China’s reinsurance industry—the world’s third-largest life insurance market and second largest non-life insurance market by premium1 —has been going through a structural transformation in recent years, driven by changes in both the primary market and the regulatory environment, says the latest report by the international rating agency AM Best.
The transformation continues, and China is set to become an increasingly difficult environment for reinsurers, especially non-life. Life reinsurers, meanwhile, have enjoyed strong growth but must deal with heightened capital pressure, says the report.
Non-Life reinsurance demand Is declining due to C-ROSS.
Motor is the major contributor to growth in China’s insurance industry, accounting for over 70% of non-life direct premium income.
Changes resulting from the implementation of the China Risk-Oriented Solvency System (C-ROSS) are creating multiple challenges for the non-life insurance model, such as top line and profitability pressures. For growth, non-life reinsurers are looking at Belt and Road initiatives and captive insurers, as well as potential business arising from the second phase of C-ROSS.
The China Re Group also dominates China’s non-life reinsurance industry; its subsidiary, China Property and Casualty Reinsurance Company Ltd., accounts for 50% of the onshore market, followed by Swiss Re and Munich Re’s branch offices, both in Beijing.
Reinsurance premium growth does not always go hand in hand with direct premium growth. Onshore reinsurer premium income decreased in both 2015 and 2016—a stark contrast to the double-digit growth of direct premium during the same period.The major driver is, again, regulatory changes, as C-ROSS was implemented in January 2016.
Both life and non-life reinsurers also need to be wary of potential competition from Hong Kong, as regulators there are working on C-ROSS equivalence, which may allow Hong Kong reinsurers to be treated as onshore reinsurers in China. Although still several years off, such changes could attract new capital to the Hong Kong market as companies look to join the Chinese reinsurance market.
Profitability Headwinds Are on the Horizon
The changes in demand for reinsurance have led to further problems. Most obviously, a glut of reinsurance capacity and growing retention by the direct industry pose clear threats to reinsurers’ profitability. In addition, the oligopolistic structure of the direct market gives large cedents more bargaining power not only on pricing, but also on terms and conditions.
This squeezes profit margins even further, especially on the proportional treaties, making them thinner and thinner. In fact, in the 2017 renewal period some of the international reinsurers—both on- and offshore— decided to scale back their portfolios in China, by substantially downsizing their participation or even dropping treaties that no longer met their internal return on capital requirements. The competition is not strictly between on- and offshore reinsurers.Medium-sized direct insurers are joining the party by writing inward reinsurance, which not only boosts their top line, but also means they are getting high-quality, more diversified nation-wide business by writing first-tier companies’ treaties.
In China, direct insurers may write inward treaty business only if they have a financial strength rating from an international rating agency and are registered in the CIRC’s reinsurance registration system.
Opportunities Ahead in Belt and Road …
On the bright side, China’s Belt and Road program has created some hope of new premium sources for Chinese reinsurers, especially state owned companies that can leverage their state-owned relationship. The early stages of the Belt and Road initiative will bring vast investments in infrastructure—the construction of railroads, highways, and tunnels—as well as developing sectors such as energy and telecommunications.
For insurers, this will translate into business opportunities, with an estimated USD 14 billion of premiums generated during the construction phase, according to Swiss Re’s estimates.
Chinese employers participating in Belt and Road developments outside China will also face worker safety risks, as their employees may face not only normal risks from accidents, but also risks from terrorism, kidnapping, and ransom, all of which will need additional insurance protection. …
Captives Captive insurance is another new source of income for Chinese onshore reinsurers. This form of insurance is in its early stages of development but will expand in the future—again, aided by encouragement from the CIRC. There are over 6,000 captive insurers globally, but only seven Chinese captive insurers (four domiciled in China and three in Hong Kong) (Exhibit 10). Several more captives are awaiting license approval. The captive formation is likely to transfer insurance demand used to direct insurance market, to the reinsurance market.