of occasions, to see how the Lloyd's market is supervised," he said. Delegations from other regulatory bodies, including the National Association of Insurance Commissioners in the United States, have visited the CIRC in China as well, in an effort to map out exchanges of information, he said.

More significantly, he said, is that the CIRC has joined the International Association of Insurance Supervisors. "They are participating fully in discussions and meetings of regulators from around the world," said James. "I think that's very significant in that laws and regulations might develop at the same speed and same level as other regulators develop laws in their own markets."

Legal Issues

Beyond the complex regulatory issues, which appear to be getting sorted out, albeit slowly, an even bigger question mark for foreigners is China's legal system. "There is very little precedent to rely on, and the laws are evolving," said Chung. "It can be thought of as the Wild West of the legal and regulatory frontier."

Zimmerman said the government "has done a good job" of making available written laws and regulations. With that caveat, he sees two main problems. "The laws and regulations are purposely vague and general, which allows the regulatory authorities as much wiggle room as possible to implement the law in a matter that it sees fit," he said.

Secondly, regulations are prepared by the same agencies--most notably the CIRC--that are required to implement them. "Since the basic laws are general and vague, and because they wrote the implementing regulations, the regulatory agencies have wide discretion to decide how, when and where the law will be applied," said Zimmerman. "To counter the capriciousness of the system, the government has adopted various laws to allow parties to appeal the decisions of the administrative agencies."

The problem with having the same agency make law and enforce it is that the law and its practice "may be two different things," he said.

The courts need better training on insurance law and coverage issues, said Zimmerman. "In common-law countries, the courts play an important role in developing and refining insurance law issues," he said. "While the Supreme People's Court has been aggressively taking steps to improve the quality of judges and case-management standards, the court system does not allow for the use of court precedent that would provide a valuable resource for judges in the application and interpretation of the law."

One interesting effect of a clarifying regulatory and legal picture is the prospect that opportunities may begin to close, said Zimmerman. "The window of opportunity as a pioneer is soon closing," he said. "The opportunities to link up with the better joint-venture partners in China are closing."

But as some market-access opportunities dry up, others are going to flourish. Niche markets will open, as will opportunities for nonlife companies to set up shop on their own, without having to find a joint-venture partner. The eventual removal of geographic restrictions also will open new areas for business.

Lloyd's, which has been writing foreign-currency business in China for many years, last July filed an application with the CIRC for an onshore reinsurance license. Like most of the other top reinsurers in the world, Lloyd's finally got the regulatory opening in 2003 to get into the onshore market, where it can do business in the Chinese currency, the yuan. "We've been insuring some of the more difficult risks that have been effectively exported from that market--aviation risks, oil and gas risks-for quite a while; so it's not a strange market to us," said James.

"The regulatory environment is changing, and we are now in dialogue with the Chinese regulatory authorities to try to secure an onshore reinsurance license to write business in China," he said. "The discussions are going very well. If successful, that would allow us to write local-currency reinsurance business. Throughout those discussions, I think Chinese regulators have recognized the value of an entity like Lloyd's supporting the development of their market as they move away from what has been a monopolistic market to one that is like most of the others that we've seen around the world."

Among the regulatory issues China's officials are now studying is that of accounting methods, said James. Chinese officials are watching the development of an international accounting standard, set to be adopted by most European Union countries next year. Whether Beijing, too, goes with IAS is undetermined, he said.

Lloyd's was granted permission to open a representative office in Beijing in 1999, a presence that has allowed Lloyd's to become "closely versed" in regulatory and market developments in China, said James. Echoing the view of other foreign market participants that patience is a virtue when seeking a piece of China's insurance market, he declined to estimate when Lloyd's might obtain its license. "We haven't set ourselves any internal or external goals," he said. "We see the development of the Chinese market as long-term.

"Compared with other markets around the world, we take a long-term view in China," said James. "In terms of market position, we have few, if any, short-term expectations. We recognize that, if the market's going to develop over the next 25 years or so, we want to be part of that process."

The unfolding nature of the Chinese regulatory environment is evident by the pattern of foreign license applications since the country's WTO accession in 2001. In 2002, major life insurers--some, like Lloyd's, with a long-term presence in the country through so-called "representative offices"--sought to set up joint ventures. Last year, it was the turn of the reinsurers and brokers, who got the green light to begin the licensing process.

Since China joined the WTO toward the end of 2001, there have been significant developments on the regulatory front, said James. "They have committed to opening the market to non-Chinese participants as part of the WTO process," he said.

In nonlife insurance, the primary market is more fully developed than the reinsurance market, as the latter is only beginning to look beyond monopolistic practices, said James. "Lloyd's had determined that we could better serve China's market on the reinsurance side, where the pace of development has been slower, since we could add significantly to capacity," he said.

Life insurance is the most-developed market, from a regulatory standpoint, said Chung. "For life insurers, China is expected to implement all commitments regarding business scope by the end of this year, which includes opening up group insurance and annuities markets," he said. "All geographical restrictions are also scheduled to be removed before the end of this year, which will allow foreign insurers to do business in any Chinese city."

But the CIRC still needs to revise regulations to allow an insurer with a branch in a city to operate in that city's entire province, he added.

Hong Kong: Is It a Gateway to China?

A unique aspect to China's unfolding insurance market is the presence of a fully formed and dynamic market right next door, in Hong Kong. The former British colony, which was turned over to the People's Republic in 1997, has traditionally been a center of financial activity for the Asia-Pacific region. Does it now serve as a gateway to the mainland?

Last year, Hong Kong and Chinese officials signed a free-trade agreement, known as the Closer Economic Partnership Arrangement--CEPA--designed to strengthen trade and investment cooperation between the two. CEPA went into effect at the beginning of this year.

According to Hong Kong's Trade and Industry Department, CEPA will allow insurance practitioners based in Hong Kong to more easily do business on the mainland. Hong Kong had already been an open market for insurers from the mainland, according to a TID statement on CEPA. The trade agreement will allow better access going the other way.

The department said Hong Kong's Office of the Commissioner of Insurance and the China Insurance Regulatory Commission are holding discussions on the details of CEPA's implementation related to insurance. Those discussions are expected to be completed by October.

Richard Yuen, Hong Kong's commissioner of insurance, said in his annual letter on the state of the industry in December 2003 that the mainland market "has been playing a key role" in Hong Kong's economic development. "The signing of CEPA enables Hong Kong service suppliers to gain access to this fledgling market," he said. "This arrangement will expand our business horizons beyond the physical boundary, and further provides a launching pad for insurance practitioners here to benefit from our hinterland's rapid economic growth."

Hong Kong, like the mainland, is also reaching out to overseas regulators to tie the local market more closely to the global market. Yuen said his office signed a memorandum of understanding in 2003 with the United Kingdom's Financial Services Authority on mutual assistance and exchanges of information, for example.

Foreign insurers are both enthusiastic and cautious about the growing ties between Hong Kong and the mainland in terms of insurance regulation. In March, Hong Kong-based HSBC Insurance Asia Pacific Holdings, an affiliate with the United Kingdom's HSBC Holdings plc, said it is planning a joint venture with another Hong Kong company, Hang Seng Insurance Ltd., to tap the mainland's insurance market. The critical factor in that agreement, said HSBC, was CEPA.

"Hong Kong regulators have information-sharing arrangements with the CIRC, but there are huge differences between the mainland and Hong Kong," said Julian James, director of worldwide markets for Lloyd's of London. "They are cooperating, but they are working on the premise of one country, two systems."

James M. Zimmerman, chief representative and partner in the Beijing office of international law firm Squire Sanders & Dempsey LLP, agreed, adding that Hong Kong's legal system is based on the English common law system, while on the mainland, a civil law system dominates. "The court systems are very different," he said. "When it comes down to regulatory issues, I'm sure that insurance regulators in both Hong Kong and on the mainland have a single objective in mind, and that is to supervise and support the industry to operate in a healthy manner."

Growing Opportunities

Despite an onerous regulatory environment, insurers are investing in China because of its great potential.

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How to Get to China

* Get to know the China Insurance Regulatory Commission, its regulations, personnel and policy objectives;

* Understand the country's market commitments under WTO, and monitor compliance;

* Get to know the domestic and foreign players, their strengths, weaknesses and needs;

* Constantly monitor industry developments, consumer trends and product trends;

* Look for and develop a niche; and

* Don't wait, but at the same time, be flexible and patient.

Source: James M. Zimmerman, Beijing office of Squire Sanders & Dempsey LLP