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The long-term prospects for China's life insurance sector are for continued strong growth, driven by China's growing economy, increased levels of disposable income and reforms to the state benefits system. Increasingly, domestic insurers will have to evolve and differentiate to meet the challenge presented by the influx of new entrants.
China's life insurance industry is currently dominated by domestic insurers, with China Life commanding around 45 percent of the market share in 2003. However, foreign firms are making significant inroads. As a result of the World Trade Organization (WTO) entry requirements, the pace of change should quicken and challenges intensify. That will put increasing pressure on domestic insurers, who at this moment are lacking the capital and technical expertise to bring themselves up to the levels of their international peers.
In Moody's view, they will need to hasten their restructuring in order to meet future challenges.
China's insurance industry has grown since the mid-1990s. Much of the growth was generated from sales of insurance contracts with high guaranteed interest rates. This practice has become a major burden on the industry because of the negative spread stemming from the contracts.
The limited investment opportunities in China have also resulted in a portfolio of investments, mainly in cash, deposits and government bonds, which has put pressure on investment spreads. The expected relaxation of investment regulations for insurers in the future should heighten asset liability issues previously deemed insignificant in this market.
Inadequate risk management has contributed to insufficient levels of capitalization. However, because of growth, investors have viewed China's insurance market favorably. The successful restructuring and initial public offering of China Life in December 2003 helped relieve capital pressures and demonstrated strong demand from investors.
China's solvency margin regulations use an approach similar to that employed in Europe for many years (and now undergoing profound changes), which does not assess capital adequacy, based on a company's asset risks.
Although the extent to which an insurer can take asset risk is limited by the investment regulations. Compared to the risk-based capital measures used in the United States and other countries, this measurement of solvency does not look rigorously at all the risks inherent in total business operations, thus requiring additional insight when analyzing capital adequacy.
Investment-linked products have been quite popular for life insurers. Generally less capital intensive than other insurance products, these should ease the capital management issues; however, the introduction of investment guarantees may reverse this advantage.
Competition from other financial institutions to offer similar products will likely be keen.
A new regulatory framework is rapidly evolving towards international standards, with a focus on solvency.
Together with competitive changes, it will present challenges for insurance companies to adapt and to plan for the future.
At present, foreign insurers cannot compete against the large domestic insurers and their vast nationwide distribution networks, able to reach even remote regions within China. However, by December 11, all previous regional and operational restrictions on foreign-invested insurers will be removed.
Foreign insurers
Moody's expects the already highly competitive life insurance market will intensify with the opening of all product markets to foreign competitors.
With greater financial flexibility and technical resources than domestic insurers, foreign insurers will increase competition, especially in product and distribution areas where the domestics are less experienced such as variable life products and bancassurance.
Although relatively new to China, those foreign insurers with an existing strong presence in Asia should be able to leverage off their regional expertise in order to assist their nascent operations in China.
Most domestic insurers have short operating histories. Operations are unlikely to be of the same standard and capabilities as established foreign insurers'. Domestic insurers are rapidly trying to develop and strengthen their technology, management and product expertise in the face of increasing competition.
However, foreign insurers are entering a market dominated by domestic insurers. Market share growth will be a challenge when competing with the huge nationwide distribution networks of local insurers, and therefore the foreign insurers will probably initially concentrate on the wealthier and more developed cities along China's eastern seaboard such as Shanghai, Beijing and Guangzhou before expanding into the less developed regions.
Data for 2002 supports this: foreign life insurers' market share was around 1.8 percent across the whole of China, but much larger at around 13.9 percent in Shanghai.
Almost 50 major international and regional insurers have already set up joint ventures, branches or representative offices in China.
Increasing demand
Moody's expects China to provide significant growth opportunities for the life insurance sector, and China's projected economic growth to be the primary driver behind these opportunities.
The annual growth in real gross domestic product (GDP) has been around 8 percent recently and is expected to continue in this range, given the government's ambitious targets for the economy.
With this growth comes increasing levels of income for Chinese households.
Furthermore, China's population demonstrates a high savings ratio (savings to disposable income) of around 40 percent, which is greater than that of the Asian economies of Japan, South Korea or Taiwan. Increasing disposable incomes will result in consumers seeking to manage and protect their growing wealth, presenting opportunities for life insurance companies.
If insurance companies can attract households to buy insurance policies with their increasing disposable incomes, an opportunity exists for the developing life insurance industry to increase the penetration (as measured by premiums as a percentage of GDP) from just over 2 percent to the global average of around 5 percent.
However, there are certain barriers to growth. These stem from the low levels of risk awareness among individuals and their modest current appreciation of the benefits of insurance. At a corporate level, risk management awareness is also low. Therefore, an initial challenge for insurers will be to educate their potential markets as to the benefits of insurance protection.
Increased penetration, together with strong GDP growth, will likely result in strong growth for life insurance.
Life insurance premiums have grown, on average, well over 40 percent annually in the last three years. Although premium income growth is unlikely to continue at such high levels in the next few years, we do expect strong growth in this area.
Social welfare reforms
As part of China's economic reforms and the reform of its State-owned enterprises and government agencies, the old cradle-to-grave social welfare system has been abolished. The provision of social welfare benefits will shift to public and private providers. China's reform of the insurance sector and the restructuring of the state-owned insurance companies present the insurance industry with the task of providing supplementary benefits, particularly group insurance products as employers look to improve the level of benefits available to their growing workforce, and to health and pensions products due to reforms in the health and pensions systems.
P&C insurance market
The prospects for China's P&C insurance sector are for strong growth as a result of China's growing economy, structural changes increasing the demand for insurance and the influx of new competition. However, the industry is currently dominated by domestic insurers with former state-owned insurer, People's Insurance Co. of China, commanding a market share of around 70 percent in 2003. The domestic insurers generally lack the technical expertise of established global insurers and will be challenged by the pace of change Moody's expects in the insurance industry.
The opening up of the market to foreign insurers as a result of China's accession to the WTO should see increased competition from foreign insurers, who are already showing a strong interest in the market.
The industry is concentrated in the personal lines, with the motor business accounting for over 60 percent of all business written in 2002. With the success of the sales of short-term accident and health products, such as accidental injury insurance, that were permitted in 2003, we expect the industry to continue to concentrate on personal lines business.
An evolving regulatory framework is replacing pricing and policy form control with prudential supervision and a focus on solvency. This change is a sign that the market is moving towards international standards. However, in 2003 the industry reacted to deregulation of motor insurance rates by engaging in intense pricing competition, which highlights the market conduct risks in this developing market.
China is prone to various types of natural catastrophes. The increasing growth of the major cities in China highlights the increasing concentration of catastrophe risk for insurers. With commercial property insurance the second largest product line after motor insurance, this will be a key area of risk management for insurers going forward.
Moody's industry outlook
Moody's anticipates China will provide significant growth opportunities in the P&C insurance sector, supported by a number of factors:
The insurance market has experienced strong levels of growth over the past few years.
Annual growth in real GDP has been around 8 percent, and we expect it to continue, given the government's ambitious target for the economy. Insurance premiums in the past have generally outstripped GDP growth by a wide margin.
Insurance penetration (P&C premiums/GDP) was less than 1 percent in 2002, compared to between 2 percent and 3.5 percent for other larger Asian countries and between 4 percent and 5 percent for the largest markets in Europe and North America. The growth in insurance penetration, together with GDP growth, should contribute to strong growth.
As industries and companies expand, the need for risk management solutions will increase.
The removal of State-supported risk management gives further incentive for growth. Increased car and home ownership within the general population should increase demand for personal insurance protection.
The opening up of the P&C industry to various short-term accident and health insurance products will likely increase opportunities for personal lines.
The evolving legal system and increased awareness of legal issues should increase demand for liability-type products.
Increased competition and the influx of foreign insurers should increase awareness of insurance in general.
Although 2003 saw strong pricing competition as a result of the deregulation of motor insurance rates, P&C insurance premium income rose 11.4 percent.
Weak legal system
In Moody's view, a strong legal framework is required to support the development of the insurance industry, particularly those lines of business that require extensive arbitration and settlement agreements. China's weak legal system is still evolving, and until a more robust framework is in place, the full development of the insurance industry will be deferred, as the risk of writing business in such an environment will be too uncertain.
Increasing competition
By December 11, all previous regional and operational restrictions on foreign-invested insurers will be removed.
Moody's expects the already highly competitive environment will intensify with the influx of foreign insurers into new areas of operation previously closed to them. With greater financial flexibility and technical resources than domestic insurers, foreign insurers are likely to provide a strong challenge, especially in non-traditional lines where the domestics are less experienced.
Innovation
Competition should bring positive developments for the industry. Although lower pricing has been used to address increased competition, Moody's expects that more disciplined companies will look to other approaches such as product differentiation, alternative distribution channels and improved service levels.
This will bring innovation into this evolving market.
The influx of foreign competition that can draw from their experience overseas should lead to further innovation in the industry, as domestic insurers begin to learn from and emulate their foreign competitors. Moody's anticipates successful companies will look to alternative solutions to differentiate themselves from the competition rather than doing so through pricing.
(China Daily July 2, 2004)
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