The Sino-European accord reached earlier this year on China's membership in the World Trade Organisation, followed by Premier Zhu Rongji's successful visit to Europe at the end of June, seemed finally to have paved the way towards a truly comprehensive economic opening of the world's largest potential market.

However, many observers believe that the decision to enter WTO is not entirely unchallenged in China. The initial years of WTO membership will coincide with the most crucial period in China's 20 year history of domestic reforms. Although there will be many immediate advantages for China's export-oriented manufacturing, WTO membership will expose less-developed industries and domestic financial markets to increased external pressures for five to ten years. This period is exactly equal to the time set by China's government for reengineering corporate governance, social services, the legal framework, and regional development, all of which require a certain level of protection from international fluctuations. In addition, non-economic factors, such as the sensitive issues of Taiwan's future and curtailing the dense jungle of official corruption, may still interfere with a smooth opening process.

On the other hand, China's economic dynamics no longer permit undulating course-corrections. The reality is that China's most advanced regions, along the east coast, have already caught up with industrialised countries in terms of technological perfection, quality standards, and product ranges. Given the increasing gap between industrial capacity in coastal cities and subsiding domestic consumer demand in recent years, the most natural step for China's future-oriented industries is an intensified co-operation with Europe, Japan, and America – even to the extent of Chinese direct investments and stock exchange listings abroad. The declared goal of modernising technology and management at state-owned corporations cannot be achieved in a predominantly domestic context.

Previously underdeveloped financial services, which range from banking and insurance to auditing and accounting, will have to emerge on a broader scale based on a solid legal foundation. Likewise, the dismantling of enterprise-based social services creates an unprecedented demand for commercial housing, education, private banking, and insurance. Disappearing governmental guarantees will require state industries to introduce prudent financial risk management, as provided by insurers with sufficient in-house know-how to provide both technological and commercial support.

Many small and medium sized township enterprises have grown into highly successful private companies that now enjoy constitutional recognition, and have subsequently been granted easier access to external financial sources. It is this domestic trend that encourages foreign investors, including financial services, to enlarge their China commitment. WTO membership will certainly reinforce this encouragement. Even though patience may yet be required, China's doors will definitely open.

The Insurance Market

Issues and prospects China's insurance industry are still quite immature, and it cannot be surprising that major opposition to early WTO membership came from China's insurance industry. Commercial insurance business was re-established only in 1978, followed by a gradual dismantling of the former state monopoly from 1988 to 1998, culminating in the establishment of a specialised supervisory authority, the China Insurance Regulatory Commission (CIRC), in November 1998. Gross written premium reached approximately $16.8 billion in 1999, of which 37.4% was property and casualty business, and 62.5% life and health. Official forecasts predict market volume of some $30 billion by 2005, assuming the number of licensed companies doubles. Today state-owned insurers of the former PICC Group continue to dominate, with 84.6% of p/c business and 69.3% of life and health. The joint-stock companies China Pacific and Ping'an have the bulk of the remainder, whereas foreign competitors account for less than 1% of the market.

Domestic insurers' fast quantitative growth has left them with a number of issues that will take time - as well as appropriate foreign assistance - to solve.

Insurance legislation, which evolved on a “decide-as-you-go” basis during the early stages of market liberalisation, no longer provides an adequate regulatory framework for the increasingly complex requirements of safeguarding solvency, market-oriented product design, company management, and consumer protection.

Insurance brokers, particularly important in an emerging market with a traditional lack of insurance awareness, have only just been admitted (there are three domestic brokers), and are still shaping their services, as yet without foreign involvement.

Traditional product design, especially in life insurance, conflicts with economic reality. Long-term life was contracted during the second half of the 1990s at a guaranteed interest rate of 9%, but within three years the People's Bank of China lowered rates seven times to their current level of below 3%. Since insurers must invest predominantly in bank deposits (options including bonds and equities were introduced only in 1999), many domestic insurers face severe liquidity problems in the years ahead.

Some non-life products, which abroad have long been recognised as essential to protect financial risks of manufacturing companies, are not yet available. For example, only one percent of all Chinese exports are actually covered by governmental credit guarantees, and commercial export credit insurance has not yet been admitted. Likewise, public liability insurance is not available to private consumers in a society that increasingly departs from the traditional non-monetary values of social solidarity.

Capital investment is strictly confined to the territory of the P.R. China, and at present limited to bank deposits, government and corporate bonds, and shares of specified companies. This regulation reflects both the limitations of an immature financial capital market and an anxiousness to retain insurance funds within the country. In the long term, a solution can only be achieved through full convertability of the national currency, the Renminbi, and the availability of capital market products based on significant progress in the reform of state-owned companies. This will take some time.

Qualified management professionals, both in insurance companies and governmental administration, are scarce. This particularly applies to actuaries, product design and marketing specialists, and investment portfolio managers. Although the number of insurance professionals trained abroad is rising, and some Chinese universities have taken steps to introduce financial services training based on international standards, it will take years to satisfy the growing human resources demand.

In the past few years pricing and rate decisions were often focused on market-share considerations. The price war aggravated the danger of financial default for some of the smaller domestic competitors, and in 1999 led the CIRC to embark upon a “rectification campaign”. The campaign, coincidentally, also involved some unlicensed foreign companies, which indirectly facilitated the pricing trend by organising fronting arrangements with Chinese insurers, thus circumventing official licensing provisions.

The branch network of China's larger insurers has yet to be brought under the full control of the respective corporate headquarters, in terms of reinsurance reporting and underwriting practices.

The CIRC has recognised all these problems, and lost no time introducing supplementary legal provisions, including solvency regulations, and producing an ambitious, five-year development plan for the domestic industry. The latter envisages continued quantitative growth and improvements in the range of products. It includes the introduction of a reinsurance pool and the establishment of specialised companies for commercial credit insurance, agricultural insurance, and cover against natural catastrophes. With an eye to China's entry into the WTO, the plan virtually prescribes a five-year window for the domestic industry to establish a level of competence that permits enlarged competition in a liberalised market.

Foreign Insurers

At the end of the 1980s Chinese academic research reflected the view that opening the country to the outside world should exclude financial services in general, and insurance in particular. Nevertheless, the State Council in 1992 approved the experimental opening of Shanghai city, and admitted American International Group (AIG) for life and non-life business. Between 1994 and 1998 another seven foreign companies obtained operating licenses, and yet another seven obtained governmental approval to prepare their market entry. However, the increase in the number of foreign market participants did not lead to an end of the “experimental stage” of market opening. In fact, foreign competitors are facing a series of limitations that puts them in a significantly disadvantageous position.

Applications for market entry will be approved only for companies that have an uninterrupted corporate history of more than 30 years, assets in excess of $5 billion, and a market presence in China through a representative office for more than two years. Offshore insurance contracts are not permitted.

License applications were generally approved on the basis of predominantly political considerations by the Chinese government, in view of foreign trade and strategic interests.

Their regional scope of business is limited to the cities Shanghai and Guangzhou. Master policies covering several risks of one client in various locations outside the licensed location are not permitted.

Foreign life insurers can operate only in a joint venture with a Chinese insurance company, whereby the ceiling of foreign shareholding is 50%, although non-life insurers may operate branches of their foreign parent company.

In terms of marketable products, foreign life insurers are confined to business with private residents (domestic and foreign) in their licensed region. Group life and health insurance are not yet accessible; foreign non-life insurers, in turn, may only insure foreign-invested corporations in their licensed region

Foreign insurance brokers are completely barred from direct business.

Following China's WTO membership many of these limitations will be lifted. The accord reached between China and the US included a gradual opening of many more industrially developed regions over five years until a final out-phasing of all geographical restrictions is achieved. The Sino-European agreement underlined this approach, and achieved a shortening of the timetable. Foreign life insurers will be permitted to offer group life and health insurance within a specified time, thus enabling foreign insurers to introduce corporate pension funds for both foreign invested and domestic companies. In non-life business foreign insurers may also conclude contracts with Chinese companies and – probably one of the most significant steps ahead – may introduce nationwide master covers for individual corporate clients whose Chinese head office is in the originally-licensed region of the foreign insurer. Former non-commercial admission criteria will be exchanged for standard prudential criteria with (theoretically) no limitation of the number of foreign insurers eventually licensed in China.

Apparently, the Chinese government remains quite anxious to retain full control over the sensitive field of life and health insurance. Neither the US nor the EC managed to abolish completely the obligation for foreign life insurers to team up with a Chinese partner. Although the foreign partner may, in practice, obtain management control of the company if the Chinese partner agrees, and the selected partner no longer has to be a Chinese insurance company, the obligation to find a Chinese partner will remain.

Given the complex developmental problems of domestic companies, Beijing cannot open the market overnight. It will be essential for foreign insurers to contribute to market stability and, to some extent, to the competitiveness of China's domestic insurers through pre-investing in know-how transfer and good-will activities derived from current issues facing China's economy at large. Eventually, China's insurance market will be liberalised, but so far it requires some effort for foreign investors to convince their Chinese counterparts that this process will be of mutual benefit.

Hans-Joerg Probst, Chief Representative of Allianz Group in Beijing from January 1998 to June 2000, is now Authorised Representative of the Board of Management of Allianz Group in Berlin. Dr Joerg-Michael Luther, Chief Representative of Allianz Group in Beijing from 1993 to 1998, then head of the liaison office of Allianz Group in Brussels and Bonn/Berlin until January 2000, now heads Allianz Group's General Representative Office China in Beijing. Zhang Yannan, has been Representative of the Allianz Group in Beijing since 1994.