Contributed By Winston & Strawn
The insurance industry in China has recently undergone major changes that will determine the long-term trajectory of its future development and, in particular, the role played by global insurers and intermediaries.
The two key developments driving the evolution of China's insurance market are, firstly, a wave of new regulations meant to reduce systemic risk created by excessive industry liberalisation between 2011 and 2015, and secondly a renewed effort to open up China's financial sector to foreign investment. In short, these current trends are leading China's insurance sector towards a market with robust, sustainable growth, sound risk-management practices, sophisticated protective products and a greater role for foreign insurers and intermediaries.
In 2016, China's insurance regulator, the China Insurance Regulatory Commission (CIRC), began issuing a wave of regulations intended to reduce excessive risk in the industry. This drive towards better regulation is ongoing and part of a larger effort by the Chinese government to reduce risk and increase stability in China's financial sector. As part of this large-scale effort, China overhauled its entire financial regulatory system from 2017 to 2018 and merged the CIRC with China's banking regulator, creating the China Insurance and Banking Regulatory Commission (CBIRC). The new market conditions created by these reforms will be more favourable to foreign insurers and intermediaries because they play to their strengths.
China's insurance industry reforms are largely a reaction to the far-reaching liberalisation of its insurance market that took place from 2011-15 during the tenure of former CIRC Chairman Xiang Junbo. While he was Chairman, Xiang oversaw:
As a result of these and other actions taken by Mr Xiang, many newly licensed life insurers began selling universal life insurance (a product with flexible surrender terms, high guaranteed annual returns and minimal death benefits). In order to pay the high returns to their insureds, these insurers concentrated their investments in high risk, and often illiquid, assets, such as large equity stakes in listed Chinese companies and offshore assets. Due to the duration mismatch, any downturn in sales or failure of an investment to deliver the expected returns could have provoked a liquidity crisis.
Concerns mounted until March of 2016, when the CIRC began to take action, promulgating the “Circular on Matters Concerning the Standardization of Medium-and Short-term Life Insurance Products,” which restricted the sale of many universal life insurance products and banned others outright. For the remainder of 2016, the CIRC continued to restrict sales of universal life insurance by investigating specific insurers and, upon finding irregularities, restricting or prohibiting them from selling. Then, on 30 December 2016, the CIRC promulgated the “Circular on Further Enhancement of Personal Insurance Regulation,” which essentially banned those insurers whose universal life insurance premiums accounted for half or more of their overall premium income from opening new branches.
Throughout 2017-18, the CIRC, and later the CBIRC, vigorously advanced its anti-risk reform campaign, implementing further measures intended to reduce systemic risk, discourage wealth-management products, and encourage traditional protective insurance (eg long-term life insurance, annuities and health insurance). For instance, in May 2017, the CIRC promulgated the “Circular on Regulating the Development and Design of Products by Personal Insurance Companies,” which, among other things, banned the sale of universal life insurance as a rider to traditional policies. Ultimately, the combined effect of these reforms caused sales of universal life insurance products to plummet by 50.3% year-on-year in 2017.
In addition to reforms that specifically targeted universal life insurance, the CIRC enacted other measures designed to reduce systemic risk and improve corporate governance. For instance, the December 2016 “Measures on the Compliance Management of Insurance Companies” significantly increased compliance and corporate governance requirements. In addition, the January 2017 “Circular on Further Strengthening Stock Investment by Insurance Funds” sharply restricted Chinese insurers' ability to invest in listed Chinese companies.
The CIRC has also conducted stricter risk assessments on insurance asset management and investments and, in the autumn of 2017, barred several insurers from selling universal life insurance, fined certain senior management personnel and banned others from the industry, and effectively issued a moratorium on new insurance licences.
Two cases of malfeasance in the insurance industry have garnered significant media attention. The first is that of former CIRC Chairman Xiang Junbo, who was dismissed from office in April 2017 and who pleaded guilty, in June 2018, to taking bribes of RMB19.4 million in exchange for helping to secure contracts, loans and qualifications. He is currently awaiting sentencing. The second case concerns the even more dramatic downfall of Anbang, formerly China's second largest insurance group, which had gained great notoriety for its high-profile acquisition of overseas assets. In February and May of 2018, the CIRC seized control of and then completely nationalised Anbang. Wu Xiaohui, Anbang's founder and chairman, was sentenced to 18 years' imprisonment and had USD1.7 billion of assets seized for charges of embezzling USD1.6 billion and illicitly raising USD10.2 billion.
Financial regulatory system overhaul
The drive to reduce risk in China's insurance industry is part of a larger effort on the part of the Chinese government to reduce risk and increase stability in financial services. Indeed, in 2017-18, China overhauled its entire financial regulatory system. By way of background, China previously operated a fragmented system, whereby four separate regulators handled monetary policy and insurance, banking and securities regulation in a horizontal, non-hierarchical structure. Critics claimed that this regulatory regime's lack of coordination contributed to the high systemic risk that has plagued China's financial system in recent years.
The State Council took the first major step in addressing this problem in July 2017, when it announced the establishment of the Financial Stability Development Committee (FSDC), a cabinet-level "super regulator" meant to oversee and co-ordinate China's four financial regulators.
On 13 March 2018, the National People's Congress announced two further reforms. The first was the merger of the CIRC with China's banking regulator, the CBRC, to create the CBIRC. This merger is meant to resolve problems relating to cross-regulation and an unclear delineation of responsibilities. The second was the elevation of the People's Bank of China (PBOC) above the remaining two regulators, namely the CBIRC and the Chinese Securities Regulatory Commission (CSRC). Effectively, the PBOC would assume authority to draft key regulations and prudential oversight in banking and insurance.
The CIRC/CBIRC regulations and the regulatory overhaul have done much to put China's insurance sector on a sounder footing. Ultimately, this should be propitious to foreign investors, which, relative to their Chinese counterparts, are more experienced in dealing with a heavy compliance burden and offering sophisticated protective products. Indeed, as discussed below, these reforms have been enacted in tandem with foreign investment liberalisations. Increased regulation and increased foreign investment are meant to be complimentary: better regulation creates conditions that are favourable to foreign investment, while the increased presence of foreign insurers will help modernise risk management and corporate governance practices and enhance the market’s offerings of sophisticated protective products.
Foreign Investment Liberalisation
Beginning in late 2017, China announced and implemented a number of reforms intended to grant foreign insurers and insurance intermediaries greater access to China's market. These reforms are motivated by a number of different factors. As mentioned above, greater foreign involvement will help modernise China's insurance industry and enhance the products offered to consumers. In addition, the timing of these announcements would suggest that pressure from the Trump Administration to open up China's financial services is likely to be an important factor.
The Ministry of Finance announced the first of these reforms in November 2017, immediately after President Donald Trump's visit to the PRC. In the spring of 2018, in the context of escalating China–US trade tensions, President Xi and the PBOC began to announce further reforms and accelerated the timetable for implementing previously announced reforms.
With respect to insurers, the key reforms that have been announced and/or implemented are as follows:
Life insurance equity cap
China now allows qualified foreign investors to take majority stakes in Chinese life insurance joint ventures. The 2018 Negative List, which came into effect in July 2018, raised the foreign ownership cap for life insurance companies from 50% to 51%. This 51% cap is supposed to be removed entirely in 2021 – a major move that will finally allow foreign investors to assume control of their life insurance ventures in China.
In 2018, the CBIRC will repeal the requirement, set out in the “Regulations Governing Foreign Invested Insurers in China,” that foreign insurance companies have a representative office in China for two consecutive years prior to establishing a foreign invested insurer. To this end, on 30 May 2018, the CBIRC circulated for public comment the “Recommended Draft of Decisions Relating to Amending Regulations Governing Foreign Invested Insurers in China.” This reform will significantly streamline foreign investment into China's insurance industry at a time when the interest of foreign investors is high.
With respect to insurance intermediaries, the key reforms are:
Hong Kong–China regulatory equivalence
On 16 May 2017, the CIRC concluded a framework agreement with the Hong Kong Insurance Administration's (HKIA) predecessor, the Office of the Commissioner of Insurance, to achieve mutual recognition that the solvency regimes of China and Hong Kong are equivalent ("Framework Agreement"). Under the Framework Agreement, the CBIRC and the HKIA will complete an equivalence assessment of their solvency regimes within four years.
In July 2018, the CBIRC took a major step towards equivalence when it promulgated the "Notice on Issuing the Solvency Regulatory Rules for Insurance Companies" ("Notice 34"). Notice 34 provides that, when a Chinese insurer cedes risk to a qualified Hong Kong reinsurer, the capital requirement of the Chinese insurer will be reduced.
Notice 34 is a significant breakthrough because China's risk-oriented solvency system, C-ROSS, effectively requires that Chinese insurers maintain a higher reserve ratio if they cede risk to offshore reinsurers. This creates a disincentive for Chinese insurers to reinsure offshore. Notice 34 removes this disincentive by reducing the capital requirement for Chinese insurers when they cede risk to qualified Hong Kong reinsurers. Notice 34 will doubtless increase the prominence of Hong Kong reinsurers and brokers in China's reinsurance sector.
In summary, these initiatives represent a significant opening of China's insurance market to foreign investment. In the wake of these announcements, multiple foreign insurance companies have announced plans to further enter, or expand their operations in, the PRC market.