Penetrating the mist: in China, regulators are groping for transparency as the insurance market surges.

China's insurance market has been growing at the fastest rate in the world since the country joined the World Trade Organization in 2001. Along with that market growth, China's regulatory framework is being refurbished at a quickening pace, in an effort to keep the market from either spinning out of control or being strangled by unnecessary constraints.

Recent research by Swiss Re Group found that life insurance premiums in China have grown by an annual average of 23.7% over the past 10 years, while nonlife premiums have grown 10.8%. China ranked eighth in the world for the size of its life market in 2003, and 13th for its nonlife market, according to Swiss Re.

The Economic Section of the U.S. Embassy in Beijing, in a report on the investment climate in China in 2005, said the Chinese government is taking seriously the obligations it accepted to open its markets to outside participants as a member of the WTO. "New laws, regulations and administrative measures aimed at implementing these general and sector-specific commitments are being issued at a rapid pace," the statement said.

One aspect of regulatory reform Chinese officials are eager to address is transparency. The U.S. Embassy's Economic Section noted that Chinese commercial law tends to be written in broad terms, with ensuing regulatory rules implemented to clarify how businesses are to proceed. "The Chinese government is currently reviewing and revising all laws, rules, regulations and other measures in advance for comment prior to implementation, and this obligation should encompass many regulations affecting foreign investment," the embassy said.

Over the past year or so, the China Insurance Regulatory Commission implemented a number of rules designed to allow foreign insurers greater participation in domestic markets, add transparency to insurance business practices and make it easier for domestic insurers to tap into international capital markets. The aim of all these rule changes is to accommodate the rapid expansion of the market in an orderly way, the CIRC has said.

"The most significant changes are in the licensing procedures," said Ernie Csiszar, president and chief executive officer of the Property Casualty Insurers Association of America. "Formerly, companies needed to obtain the signature of the Chinese premier to do business in the country. That bureaucracy has been significantly streamlined of late."

Clarence Wong, head of economic consulting and research in Asia in Swiss Reinsurance Co.'s Hong Kong office, said the CIRC last year allowed foreign insurers to operate anywhere in China once they are licensed, a big step from the previous licensing framework, under which foreign insurers had to apply for a license to operate in each city separately. "Following this liberalization, foreign insurance companies are now applying to expand into rural or second-tier cities," he said.

Wong added that the CIRC also opened the group, health and pension markets to foreign participation. A third rule change allows foreign-based brokers to own a 51% in joint venture, up from the previous maximum of 50%. For the first time, foreign firms can be majority owners in Chinese joint ventures.

Kevin Bogardus, senior manager, greater China, for reinsurance broker Benfield Group plc., and chief representative for Benfield's Shanghai representative office, said the CIRC has been "very busy" reshaping China's insurance and reinsurance regulations. The rules governing agents and brokers have been implemented to bring greater professionalism and transparency to the industry. "Broking firms must now have a sufficient number of qualified personnel, through examinations and training, in order for the broking company to operate," he said.

There is even a requirement that agents and brokers must have 80 hours of ethics training before assuming any responsibilities. Subsequently, there are annual refresher courses on law and ethics, which are required, he said.

Transfer of Power

The CIRC was set up in 1999 to take over regulation of insurance from the Bank of China. The main law governing insurance is the Chinese Insurance Law of 1995. Subsequent revisions to that law were made, mostly in 2001, as China prepared for its entry into the WTO in December of that year, said Paul Morgan, network country manager with Willis Group Holdings' Willis China unit.

Among the key restrictions on foreign insurance participation still in place, nonadmitted insurance is prohibited. "All domestic risks in China have to be covered by admitted carriers," said Morgan in a conference call on the China market. There are a few exceptions, such as marine cargo or product liability for some exports.

"The CIRC has not gone to great lengths to police this requirement, but restrictions on foreign currency make it difficult to write on a non-admitted basis," said Morgan.

There are two basic compulsory insurance requirements in China--third-party auto liability and "social welfare and employee injury funds." The latter are often provided by local authorities, or sometimes by commercial providers through intermediaries, said Morgan. "The commercial providers still have to follow the rates provided by local authorities," he added.

Foreign insurers also must deal with currency and foreign exchange restrictions. Currency restrictions sometimes can be waived if policies are backed by assets held in a foreign bank in China, said Morgan.

Many of the recent rule changes are designed to encourage greater foreign participation in the Chinese market. But a few are aimed at helping domestic insurers become more competitive, and with positive results. "It is interesting to note that during the second half of 2004, the CIRC has granted a series of new domestic licenses--10 life insurers, 11 nonlife insurers and five health insurers" said Swiss Re's Wong, though he added that "it is not clear whether all the licenses will materialize into new companies."

Chinese insurers got two big boosts through rule changes related to capital markets. In October, the CIRC announced it would allow insurers to issue subordinated debt. "This will add another financing source to insurers along with public listing, capital re-injection and the admission of foreign strategic partners," said Swiss Re's Wong. "The move will broaden the funding channels of domestic insurers and improve their financial strength to go along with the full opening to China's insurance sector to foreign competition."

Also in October, the CIRC, together with the China Securities Regulatory Commission, announced that domestic insurers can invest the equivalent of up to 5% of their assets directly in the stock market, where they can buy stocks, convertible bonds and other capital instruments. "Insurers can also invest up to 80% of their foreign currency holdings in the international capital market," said Wong. "These changes will, over time, help to improve the insurers' investment performance, but will also exert greater demand on their asset-liability management capabilities."

Insolvency Protection

Wong said that among the CIRC's more significant rule changes over the past year, the regulator established an insurance protection fund system to which all insurers are required to contribute a portion of their premiums. The fund is intended to compensate policyholders should their insurer become insolvent. The fund became effective this year. "This was followed by comments of CIRC officials that insolvent insurers who failed to improve their solvency margins will be closed," he said.

Last November, the CIRC issued rules designed to standardize industry data reporting. "The new rules require insurers to set up a statistics unit to ensure accuracy in data," said Wong. "This is particularly important in improving the industry's transparency."

With all the recent activity at the CIRC, much has yet to be done to bring China's insurance regulation up to global standards. "The regulators have a huge task bringing a fairly young industry in China in line with international practices," said Benfield's Bogardus. "The CIRC is addressing issues step by step and focusing on the most urgent matters first. It seems that they have a good handle on priorities."

Regarding Reinsurance

"As for reinsurance regulations, they have gone through a number of drafts over the past several years," said Bogardus. "I believe they are finally expected to be released this year," he said.

Currently, China has no laws preventing reinsurance from being written, but the CIRC does require that "reinsurance deals be justified," and is "slightly suspicious" of anyone who seeks to completely reinsure their insurance program outside of China, said Adam Garrard, managing director for Willis Asia, in a recent conference call on China's property/casualty market.

"Most international insurers are encouraged to retain between 20% and 30% of the risk on their policies," said Garrard. "It is possible to negotiate around that, but it is decided on a case-by-case basis."

One important development of note for the reinsurance market is that China Re, the state-owned monopoly insurer, will next year lose the compulsory business it had enjoyed since its creation in 1999. At that time, property/casualty insurers operating in China were required to cede 20% of their premiums to China Re. Over the past few years, mandatory cession to China Re has been reduced--it is at 5% this year and will be zero in 2006, said Garrard.

"This means that, theoretically, it should be possible to reinsure more business outside of China," said Garrard.

Well aware of its looming vulnerability to a liberalized market, China Re launched a reform strategy in 2003, under which it would become a holding company with stakes in several subsidiaries. China Re plans to branch out into primary insurance, banking and securities to offset lost reinsurance business.

Wong added that there is also a proposal to establish an earthquake insurance pool.

In its effort to improve the regulatory system, the CIRC has been an eager student of insurance regulation in other countries. The Chinese agency joined the International Association of Insurance Supervisors in 2003, and has since studied a variety of regulatory methods in many markets." It is unlikely that the CIRC is following any particular model," said Wong. "It tends to compare experiences of various markets while at the same time taking in advice from international organizations like the IAIS."

Csiszar, the former insurance commissioner for South Carolina in the United States, said the CIRC appears to be following the European regulatory model most closely.

Chinese regulators are studying regulations from all over the world, taking elements from various countries that they believe will work best for China's unique circumstances, Bogardus said.

On the legal front, arbitration appears to be the preferred course of action for settling business disputes. "China's courts, I believe, are largely based on statute law, so there is less discrepancy between different courts' interpretations," said Bogardus.

Key Points

* The China Insurance Regulatory Commission has implemented rules to allow foreign insurers greater participation in domestic markets, add transparency to insurance business practices and make it easier for domestic insurers to tap into international capital markets.

* The aim of the rule changes is to accommodate the rapid expansion of the market in an orderly way.

* Premium income in China's property/casualty market rose 139% since 1998.

Rule Changes Made by the China Insurance Regulatory COmmission in 2004

* Foreign insurers permitted to operate anywhere in China, and given access to group, health and pension markets.

* Foreign brokers permitted to own 51% of joint ventures, up from 50%.

* Domestic insurers allowed to issue subordinated debt.

* Insurers permitted to invest up to 5% of assets in securities markets, and up to 80% of foreign currency holdings in international capital markets.

* Industry financial reporting standardized.

* Mandatory-participation insurance protection fund established to cover insolvent insurers' obligations.

* New rules governing agents and brokers provide for greater financial flexibility and better disclosure of agency practices.

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RELATED ARTICLE: China P/C market emerging with a vengeance.

"It's somewhat of an epigram to say that in China, everything appears to be impossible," said Adam Garrard, managing director for Willis Asia, in a recent conference call on China's property/casualty market. "But with the right approach, everything is in fact possible."

China's insurance market has opened considerably since the 1980s, when there was essentially only one state-owned nonlife insurer--PICC--writing coverage, said Garrard. Since China joined the World Trade Organization in 2001, the government has made great strides in loosening the rules governing insurers, but there is still considerable constraint.

There are now 14 domestic property/casualty insurers in China who write 99% of the business. The top three Chinese insurers claim 85% of the market--63% going to the original PICC, said Garrard. "While the market had opened considerably since the 1990s, and there are now 26 property/casualty companies writing in China, it's not completely open, and the restrictions can stifle competition and limit innovation," he said.

The lack of competition in China prior to 2001 has had a lingering effect on the market, said Garrard. Product innovation is unfamiliar and talent is scarce among Chinese-owned insurers--problems international risk managers must face when they seek to set up shop in China.

Claims settlement is problematic in China, where local branches of an insurer often can reach agreements with insureds that are not stipulated in the insurance contract. "Agreements are being made without the insurer being sure of what the cover is that is really being provided," said Garrard.

China still lacks a sound legal system to enforce insurance contracts, said Garrard. "It is developing, but there's no such thing as precedent; opinions given yesterday can be ignored today" he said. "There's a large reliance on individual interpretation."

Garrard said there is a huge reliance on the idea of "guanxi," roughly meaning "relationship" in Chinese law. "A trust or friendship is built up among people doing business," he said. "It's a significantly different business paradigm from that of international organizations."

"In China, you don't really want to get to the point of being in a dispute," he said.

Garrard said the phenomenal growth of China's insurance market in recent years is pushing the authorities to speed up regulatory change. Premium income in the country's property/casualty market rose 139% since 1998, far outpacing any other market in the world. "Much of the growth is driven by international firms seeking coverage when entering China," he said.

He added that foreign insurers are not yet allowed to write third-party auto liability, an obvious handicap given that is by far the biggest property/casualty market.

Reinsurance has been even less competitive than primary property/casualty, with one domestic company--China Re--claiming 90% market share so far. "One of the most striking things about the China market is the level of capacity available for domestic risks," said Garrard. With more than $1 billion of capacity available, China is unique in Asian markets outside of Japan, he said.

That capacity greatly reduces the requirement for international facultative reinsurance, except in niche markets such as oil and gas. That has led to treaty reinsurance business in China being written "very cheaply" by international reinsurers such as Swiss Re and Munich Re, said Garrard.

"I've asked those companies how they could write treaty business so cheaply in China, and they said 'well, we've just got to be in China'," he said. "That situation can't go on forever--eventually you are going to have to start making money in China. But for now, those low reinsurance rates allow low rates to continue in the primary market."

In the brokerage market, there are about 80 licensed domestic insurance brokers. Most international brokers have representative offices in China, but cannot yet do business, said Garrard. Willis and Aon Corp. each have a 50% stake in a brokerage joint venture with a domestic partner and a full broking license, he said.

China P/C Insurance Market

(Premium Income ($ Billions)

                                       Growth
Country             1998       2003     98-03

China              $6.04     $14.47      139%
South Korea        11.00      17.76       61%
Japan              92.00      97.53        6%
USA               387.93     574.57       48%

Premium Per Capital ($ Billions)
                                       Growth
Country             1998       2003     98-03

China               $4.8      $11.3      135%
South Korea        264.4      371.7       40%
Japan              709.4      751.1        5%

USA              1,425.7    1,988.2       39%


Auto Third Party Liability        60%
Commercial Property               17%
Other                              8%
Cargo                              6%
Liability                          5%
Householders                       3%
Guarantee                          1%

Note: Table made from pie chart.