Slowly but surely, China is dismantling the wall of regulation that has so far held back overseas investment in the reinsurance market. This is a time of change, however frustrating the pace may seem
Twelve years ago, the Chinese reinsurance market was worth less than RMB100bn (£9bn). Although overseas firms accounted for almost 50% of that business, Western companies’ penetration of the market was hampered by a raft of Kafkaesque regulations.
Today, eight years after China fulfilled its 20-year quest to join the World Trade Organisation (WTO), the insurance market is worth more than RMB1.1 trillion, according to Willis Re, with non-life accounting for RMB288bn. Around 20% of that is ceded as reinsurance, with 60% going to overseas reinsurers. That market share is likely to increase as China’s burdensome regulatory framework continues to be dismantled in line with the provisions of WTO membership.
Willis Re has 20 offices in China and the largest local network of any overseas broker operating in China. “The opportunities are very exciting in all arenas,” Willis’s managing director for Asia Pacific and the Middle East, Maurice Williams, says. “We’re seeing growth and lots of opportunity in both transactional and advisory terms.”
Despite the global slowdown, China remains one of the fastest-growing reinsurance markets in the world. A massive fiscal and monetary stimulus as the country embraced capitalism has also created rapid growth in domestic consumption as the credit crunch sharply reduced its export markets.
Not quite clear
Although many of its regulations have been relaxed – particularly last year’s sweeping legislative changes, which allow greater access to foreign reinsurers by removing the requirement that reinsurance cessions be offered first to domestic reinsurers – China’s regulatory environment is still not entirely transparent and remains some way short of Western standards.
The best opportunities for overseas companies are in what can best be described as the ‘usual suspects’.
“P&C [property and casualty] reinsurance accounts for 90% of all reinsurance business in China,” Swiss Re’s chief economist for Asia, Clarence Wong, says. “While the tremendous growth of the motor and enterprise property lines in the direct market has raised the volume of their respective shares in the reinsurance market in the past few years, P&C insurers have also increasingly appreciated the value of reinsurance in some casualty lines, including liability and accidents.”
Wong adds that the recent regulatory changes, including the introduction of a comprehensive Tort Liability Act, are likely to further accelerate the growth of the casualty reinsurance market.
Agriculture and product liability reinsurance are established strong growth areas and, more recently, natural catastrophe has become a factor in the market. “China saw quite a number of natural catastrophe events in 2008 and so the general concern about nat cat perils has increased substantially,” Swiss Re’s Beijing branch general manager and head of its property and casualty business in China, Qin Lu, says.
“This is not only in the property sector, but also for the agro sector, and the current drought in south-west China has once again highlighted the point. The fast growth of the economy has increased the risk accumulation in China. And with the rising insurance penetration in this market, nat cat will have an increasing impact on the reinsurance sector.”
At a snail’s pace
Despite China’s WTO membership, the issue of its regulatory framework remains a bone of contention. Although few Western companies want to be seen to openly criticise the government, its piecemeal approach to dismantling restrictions on overseas firms is trying the patience of Western governments. But market regulation is evolving, albeit slowly.
Until this year, insurance companies were forced to offer up to 50% of ceded reinsurance business to firms established within China, although the provision was frequently circumvented using knowledge of different reinsurer appetites. The new regulations, announced with much pomp last year, go some way towards creating a level playing field for locally licensed and overseas reinsurers.
Despite its limitations, this particular change means there is now much less advantage to firms like Munich Re and Swiss Re that have established local offices in China.
“It’s true that there’s no regulatory advantage now to being licensed and capitalised in China as opposed to say Hong Kong, but having a local presence in China gives you a good understanding of the local market and that’s a very good incentive to be there,” Williams says.
Last year’s changes also introduced a shift in the supervision of insurance solvency towards the risk profile of insurers, rather than the scale of operation, and brought in changes in financial reporting of insurers. The new solvency requirements may well open up a fresh market for reinsurers in helping companies meet the requirements.
“We are happy to see the regulatory scheme turning to a more risk-based approach,” Munich Re’s China non-life chief executive, Steven Chang, says. “We think it is extremely important that capital requirements correspond to the risks taken by insurance companies. We also see business opportunities for reinsurers stemming from the solvency requirements as reinsurance functions like a capital substitute and is thus a flexible tool for capital management.
“China is still a rather immature reinsurance market, but we are quite positive about what CIRC [the China Insurance Regulatory Commission] has done so far.”
Gripes in the reinsurance market are also coming from the fact that intense competition between domestic insurers and overseas companies has kept rates low across all sectors, but particularly in P&C.
“Making money is challenging because you’ve got a constant stream of new entrants coming into the market,” Williams says. “The market’s evolution is following the same cycle as seen elsewhere. You’ve got a liberalising market that erodes margins and that has led to the tightening of terms of treaties, which in turn then leads to insurers becoming more disciplined.”
Chang adds: “We are seeing a modest rate recovery in general, but it is difficult to predict the development in the specific sectors.”
The other issue that is of particular relevance to reinsurance companies, due to the nature of annual premiums, is increased speculation that China will finally accede to longstanding demands from the USA to allow the renminbi to appreciate.
“China and other Asian central banks will likely allow for greater currency appreciation,” fund manager Aberdeen Asset Management’s Singapore-based head of Asian currency, Adam McCabe, says. “The era of Asian central banks intervening to keep their currencies weak is over.”
Western reinsurers concede that the pressure is growing on China to revalue its currency, but are divided over its impact on the reinsurance market.
“It seems there is an increasing pressure for renminbi to appreciate, especially against the US dollar,” Lu says.
“Obviously, if the currency appreciation occurs, the capacity required in the Chinese market will increase for those who operate in this market. Whether this will lead to capacity strain is yet to be seen, but the currency issue should be on the agenda of foreign companies operating in China.”
While Willis Re’s Williams agrees reinsurers need to be aware of the potential impact that a sudden revaluation could have on business, he believes the likelihood of it happening without allowing time for reinsurers to prepare for it is slim.
“The government doesn’t show any sign of doing that right now and the Chinese government is not prone to doing things out of the blue. That’s what gives businesses operating in China stability,” he says.
Williams’ view is echoed by Chang. “I do not see a link there. As part of their risk management, reinsurers should be well aware of the currency risk and hedge it wherever necessary.”
Finally, while the government’s huge stimulus programme has been aimed at the country’s infrastructure requirements, spending is widely forecast to shift towards healthcare and education in the coming years, with the former offering huge potential for life reinsurers.
“The life and health reinsurance market will continue to show strong growth in the next five to 10 years,”
US giant General Re’s Shanghai branch general manager, Chua Tuan Miang, says.
“Many Chinese consumers still do not have adequate protection cover and with ever-increasing healthcare costs and an increasing disposable income, many Chinese consumers will be looking to cover their resulting financial needs.”
State-owned China Re is the country’s biggest reinsurer and dominates much of the market. Earlier this year, it posted full-year pre-tax profits of RMB5.95bn for 2009 on a turnover of RMB40.16bn, of which RMB29.9bn came from reinsurance premiums.
China’s finance ministry has a 14.5% stake in the group, with the remainder held by Central Huijin Investment, an investment company owned by the government’s sovereign wealth fund, China Investment Corporation (CIC).
“China Re is still the most important player in the Chinese market,” Munich Re’s Chang says. “We also expect its international expansion, starting in Asia, to be interesting for all other market participants.”
Until last year, China Re was run by industry watchdog, the China Insurance Regulatory Commission (CIRC), but is now being managed by CIC as it prepares China Re for its long-awaited public listing in Shanghai and Hong Kong. The long-term strategy is for China Re to expand its presence in Asia, but the group also has ambitious plans to increase its market share in the West, and opened an office in London two years ago as a potential bridgehead into the European market.
“Ultimately, China Re wants to be a global player and part of that will come through overseas investment,” Willis’s Williams says. “But right now, it’s all about preparing China Re’s balance sheet to present to IPO markets in China and elsewhere.”
Swiss Re’s Lu says China Re’s flotation is likely to bolster its dominance of the domestic market, but adds that overseas firms are unlikely to be disadvantaged.
“Despite the predominant position of China Re, foreign reinsurers have been able to take part [in the market] because of their expertise and, after a decade’s footprint in China, foreign players have now developed strong client relationships.” GR