Why China Needs to Improve Its Financial Management in Life Insurance
Why China Needs to Improve Its Financial Management in Life Insurance
China is poised for dramatic changes in its life insurance industry that will raise both opportunities and challenges.
It is a fact that a growing life insurance company needs capital, and while going to the stock market through public listings gives a ready source of capital and easy access to new capital in the future, it does come with its "price." China has particularly spectacular growth prospects, and given the nature of the business–where to expand means to invest–the industry will have an almost insatiable appetite for capital.
In order to fulfil this, China's insurance industry needs to advance its financial management and improve its ability to produce transparent financial information, in a timely and reliable manner. Without this, investors may not continue to be so forthcoming with the much-needed capital.
Facts About China
The life insurance industry in China is experiencing dramatic changes that raise both opportunities and challenges for industry players. Whichever way you look at it, there is enormous potential for growth in the market. In the next 10 years, if life insurance premiums increase from 2.3 percent (based on life insurance penetration in 2003) to 4.5 percent of GDP (in Taiwan insurance premiums represent around 6 percent of GDP), and if real GDP grows at 8 percent per annum, life insurance premiums will increase by over four times in real terms.
- Based on the most recent data from Swiss Re's SIGMA Report:
- In 2004 the total premium income in the life insurance industry totalled RMB 323 billion (including accident and health).
- China is already in third place overall ahead of Taiwan and behind Japan and South Korea.
- The growth rate of premium income for the industry is the region's highest at some 30 percent for 2003.
- China will probably overtake South Korea in total premium income to become the second largest market in Asia in the 2006 calendar year.
- The current asset mix held by life insurers is dominated by bank deposits, which offer modest returns. (See Chart)
In order to succeed, life insurers rely heavily on robust financial management, and in particular on finding the right balance between the investment returns they can achieve (following their chosen asset allocation strategy), and the yields offered to policyholders–which is determined by a combination of their product pricing and policyholder dividend strategies.
They compete with banking and other fund industry products for their share of the consumer's wallet, and so often this competition comes down to a question of promised yields to the customer. This is a difficult and risky road to follow and requires careful financial management to avoid insolvencies.
The Life Insurance Industry in Perspective
Life insurance is playing an increasingly important role in the China financial services industry, yet achieving the expected growth profitably will depend heavily on being able to invest in suitable long duration assets. The supply of such assets in the local market remains meagre and ultimately may pose a threat to life insures and their ability to grow, unless the local financial markets can develop at a similar pace to the insurance industry or companies can invest overseas without significant currency exposures. To this end the regulator has recently taken steps to allow some additional freedom to invest offshore (but only for a small number companies at this stage).
The reliance on investment returns will become especially acute when product pricing regulations liberalize (although this may take a few more years yet, as the regulator continues to protect the solvency of the industry as a whole by setting relatively low maximum pricing interest rates).
A major impetus for change in the domestic insurance market is the wave of initial public offerings, which began with the listing of China Life on the New York and Hong Kong stock markets in late 2003 and then Ping An on the Hong Kong market in 2004.
The capital raised from these public offerings, as well as improving the financial strength of the industry, should also enable the major players to fulfil their growth ambitions, both domestically and perhaps overseas.
Furthermore, China's entry into the WTO has already started to give the foreign joint ventures greater geographical access to China's untapped markets. Up until recently all of these joint venture companies were restricted to selling their products in one or at most two Chinese cities. As a result of the agreements made through WTO, many companies have now received licenses for additional cities, for example Prudential UK recently received a license for an eighth city. This is another important factor that should contribute to the rapid expansion of the industry and therefore lead to the need for capital to finance its growth.
The Need to Improve
However, given the current strategy to go to the capital markets to fund growth, the newly listed Chinese life insurers will need to give greater focus on the quality of information produced, as shareholders will look for reassurance on the quality and performance of their management.
In addition, analysts who follow these companies and provide potential investors with advice on buy/hold/sell strategies will require more detailed information and confidence in that information and its timely delivery, if they are to give the investment community the kind of advice life companies will be looking for to support their share prices.
The implication of this is that companies will need to pay closer attention to financial management in the near future. In particular, shareholders in China's life industry will demand higher quality financial reporting and greater transparency.
How do You Improve Your Financial Management?
While companies operating on the mainland have shown advances in asset liability management techniques in recent years, the techniques used remain relatively unsophisticated by Western standards.
The sorts of challenges facing most companies include:
- The need to carry out scenario testing to analyze the impact of changes in interest rates on profitability and solvency.
- The need to set up asset liability models, and to understand how to extract valuable management information from their use.
- Establishing effective working management committees to analyze the information available from their investment (the asset "minders") and actuarial departments (the liability "minders").
- Implementing reliable accounting processes that will ultimately provide accurate information for use in the models and reporting.
- Establishing guidelines on how investments should be managed, including benchmark asset allocations.
- Monitoring the investment performance achieved against appropriate indices.
- Offering yields on products that match those the investment managers can expect from the domestic market, allowing for the limitations in the local investment vehicles available.
Meeting these challenges will require a greater understanding of the financial risks faced by each company in the market, and may involve the investigation of:
- The impact of likely changes in financial markets on the current solvency position of the company.
- The impa ct of likely future changes in financial markets on the future projected profitability and solvency of the company.
- The extent to which management action can offset the risks posed by adverse scenarios through: changing the asset allocation, repricing products, managing the mix of new products sold and managing bonus rates paid to policyholders.
Such analyses should be carried out both deterministically, based on specified scenarios, and also stochastically to allow management a better understanding of the likelihood of different financial outcomes.
While such financial management techniques are becoming more accepted and widespread in many Western insurance markets, their use remains the exception rather than the rule in mainland China.
What Should Life Insurers be Aiming For?
The stakes for life insurers in this changing landscape are high, since one of the key ingredients for success in the China life insurance market going forward will be access to capital at reasonable cost, to allow the expansion of their operations as the market grows.
Meeting shareholder expectations of greater transparency and reasonable growth rates in share prices will be key success factors in the companies' ability to access new capital when needed.
The cost of not understanding these risks, or even underestimating them, and therefore not being able to access capital to exploit opportunities and maintain financial strength are high–especially at a time when competition is likely to increase. In such a changing landscape, making the right strategic choices will pose a significant challenge, and having access to internationally experienced practitioners will be a real advantage.
A focus on financial management standards to a level consistent with that seen in international markets will go a long way to ensuring success for any market player. There are many challenges a company faces in a market such as China. While many of the challenges are obvious, some may not consider financial management among them. But for the reasons outlined in this article, it needs to be. And a commitment to international standards in financial management by executives and directors will be just as critical for sustainable success as distribution strategies, product pricing, customer service and compliance.
Jeremy Porter is a principal in the actuarial practice of Deloitte based in Hong Kong.
Portions of this article are reprinted with permission from Asia Insurance Review.
The opinions set out in this article are those of the author and do not represent the views of Deloitte. This article is provided for general information purposes only and must not be relied upon without seeking independent professional advice on the relevant issues.