Friday, March 23, 2018

Tough times for reinsurers in China

The transformation of China’s insurance market is creating a tough environment for onshore reinsurers, as tighter regulations and the introduction of the country’s new solvency regime puts pressure on both the top and bottom lines.

Insurance ratings specialist AM Best says reinsurers also need to be wary of potential competition from Hong Kong, where regulators are working on equivalency with the China Risk-Oriented Solvency System (C-Ross), which could allow rivals based in the city to be treated as onshore reinsurers in China — although any such competition is still several years away.

C-Ross has also led to falling reinsurer premium income in 2015 and 2016, even as direct premiums have more than doubled. The cause of this is an unusually low risk charge under C-Ross for motor premiums, which comprise more than 70% of the non-life market, leading direct insurers to retain more of this risk. Under the new regime, the motor base premium risk charge was set between 8.43% and 9.3%, while the property risk charge was set between 29.1% and 40.2%.

Even without the added competition from Hong Kong, the number of onshore players is set to rise after the government said in November that it would allow overseas firms to take majority stakes in insurers.

“It is anticipated that the CIRC [China Insurance Regulatory Commission] will approve the entry of more new subsidiaries of international reinsurers into the market in the short to medium term,” said AM Best in a recent report on the Chinese reinsurance sector.

That would represent a significant shift. There are currently just 10 non-life reinsurers in China, including the branches of international reinsurers such as Swiss Re, Munich Re and Scor, in a market that is dominated by China P&C Re, a subsidiary of China Re. While around 20 companies have tried to enter the reinsurance market recently, only three have won approval from CIRC — PICC Re, Qianhai Re and Hong Kong’s Taiping Re (which was allowed to convert its branch to a subsidiary).

A more open insurance sector will likely see an inflow of capital from the international players as they compete to establish market position, as well as continued development of the domestic players. The result could be a crowded market.

In this more open environment, international insurers and large domestic players could stand to benefit from an increasingly tough approach by the regulator, which is keen to weed out weak and unscrupulous companies. For example, CIRC published guidance in December aimed at combatting misleading and deceptive conduct in the sector, and during the period from November to December 2017 it issued administrative orders to six domestic insurers and one foreign-invested insurer.

As in most areas of finance, China’s insurance industry is being forced to invest more in risk management and compliance, and this will favour those companies that already have experience of such systems and procedures in other jurisdictions.

“Reinsurers with strong capabilities to interpret regulatory intentions, and are flexible enough to customise their reinsurance solutions accordingly have a higher chance of success,” as AM Best puts it.

However, the shrinking onshore premium pie could see margins squeezed amid an over-abundance of reinsurance capacity and growing retention by the direct industry.

“In addition, the oligopolistic structure of the direct market gives large cedants more bargaining power not only on pricing, but also on terms and conditions,” says AM Best. “This squeezes profit margins even further, especially on the proportional treaties, making them thinner and thinner.”

But it is not all bad news. As with every industry in China these days, much hope is placed on the government’s Belt-and-Road scheme to drive new business. Swiss Re estimates the construction phase of the infrastructure build-out could generate US$14 billion of premiums.

It remains to be seen how accurate that will be, but it could be a boon for an industry in need of new sources of business. Captives are another area of potential growth, according to AM Best, given the lower risk charges for captives to cede onshore. However, talent also remains a limiting factor that weighs on the industry’s ability to grow.

If underwriting margins remain tight, the focus will instead be on investment returns, which means taking on greater risk. Whatever happens in 2018 and beyond, China’s onshore reinsurance industry is facing a difficult environment.


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