The Year of the Pig promises to be a prosperous one for China's insurance and reinsurance industry. As the Middle Kingdom further opens its doors, Helen Yates considers the main challenges for the market and its new entrants.

With its proud traditions and impressive but often turbulent history, China's bid for economic growth and development has not been an easy ride. The reconciliation of encouraging a thriving market economy in an otherwise communist state was a major hurdle. "They do want an open market economy," says David Laskey, managing director of Hannover Life Re (Asia) in Hong Kong. "There's more and more economic freedom, but political freedom is still a long way off. So they have a very interesting challenge ahead of them." But time and patience is beginning to pay off, and for the global insurance and reinsurance industry, with the constant pressure to tap new markets, China holds great promise.

In fact, the opportunities in rapidly developing China has got the industry into a frenzy of excitement. "Excitement would be an understatement," says Roger Wilkinson, managing director of Willis Asia. "It's going to be very exciting time for insurers and insurance investors in China for the next 20 years," echoes Laskey. According to Standard & Poor's, the industry looks set to become the world's leading insurance system by premiums within a decade. "Whether it's ten years or 15 years, I don't see how China could not be the largest insurance market in the world," Laskey adds.

China opened its doors to foreign non-life insurers in December 2003 and foreign life insurers in December 2004, as part of its accession to the World Trade Organization (WTO). And not a week, it seems, goes by without another licensing or joint venture announcement from a large global insurer, reinsurer or broker. Lloyd's, Munich Re, Swiss Re, Hannover Re, General Cologne Re, SCOR, Zurich Financial Services, ACE and brokers Willis, Marsh, Aon and Benfield are just some of the big names bidding for a slice of the action. On the broking side, Willis and Aon are the only two international insurance brokers with a 50% share holding and a full insurance broking license in China.

In March, Lloyd's announced it had received the formal license document from the Chinese regulator - the China Insurance Regulatory Commission (CIRC) - to begin operations for its new reinsurance company in Shanghai, Lloyd's Reinsurance Company China. The new company was promptly issued an "A" rating by AM Best. "Lloyd's reinsurance operation in China will enable us to expand our global footprint and support one of the fastest growing economies in the world," enthused Lloyd's chairman Lord Levene. And it's not just one-way traffic. China Reinsurance and a number of local insurers are increasingly investing outside of China into insurance markets in Europe, the US and Asia.

China: then and now

"You would have thought it would have taken a long time to transition from the old centrally-planned economy, old communist party system, into a market economy but it's happened very quickly, and almost without a hitch," says Laskey. While China is fast becoming an economic success story, its insurance industry is still at a stage of relative immaturity according to Benfield. But its prospects look good. The CIRC expects premium growth in the five years to 2010 to be in the range of 15-17% (figures supported by S&P), allowing total premiums to roughly double in that time. Premiums have been increasing at a rate of 25% per annum since 2001, reaching $61bn in 2005 (see figure 1).

Historically, insurance was the sole domain of state-owned and run insurance companies, with reinsurance dominated by the state's reinsurer China Re (which still holds a 90% share of the market). While this monopoly continues (according to S&P the country's top 20 insurance companies collectively account for 94.5% of life premium and 97.2% of non-life premiums), foreign companies are now witnessing faster growth over their local counterparts, according to a recent report in Chinese newspaper, the People's Daily.

The growing influence of foreign insurers and reinsurers is causing fierce competition. That, and the recent spate of public offerings (IPOs) by some of China's state-run insurers, have set the scene for a more buoyant and transparent market. "We see several implications in the IPOs of the major life and non-life players," says Phil Smith, chief financial officer of Zurich Greater China. "These have had the impact of modernising these companies very quickly, have opened them up to a lot more scrutiny and have given them access to a lot more capital."

In addition, the country's population is becoming wealthier, although huge disparities between the urban and rural parts of China persist (between 2001 and 2005, GDP in China grew at 10% a year, making it one of the fastest growing economies according to the Asian Development Bank). "The growing prosperity of the country and the growing GDP per capita in the large eastern cities (particularly Beijing and Shanghai) point in the direction of ever-expanding insurance penetration," predicts Laskey.

Reform and regulation

Economic development and a series of important reforms are the key drivers for this growth. "The regulators have been quite keen on opening up," explains Wilkinson. "The WTO is allowing foreign insurers to come in, and the IPOs will help the local insurers. They will have to underwrite in a more transparent manner and they will eventually get ratings (because none of the state-owned companies have ratings at the moment). So all this will help the insurance industry in China evolve."

The expanded market access for foreign insurers and the removal of geographic restrictions that followed China's implementation of WTO commitments was but a first step. Recent reforms by the CIRC are intended to improve transparency in the market. In 2005, CIRC released regulations on reinsurance and provided a clarification of the provision of group insurance. The State Council also released a directive to guide the continued reform efforts of the insurance regulators.

Significantly, the directive recognises the important role of insurance in stimulating domestic consumption, lowering savings rates and accelerating investment. It noted the role of foreign insurers, particularly as a source of innovation and high standards. In fact, the directive urged local insurers to adopt international norms. Clarence Wong, head of economic research & consulting, Asia, for Swiss Re, sees the influence of foreign re/insurers in the market as a significant factor in China's development. "Foreign companies are bringing in new products and encouraging the development of new distribution channels," he explains. "At the same time, foreign competition is a strong catalyst for domestic companies to improve their efficiency and become more customer-focused."

But issues in governance and transparency remain, despite recent reforms. "There are lots of things going on that might not be tolerated under Sarbanes Oxley," says Laskey. "We have done some transactions, with the knowledge and support of the regulator, which might not have been allowed in other jurisdictions." There are also inconsistencies in how companies are regulated, he explains. And in some ways state influence continues to be a barrier to corporate governance, particularly for those insurers with a wide network of regional branches. "Operations at a provincial level within China are more beholden to the local party secretary than they are to their own chairman," reveals Laskey. "How do you change the structure of these huge nationwide companies so that management will respect the chain of command as oppose to adhering to old provincial loyalties?"

Pricing pressure

There are also fears that in an increasingly competitive marketplace, many insurers are opting for market share above underwriting discipline. "There is intense price competition in virtually all classes," says Maurice Williams, managing director of the AMETA team at Willis Re. "Many attribute this to the ongoing arrival of new insurers and reinsurers seeking to establish at least a cost-covering level of market share." But Wilkinson says the situation is improving. "Market share is still important for the Chinese insurance companies but profitability is now becoming important as well," he insists.

Another concern is that many local players are not adequately capitalised. "Weak capitalisation and possible under-reserving amid strong premium growth may trigger some corporate failures, despite improvements across the wider industry," warns S&P. "That is a possibility," concedes Wilkinson. "There's no getting away from it ... I hope that the market doesn't evolve through a corporate failure but you can never discount it." According to Laskey, it is clear which companies are most vulnerable: "You could argue that there are some companies today in China that are still zombies - walking dead." Wong says local insurers must secure capital in order to support their business expansion "otherwise they will fall behind in growth relative to foreign players".

In this regard, IPOs are considered a very positive move. PICC and China Life listed on Hong Kong and New York stock exchanges in 2003. China's second largest life insurer Ping An went public earlier this year, and China Re is planning a dual IPO in Hong Kong and Shanghai, where it aims to raise as much as $2.6bn, according to reports. And more Chinese insurers, such as China Pacific, Huatai Insurance Company, Taikang Life Insurance Company and Tian An Insurance Company are looking for stock exchange listings to bring in new capital and foreign expertise. "Chinese insurers are realising they need to strengthen their capital in order to bolster their solvency level to international standards, as well as to sustain their business expansion," explains Wong. "IPOs also support the introduction of better corporate governance and higher transparency."

New reinsurance rivals

Having enjoyed such a monopoly for so long, China Re must now contend with having others on its patch. According to Williams, these new competitors may have a short-term advantage in terms of expertise. But Laskey suggests the reinsurer might wield its political connections in a bid to maintain its stronghold. "Even though the compulsory cession has disappeared (in 2006], there's still a lot of political pressure - so in China they have a real advantage in terms of dealing with the government and also they can go to cedants and say, 'Look at our connections - doesn't it make sense for you to deal with us?'"

But for Williams, the reinsurer is becoming more sophisticated. Its recent announcement that it has contracted to use technology platform eReinsure suggests it is keen to tap foreign expertise. "China Re has actually grown its market share in 2007, despite the disappearance of compulsory cessions and the arrival of new local competitors," explains Williams. "'Guanxi', and a deep understanding of the dynamics of their market, make them a difficult competitor for the foreign entrants."

Guanxi, which means "relationship", remains as important in China as it is in other insurance markets. It is a natural advantage for local companies, and something that will prove a challenge to foreign insurers and reinsurers. "In my view it's one of the most important facets of doing business in China," says Wilkinson. New entrants, believes Laskey, will be best served by taking on local talent. "It's relatively difficult to do business in a country if you don't speak the language ... The right approach is that the people should be Chinese."

Although herein lies another issue. "There's no shortage of talented people but there's a real shortage of talented people with experience," says Laskey. Realising the importance of investing in this area, Willis, Zurich and Swiss Re have all begun graduate trainee programmes in Mainland China and Hong Kong. "For the insurance broker the war for talent will increase," predicts Wilkinson. "There's a lot of very energetic and very bright people in China - but very few with insurance broking experience."

For reinsurers entering China, it will also be important to educate cedants on the importance of reinsurance. "Some buyers still view reinsurance as a cost to avoid, and lack an understanding of the role of reinsurance in overall enterprise risk and capital management," says Wong.

For foreign insurers, tapping new business flows could provide an advantage. "They are trying to develop in areas where perhaps the traditional state-owned insurers don't play as much," explains Wilkinson. The expansion of car ownership and higher car values has led to motor insurance being the dominant business line. But both Wong and Wilkinson predict liability business will become a new growth area as a function of tighter product liability requirements and more domestic litigations. Other lines tipped for growth include business interruption, agriculture insurance and commercial health insurance.

The outlook from market commentators remains overwhelmingly upbeat. China has proved it is a country equipped to adapt. "Chinese people are very smart and catch on to what's required in the international world very quickly," says Wilkinson. And while the challenges and potential risks cannot be dismissed, China, it seems, is now the place to be. "We believe that (foreign insurers) will gain market share, as they have been doing over the past few years," says Zurich's Phil Smith. "Building awareness, building talent, building distribution and ultimately persuading the customers that there is more to an insurance product than price. This will be the key to gaining new customers."

- Helen Yates is editor of Global Reinsurance.