Changing Regulatory Philosophy?  Chinese Regulators Seek to De-Risk Insurance Products after NPC
By Henry Hing Lee Chan

Changing Regulatory Philosophy? Chinese Regulators Seek to De-Risk Insurance Products after NPC

Mar. 28, 2016  |   Blog   |  0 comments


In recent months, Chinese insurers have been active in both overseas and domestic markets in acquiring equities and real estate. Industrial observers noted that the buying spree started after the China Insurance Regulatory Commission (CIRC) loosened restrictions on insurance investment in 2014. Concerns have been raised on whether these types of long term investment fit the insurance industry in terms of liquidity and duration. 
 
First Hostile Takeover Saga in China 
 
China’s first major hostile takeover bid — the acquisition of the world’s largest property developer, China Vanke of Shenzhen, by the privately owned and largely unheard of Baoneng group last December — revealed the new financial clout of insurers. China Vanke was an industry icon with a market capitalization in excess of RMB 100 billion when the Baoneng group started accumulating Vanke shares in the open market in late 2015, Baoneng became the largest stockholder of Vanke in early December and held close to 25 percent of the company when trading on Vanke was suspended in mid-December. Industry observers estimated Baoneng had spent close to RMB 50 billion to acquire its Vanke shareholding. 
 
China Vanke is led by a corporate luminary, Wang Shi. He fought back against the takeover attempt by suspending the open market trading of the company and actively seeking white knight investment to dilute the shareholding of Baoneng. Under Chinese securities law, such suspension is allowed when the company is undergoing reorganization. Wang also went to the press and highlighted the source of funding of Baoneng. He pointed out that a significant part of the acquisition fund came from its subsidiary, Foresee Life Insurance, and that the insurance firm might have violated insurance law. Foresee was set up in 2012 with RMB 4.5 billion in capital and had RMB 65 billion in assets at the end of 2014. Its ability to raise a significant chunk of the acquisition fund hence remains a question to many. 
 
Wang recently arranged an asset for share swap with a state owned enterprise (SOE), Shenzhen Metro and the SOE will become the largest stockholder of Vanke after the deal’s completion. Baoneng might sit on billions of losses.   
 
Wang’s charges put the insurance industry and the insurance product that Foresee Life used to raise funds, Universal Life Investment Policy (ULIP), in the limelight. The public disclosure prompted CIRC to announce in late December that it is looking into Baoneng-Vanke case.  
 
The insurance sector is the fast growing major financial sector in China lately. Between 2010-2015, the sector’s assets increased from RMB 5 trillion to RMB 12 trillion and its profits increased from RMB 83.1 billion to RMB 282.4 billion. In contrast to the banking sector with virtually zero profit growth, the insurance sector recorded double digit asset and profit growth from 2014. 
 
Universal Life Insurance Policy (ULIP) 
 
One of the most popular products that has driven the insurance sector’s profit growth in recent years is the Universal Life Insurance Policy (ULIP). ULIPs were introduced to China in 2000 and by 2015 they accounted for almost 28 percent of total life insurance outstanding. The increasing market share in the life insurance sector from 20.5 percent in 2014 suggests a surge of business in ULIPs in 2015. The attractiveness of ULIPs in China is a combination of high insurance benefits, subscription/withdrawal flexibility, and high promised returns. ULIP sales surged in early 2015 after CIRC raised the cap on the minimum guaranteed return offered by ULIPs from 2.5 percent to 3.5 percent and raised minimum insurance pay-outs in early 2015. 
 
ULIPs work as follows: after origination expenses are deducted from each period’s premiums, the balance is deposited to the policy account. Insurance companies will collect the mortality risk premium, policy management fee, asset management fee, and administration fee from the policy account. The remaining funds will then be put in an investment account. The asset allocation and investment decisions of the investment account are controlled by investment companies designated by the insurance companies. Policyholders have no right to decide. This setup is in contrast to traditional investment-linked insurance policies that have multiple investment accounts and which allow the policyholder to choose the investment accounts to place his funds in. If the policy holder decides to cancel the policy before its maturity, the insurance company will collect the cancellation fee. The structure of the ULIP is more similar to a mutual fund than an investment-linked insurance product. Lately, the policy duration of ULIPs has been getting shorter, sometimes to less than one year. Such a short policy duration really makes many ULIP products even more akin to mutual funds rather than life insurance products.  
 
Some economists have noticed the moral hazard of the ULIP product. An insurer can sell products with high promised returns and insurance pay-outs, and use the money to chase potentially high yielding assets. If it works out, the owner of the insurer will earn a huge profit; if it doesn’t, the government may be forced to bail out the firm, especially if it’s big. The idea of explicit and implicit profit guarantees of ULIPs and the leveraged balance sheets of some insurance companies has caught the attention of economists and there is an increasing call for regulation. 
 
CIRC chairman Xiang was asked about the aggressive bidding by insurers in A-share listed companies such as Vanke by Baoneng group in the CIRC press conference at the National People’s Congress (NPC). Chairman Xiang responded that the risk of the insurance sector is under control and the investment of Baoneng in Vanke is legal. At the end of 2015, 10 insurers spent RMB 365 billion — 3.3 percent of their total assets — to accumulate significant stakes averaging 10.1 percent in 36 listed A-shares. He promised that CIRC will strengthen its supervision in this area and his personal view on the key risk of ULIPs is their duration mismatch.  
 
New Regulations on Insurance Products 
 
CIRC announced the tightening on its control over short and mid-term life insurance products on March 17. The rules will take effect on March 21 with the expressed intention of curbing potential risks from aggressive insurers investing heavily in stocks and long-term assets using short-term funds. 
 
Under the new rules, Chinese insurers will immediately stop selling products in which more than 60 percent of policies are expected to have less than a year’s duration, and gradually cut back other short- and mid-term products. (Short- and mid-term products are defined as policies in which 60 percent are expected to have less than a 5-year duration.) CIRC intends to reduce the industry total premiums from such products to 90 percent level in 2016 from the RMB 650 billion collected in 2015, 70 percent in 2017 and 50 percent in 2018. CIRC will ensure the premiums from such short-and mid-term products will be less than RMB 325 billion from 2018 forward. 
 
The new rule will assign a ceiling on premiums collected from such ULIP products to each insurer based on their capital position. Those whose premiums from such products exceed the ceiling must increase their capital within three months to meet the requirements under the new rules. 
 
The director of CIRC’s life insurance supervision department who chaired the press conference announcing the new regulations, Yuan Xucheng, revealed that there are 57 life insurance companies selling such products at the moment. Some insurance companies have been very aggressive selling these policies, with the more aggressive ones getting more than 90 percent of total premium coming from such products.  
 
He noted that the rapid growth of short- and mid-term insurance products has caused concerns about the risks created by potential asset-liability mismatches and liquidity conditions. Yuan further commented that "Insurance company profits should come from active risk control, not aggressive investment," and that "insurance companies shouldn't sell quasi-wealth management products purely for investment purposes, that's not insurance." 
 
Changing Regulatory Philosophy after NPC? 
 
Yuan’s revelations at the NPC are disturbing and highlight the failure of many industry players on self-regulation. The financial industry is an industry full of moral hazards and temptations, and it is perhaps high time for regulators to look at the industry structure to minimize the presence of unruly players. The life insurance industry is essentially a long asset play and industry players should possess self-regulating aptitudes. It is simply impossible to watch life insurers’ every investment move. 
 
The new rules on ULIPs will hopefully be successful in curbing the potentially risky practices of the industry. We have seen a renewed emphasis on consumer protection in the financial sector after the recent NPC meeting. We just hope the new emphasis really reflects a long term regulatory philosophical change and that the Chinese financial sector’s investors will be protected from product mis-selling in the future. 
 



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