China

en Jorn Kristensen, a young executive of Winterthur, the Swiss based insurer, was asked in the mid-1990s to establish the group's first office in Shanghai, it was an opportunity he could not resist.

Alone and armed only with a suit-case and a licence issued by the Chinese government, Kristensen arrived in the city in 1996.

"I felt this was a once-in-a-lifetime challenge," says Kristensen, who is now heading up the Asia Pacific operations of Winterthur.

Today the company, the first European insurer to win a licence in China, has 50-60 employees in Shanghai all of them Chinese apart from the general manager. With Ynl00m in premiums, Kristensen expects the company to make a profit this year.

Winterthur is just one of an increasing number of foreign companies queuing up in Shanghai in anticipation of the expected liberalisation of China's insurance market.

As the government pushes ahead with market-oriented economic reforms, it urgently needs to develop the insurance industry to help balance corresponding increases in risk. The challenge for Beijing, particularly after its expected entry into the World Trade Organisation (WTO) early next year, is how to tap foreign expertise and capital in the insurance sector without undermining the domestic industry.

The challenge for foreign investors, meanwhile, is how to secure market share and make a profit while navigating a path through what promises to be a long and tortuous transition. As in most industries, the potential of the Chinese insurance market has attained almost mythical status among the large Western insurers.

"China is like a legend [among foreign companies]. The only large virgin market remaining for foreigners in the world. If you look the numbers, there are 1.3bn people, with each person spending on average less than US$20 on insurance coverage per year," says Mr Alex Wong, director of insurance at PricewaterhouseCoopers in Shanghai.

Steady growth forecast
Last year, the total value of insurance premiums in China rose 14.5 percent compared with 1999, to Yn160bn. In the six months to June this year, they jumped 28 percent compared with a year earlier. Of the total, life insurance premiums grew 37 percent year-on-year during the period, while non-life premiums rose 14 percent.

The China Insurance Regulatory Commission (CIRC) is forecasting steady growth of about 12 percent a year for the industry as a whole, to Yn280bn by 2005. This would represent an increase from 1.5 percent of gross domestic product last year to 2.3 percent in 2005, still well short of levels in developed countries, which range from eight percent for the US to 11 percent for Japan.

The forces driving this growth are formidable. As in post-communist Eastern Europe, companies and workers in China who once relied on the state for their needs are today facing greater uncertainty.

China has been accelerating its privatisation programme, laying off hundreds of thousands of staff and reviewing benefits such as pensions, healthcare and housing allowances. Managers of newly privatised companies are being forced to consider insurance to protect their assets. Employees, faced with less job security, need to find new ways to guarantee their families' welfare.

On the home front, Beijing's ?one-childpolicy' has undermined the traditional Chinese safety net – the extended family. "Chinese people are realising that insurance is important because if you have a one-child policy there might be no one to take care of you as you get older," says Kristensen.

China is also under pressure to reconsider its pension system. The government is currently paying pensions out of its recurrent budget. But the ageing of the population is forcing the authorities to consider switching to a funded scheme (one that is financed through members' contributions).

Qu Hongbin, an analyst with Bank of China International, estimates that China's current pension liabilities total US$850bn, or about 80 percent of GDP last year, a deficit that will have to be funded at least partly through private sector pension funds.

"Every Chinese leader I talk to, vice minister or above, they're all deeply concerned about the pension issue in China," says Marc Sterling, vice president of regional operations at Canada's Manulife.

To accelerate change, China over the past decade has begun allowing more foreign participation in the insurance industry. There are now 16 wholly-owned foreign companies and foreign joint ventures and nearly 100 representative offices. Aside from Winterthur and Manulife, foreign companies operating in China include units of American International Group, Tokyo Marine Insurance, France's AXA and Germany's Allianz.

However, three major state-run companies, China Life Insurance, the People's Insurance Company of China – which covers the non-life business – and China Reinsurance, still controlled 88 percent of the business last year. Foreign insurers accounted for only 1.5 percent of the market and 15 smaller domestic companies the remainder.

Foreign enterprises are currently being held back by a myriad of regulations contained in diffuse and often conflicting legislation. According to Linklaters & Alliance, an international law firm, these rules require foreign companies to obtain CIRC approval to establish an insurance company in China. Foreign investors are allowed to take up to 50 percent equity stakes in life insurance companies. Non-life insurers are allowed to take up to 51 percent.

Geographical restrictions
Foreign operators may not engage in both life and non-life or commercial business and their activities are geographically restricted to specific cities, in most cases Shanghai, Guangzhou and Shenzhen. Non-life companies may sell insurance only to other foreign-invested companies while life insurers may sell policies to foreigners or individual Chinese only, Linklaters says.

However, exceptions abound. The leading foreign company in China, American International Group, for instance, has been allowed to run wholly-owned life and non-life businesses in Shanghai because its Chinese operations were established before the restrictions came into force. In another anomaly, foreign insurance companies in Shanghai are allowed to insure foreign clients' assets only if they lie within the city's boundaries. Factories lying just outside the city limits are out of bounds.

Aside from legislation, foreign insurers face numerous obstacles. A key challenge often overlooked by foreign investors is the level of fragmentation of the China market, says Wong of PricewaterhouseCoopers. Economic development, the unemployment rate, the level of involvement of regulatory authorities and the tax regime can all vary enormously between cities and provinces.

"The products needed for each market can be quite different. You can't just have one product and one marketing campaign for the whole country," says Wong.

The market is also labour-intensive. Unlike in the West, where e-commerce is becoming more popular, life insurance companies in China still need to employ armies of agents. While labour costs are lower than in developed markets, so too is the average premium. Non-life insurers too, face higher processing costs. The law does not yet allow for foreign brokers, so non-life insurers must do their own intermediary work.

Another potential constraint is the lack of sound investment channels. Insurance companies are allowed to invest in bank deposits, government bonds and some mutual funds that buy shares in domestic companies. These channels generate limited returns. Interest rates are low. Poor corporate governance and a casino-like mentality among Chinese retail investors make the country's stock markets a risky place to invest. China's capital account controls mean that premiums cannot be invested offshore.

Manulife's China operation has been making a steady return from its investments in domestic bank deposits and bonds and, after five years, is expected to break even this year or next. As a start-up, it has pursued a conservative policy but it would consider branching out into equities if insurers were allowed to invest directly into the market rather than only through mutual funds. "As the law allows insurance companies to invest directly in equities, then I think we'll become much more active," Sterling says.

Expectation gap
Foreigners also have to be careful in choosing their joint venture partners. Offshore investors will generally be prepared to take up to 10 years of losses in order to build up the business. However, local investors, accustomed to rapid growth in other industries in China, may be less patient.

"Some Chinese investors will expect a dividend in the very early years, so in that respect there can be a big expectation gap between Chinese and Western investors," Wong says.

Weighed down by these restrictions and challenges, most foreign insurers are pinning their hopes on China's entry to the WTO, now almost certain to happen early next year. Under WTO rules, foreign companies will be able to participate in the reinsurance industry and they will be freed of geographic and product limitations. Non-life insurers will be able to establish wholly-owned subsidiaries within two years of China's accession.

Wait-and-see attitude
The position for foreign life insurers is less clear. They are meant to be restricted to joint ventures, although US negotiators say AIG has secured the right to expand on a wholly-owned basis. The EU believes that the wording of a WTO working party report gives European insurers the same rights as AIG. If the rules are challenged in future, as seems likely, they will have to be resolved by the WTO's dispute resolution system.

While the changes have the potential to revolutionise the market, foreign insurers will first have to wait to see how the CIRC implements the measures contained in the accords, says Kevin Wong, managing partner n Shanghai with Linklaters.

"More insurers will be allowed in but this s really only the thin end of the wedge," he explains. "Allowing them to expand the cope of their operations, allowing them Wore investment opportunities for premiums s the key thing and how that's going to pan out is still anyone's guess."

Winterthur's Kristensen, a veteran of the earlier stages of liberalisation, agrees the hard work is far from over. "You need to have a long-term view," he says. "People say it over and over again about China, but it's true."

More hotels for leading cities
The supply of international hotels is expected to expand in Beijing during the lead up to the 1008 Olympics, but Shanghai is also opening new properties, especially in the Pudong area of the city. At the end of 2001, there will be 39 four- and five-star properties with a combined total of 18,442 rooms, according to a report by FPDSavills. By the end of next year, according to the property consultants, Pudong's share of the city's room stock will have risen to 32 percent. This is up from 22.4 percent at the end of 1999.

Supply will increase significantly over the next couple of years, encouraged by improving occupancy rates over the past 16 months and an increase in occupancy and average room rates. However, the forecast suggested that the coming supply bulge would exceed demand growth in the short term.

Surge in museum construction
Work is progressing on the construction of 32 new museums in Beijing, bringing the total number in the capital to 150 in time for the 2008 Olympics.

One of the most important will be the Capital Museum on western Changan Avenue, which will tell the story of the city's geology, culture and economy, according to Beijing Daily. Many new museums will be situated in the northern part of Beijing, close to the principal Olympics venues.