China's accession to the WTO at the end of last year has started to open up the world's largest country to international insurers.

One of the key sticking points in the negotiations leading to China's entry to the World Trade Organisation on December 11 last year was the long-protected insurance industry. Despite some hitches, the deal was done, and over the next few years, according to China's commitments, foreign insurance companies are expecting to be given pretty much full access to the China market, the last major undeveloped market in the world.

According to the WTO agreement, foreign insurance companies will be able to gain operating licenses for the domestic market if they have more than 30 years of experience in a WTO member country, if their total assets surpass $5bn, and if they have had a representative office in China for more than two years.

One year following, all geographic restrictions are to be lifted, enabling foreign insurance companies to open anywhere they want.

The actual speed of the opening-up process will to some extent depend upon how successful the foreign insurers are. The more successful, the slower the process, is the assumption.

Insurance battleground
Insurance is shaping up as a huge battleground between the state-owned insurance companies and foreign insurance companies, operating largely through joint venture vehicles. The foreign companies have an advantage in terms of experience, efficiency and expertise, but local companies understand the local market better, and already have branches in all corners of the country.

"It's in its infancy compared to other markets," said one foreign insurance executive. "It is potentially enormous, but at the moment for instance, the total China insurance market is only a quarter the size of the French market."

The industry is convinced that the Chinese state insurance companies will need to make major changes in order to adapt to the new open market conditions. Transaction costs are currently too high, and inefficiencies too widespread.

The first two cities to be fully opened to foreign insurers are Shanghai and Guangzhou. Other cities, including Beijing, Chengdu, Dalian, Chongqing and Shenzhen, will be opened up within two years of WTO entry. China's entry into the WTO is not all bad news for domestic insurance companies, however, since it will help speed up the growth of the industry as a whole and provide an opportunity for the insurance companies to seek stock exchange listings, raising capital to fuel further growth.

Life licenses
The first foreign life insurance company to receive a license to operate in China in the current era was American International Company (AIA), the China unit of international insurance giant AIG. The company was founded in Shanghai in the 1920s, with a small office in the building it now owns on Zhong Shan Dong Yi Road, formerly the headquarters of the North-China Daily News. AIG, now the world's largest insurance company, received approval to return to the Shanghai market in 1992.

Manulife, which operates through its Manulife-Sinochem Life Insurance Co Ltd joint venture established in Shanghai in 1996, was the second foreign life insurance company to receive a license. Manulife recently received approval from the Chinese Insurance Regulatory Commission (CIRC) to begin preparations for opening a branch in Guangzhou.

In total there are now around a dozen life insurance foreign joint ventures operating in China in different cities, all under very specific geographical limits on their business operations. Over the next five years, the restrictions under which foreign insurers operate - geographical, products and ownership - are to be gradually removed.

Currently, the largest player in the life insurance market is China Life Insurance Co, which has a 65% market share. Ping An, which opened for business in 1988 and started selling life insurance policies only in 1995, now has around 23% of the national market and more than half of the insurance market in Shanghai, by far the most important in the country. In this market, AIG has a share of around 10%.

Manulife, meanwhile, reports having around 3,200 agents serving around 100,000 life insurance policyholders in Shanghai, giving it a market share of around 2.3%. But business is growing strongly for all players.

Ping An, the most aggressive operator in the market, is to be seen everywhere in Shanghai; it advertises heavily, and its agents are often to be seen on street corners and in parks, urging residents to sign up. Ping An places a far stronger emphasis on customer service compared to other Chinese insurance companies, and runs a 24-hour call centre and a website offering online insurance sales. The effect on Ping An's bottom line is clear: its reported premium sales and profits are more than doubling every year.

Ping An Life has a state majority shareholding, but also has outside investors, including Morgan Stanley and Goldman Sachs. The company has said it wants to make progress on preparing for a listing by the end of this year. Under the current regulations, individual foreign shareholders are allowed to hold up to 5% of a domestic insurance company's shares, with a 25% cap on foreign ownership. China Pacific Insurance is another company that hopes to achieve a listing, and has split its operations into two - general insurance and life insurance - in order to list both companies separately.

China's insurance market may be relatively undeveloped, but it has come a long way in a relatively short time. Until the early 1980s, there were no insurance companies in China. Then in 1984, the People's Insurance Company of China (PICC) was spun off from the People's Bank of China (PBOC) as a separate entity. Within a few years, another dozen or so domestic insurance companies had been created, but they remained very much in the shadow of PICC. Then in the mid-1990s, PICC was divided into three entities, and competition between domestic companies entered a new era. China finally issued an Insurance Law in 1995, and the China Insurance Regulatory Commission (CIRC) regulatory body followed in 1998. The CIRC has now set up the skeleton of a regulatory framework for the insurance industry in all parts of China.

Chinese people have leapt at the opportunity to take out life insurance policies with foreign insurers, partly because of a lack of faith in the state-run pension schemes associated with the old state enterprise system. The growth of life insurance business for foreign insurers has mirrored and paralleled the dismantling of the state-owned enterprises, as individuals realise that they have to plan for their own futures.

So, how big is the opportunity?

A key comparison for insurers is the Hong Kong and Taiwan markets, where it is assumed the psychology and attitudes towards life insurance will be similar to the Chinese mainland. A foreign insurance company executive said that life insurance penetration rates in Hong Kong and Taiwan were effectively at the same levels as in the West, which implies there is huge potential for market growth in the years ahead. Currently, the total life insurance market in China (with a population of 1.3 billion) is slightly bigger than that of Switzerland (with a population of 8 million).

Around 100 insurance firms have set up representative offices in China to date, of which about 20 have so far managed to find a way to start business.

"The insurance market is just as protected as the banking market, but WTO should open it up. The clock is ticking," said the foreign insurance expert.

The market size of the insurance industry in China came to around $15bn in 2000, and according to some estimates should hit $33bn by 2005. The CIRC has estimated an average growth rate of around 12% per year for the market over the next five years.

But this is still small compared to where it should be soon if China follows the Hong Kong and Taiwan examples. By 2005, China's insurance industry would still account for less than 2% of the entire economy, compared with 8% in the US. China's personal bank savings at the moment are around $900bn, and the bet is that a significant portion of that will be transferred into life and property insurance policies in the years ahead. Not only is China's market for insurance small at present, but the products offered are few in number and Chinese consumers are still largely unaware of the benefits and procedures for taking out a life insurance policy.

One major problem faced by the insurance sector is where to put the money. In the West, a significant proportion of insurance company funds is invested in stocks to generate the returns necessary to cover payouts on premiums, as well as funding costs and producing profit. But the Chinese share markets are currently unsophisticated and volatile, with too few solid companies listed to be considered for large investments by insurance company funds. This is unfortunate; the injection of vast sums from insurance companies would go a long way in providing stability to the share markets. The China Securities Regulatory Commission (CSRC) has taken steps to allow the start of insurance funds entering the share markets, but the weakness of Chinese stocks over the past year is not helping.

Shanghai example
Shanghai is one of the largest and most open insurance markets in China, and its industry and economy continue to benefit from foreign insurance carriers that bring in new ideas. Since 1992, foreign insurers have brought numerous benefits to both corporate and individual consumers by creating positive competition, new products that respond to market needs, customer-focused management techniques and a general improvement in the operating environment.

Shanghai is proof positive that both domestic and foreign companies can work to meet the ever-growing needs of this expanding market. Foreign investors are crediting the Shanghai government with taking the first bold steps that demonstrated the practicality of creating an international market within China.

Shanghai's authorities have recognised that continued development of the insurance field, both in size and innovation, is a vital part of China's effort to modernise and restructure its economy. Properly managed insurance allows individuals and companies to spread risk, and by doing so makes the consequences of risk more predictable. This allows individuals and enterprises to take chances and make investments that they might otherwise avoid.

In market economies, insurance companies also help to mobilise capital for investment. They take in premiums and invest them, concentrating funds from disparate policyholders. By directing those funds into worthwhile long-term investments, insurance companies provide an efficient mechanism for the distribution of capital in the economy as a whole.

Insurance acts as an engine for growth for many other industries, from agriculture to high-technology manufacturing. This process is speeding up now China has joined the WTO and as the country implements further reforms. And for China, a modern insurance industry will create a better environment for individuals and enterprises to make the investments that China needs to modernise its economy.

However, the pace of overall industry reform remains slow. Foreign insurers are still geographically restricted, cannot participate in many sectors and are forbidden to invest in many fields. In addition, the regulatory process is in many cases obscure.

Market access
Under WTO, China has agreed to eliminate all geographic restrictions for foreign insurers within three years of accession. The government has also agreed to expand the permitted scope of business for foreign insurers to include health, pension and group insurance within two years.

Foreign investors are welcoming the gradual removal of geographic restrictions under WTO, open access to all commercial and private customers, implementation of transparency governing approvals of new licenses and eventual national treatment for all insurance companies. Foreign investors believe the government should implement these reforms in a consistent and open manner for them to be effective.

Development of the insurance industry will create a better environment for individuals and enterprises to make the investments that China needs to modernise its economy. Foreign companies will bring world-class products, services and know-how to China, enabling it to deal with the broader challenges facing insurance industry reform - capital market formation, insolvency, creating a sound pension system (instead of the current pay-as-you-go system), and accelerating reform of state-owned enterprises (SOEs).

This growth is much more likely to happen quickly if insurance licensing and other regulation is conducted in an open and transparent manner. Licenses, for example, should be granted according to written, published criteria. This will allow insurance companies to predict the results of their efforts and compete in the market on commercial grounds, widely viewed as the best and most efficient way for the insurance industry to move forward in modernising the Chinese economy.

Internal branching
China remains the only country where licenses are granted on a city-by-city basis. To date, domestic insurers are the only companies which enjoy licenses granted on a national or regional basis. A further barrier to foreign insurers is the branch capitalisation requirement.

The Chinese government stipulation that insurance operations in each city must be capitalised at Rmb200m ($24m) creates obstacles to operational efficiency and long term profitability.

Foreign investors are now urging the Chinese government to allow insurers the ability to establish new operations through internal branching.

Under WTO, foreign insurance companies will be permitted to establish branches as geographic restrictions are phased out. The government will need to establish clear and coherent rules about branching, but no additional licenses should be required. The capitalisation requirement sets up prohibitive obstacles for foreign insurance to grow along with the Chinese economy. The beneficiaries of such restrictions will be a few select cities, whilst the rest of the nation may be excluded.

So far only a few cities on the prosperous east coast have enjoyed the benefits of a modern insurance market. Allowing the free establishment of new branches will bring those benefits to many more regions in China, including regions that China is trying to develop with the `Go West' campaign.

The benefits of a modern insurance market have clearly been demonstrated in Shanghai, where foreign firms have played a key role in establishing the city as the most progressive and vibrant insurance market in the country. Foreign company inclusion has helped create the widest range of products and services, while domestic companies have reacted vigorously to the competition, strengthening their service and products.

Investment restrictions
Currently, insurance companies in China are permitted to invest in only a few types of financial instruments, including bank time deposits and government bonds. For the insurance industry to grow and to reach its potential for supporting the deepening of the overall economy, the permitted scope of investment for insurance companies must be expanded at a more rapid pace.

Foreign investors are recommending that insurance regulatory authorities judiciously but quickly lift restrictions on how insurance companies may invest.

Insurance companies cannot efficiently fill their economic role in concentrating capital for investment if the kinds of investment they can make are restricted.

Investment restrictions in China can be explained in part by the lack of developed markets for many types of financial products. Foreign investors believe that allowing insurance companies to diversify their investments will act as a catalyst for more rapid development of the financial markets in the country. Foreign investors are encouraged by the recent expansion of investment options that allow 15% of assets to be invested in domestic mutual funds. This is a very positive move and foreign firms are encouraging that process to continue for all insurance companies.

Hong Kong example
Hong Kong's Commissioner of Insurance Benjamin Tang said during a trip to Singapore that Hong Kong, with its top talents and freest economy in the world, is developing itself into another insurance niche, on a par with any well-known insurance centres worldwide. Hong Kong's reputation "is being built on its proven track record, a clear vision of the direction of economic development, and a multitude of infrastructural advantages," he said.

Hong Kong's insurance market has been developing very soundly, and the market is attracting more and more world insurers to run their Asia-focused business there. Despite a worldwide economic slowdown, provisional statistics show that the total gross premiums of the Hong Kong insurance industry reached HK$85bn ($10.8bn) and sustained a growth rate of 32% last year. Statistics also indicate strong signs of recovery in the general business market, with gross premiums of approximately HK$19.5bn ($2.5bn), an increase of about 10% over 2000.

According to the government's latest figures, there is a total of 202 authorised insurers operating in Hong Kong. Of this total, 139 are general business insurers, 45 are long-term business insurers and the remaining 18 are composite insurance players. These insurers included 29 professional reinsurers and a few specialist insurers engaging in captive, mortgage, credit, marine, alternative risk transfer and title insurance business. Over half of the authorised insurers are incorporated outside Hong Kong in 25 different countries, with US companies taking the lead. China's accession to the WTO opens up more opportunities for Hong Kong insurers since Hong Kong has many advantages as a gateway to the mainland, Tang said. China's total premium income grew to Rmb211bn ($25bn) for 2001, an increase of 32% over 2000. Now that it has joined the WTO, China is committed to widening market access to foreign players, enabling Hong Kong to play a bigger role in the future.

By Gordon Feller
Gordon Feller is an independent journalist whose clients have included the World Bank, the Financial Times and McGraw Hill. In addition, he has devised numerous international risk conferences, acted as an advisor to multinational corporations including Chevron, Bechtel and IBM and worked with non-profit think tanks such as the World Policy Institute