For Shanghai professionals Fiona Mao and Joyce Chen, the future is bright. Both in their early 20s, they represent the new Chinese middle class, with good jobs, money to spare, and the security of knowing they can afford to look after themselves when they retire, or if they become ill.
But they are still a minority among China's 1.3 billion people, around 70% of them rural residents who are struggling under the weight of low incomes and growing apprehensions about tomorrow.
"I am worried about the country's future," said Chen, who is taken care of through a company pension and insurance scheme, and also contributes to a private pension scheme. "Welfare is not good here because there are too many people."
As China dismantles its "iron rice bowl" cradle-to-grave welfare state, it is these simple human fears that are attracting global insurers, banks and financial conglomerates, and driving the rapid growth of China's nascent insurance industry.
"The social systems are eroding and the government doesn't have the funding it would need to finance it all," said Stephan Binder, a partner in McKinsey & Company's Shanghai office, citing a pension shortfall that is expected to cost the government US$110 billion by 2010 (See: Old but not yet rich).
Figures from China's insurance regulator, the China Insurance Regulatory Commission (CIRC), show that faced with an uncertain future, people are beginning to take their security into their own hands.
On the rise
From 2000 to 2005, revenue from insurance premiums in China tripled to US$61 billion, with growth in life insurance primarily responsible.
Life premium revenues rocketed from US$3.76 billion in 1996 to US$46.25 billion by 2005, at which point they accounted for 75% of all insurance premium revenues, far in excess of the US$15.2 billion brought in by non-life premiums last year. This is all the more astounding considering that as recently as 1996, life insurance premiums lagged behind non-life premiums.
Low insurance penetration and a rising middle class – which is sitting on US$1.72 trillion in low-yielding individual bank deposits – are fuelling expectations that the good times will continue for insurers.
According to estimates by Swiss Re, the world's largest life and health reinsurer, insurance penetration in China was just 2% of GDP in the life sector in 2005, compared with 3.5% for other Asian countries and 4-5% in Europe and North America's largest markets. In the property and casualty sector, penetration is just 0.7% (See: Driving over the non-life roadblocks).
State officials expect China's middle class, which is defined as households with an annual income of US$7,200 to US$60,400, to increase from 5% of the population today to 45% by 2020. Though perhaps optimistic, it's clear that the key demographic targeted by insurers is rising.
According to financial services research and advisory firm Celent LLP, the market is poised to nearly double to over US$100 billion by 2009. China is forecast to become the fourth largest life market in the world by premiums in 2008, after the US, Japan and the UK.
But the low base in the non-life segment means it will be 2031 before the insurance industry as a whole enters the top five in terms of net premiums written.
However, 2005 saw a slowdown in growth in the life sector. Although the headline growth figure was 17%, a one-off US$2.4 billion premium group life transaction undertaken by Generali China Life, the local joint venture of Assicurazioni Generali, Italy's biggest insurer, was responsible for a major chunk.
Discounting this deal, life premiums grew a relatively modest 8% in 2005, lagging economic growth for the period and representing a significant tailing off from the 20% year-on-year growth recorded in 2004 and 29% in 2003.
While much of the downturn can be blamed on the government raising deposit rates, it can also be linked to aggressive and misleading sales practices by banks during 2004, which gave the industry a bad name.
In an effort to grow business in an increasingly tight market, many banks advertised return guarantees on five-year single premium policies that were higher than they could deliver, causing widespread disillusionment among investors. As a result, Bancassurance, or the selling of premiums by banks on behalf of insurers, declined by around 20% in both 2004 and 2005, according to Sally Ng, co-head of UBS Asian Banking Research, dragging the market with it.
The life insurance market appears to be slowly getting back on track, with the latest official figures showing an 11.3% increase in premium incomes to US$25.1 billion in the first half of 2006
While it's certainly not the end of the road for insurance in China, it is not simply a case of turning up to make money as domestic firms have already snapped up much of the low-hanging fruit.
"It's very much a domestic story so far," said Binder, stressing the size of the barrier that dominant domestic providers place in the path of foreign entrants.
Foreign insurers accounted for only 8.78% of the life insurance market in 2005 with US$4.05 billion in premium revenue. While this is up on the 2.3% secured in 2004, subtracting Generali's US$2.4 billion group premium deal puts the market share at a much more modest 3.75%. In the non-life segment, foreigners only won 1.31% of total revenues, or US$212.25 million.
Given that all foreign insurers are working in joint ventures – apart from American Insurance Group (AIG), the world's biggest insurer, which won a license to do business in China in 1992 as a result of former chief executive Maurice "Hank" Greenberg's relationships with Chinese officials – foreign market share needs to be halved to give a true picture.
It's not only a small pie, but it is also one that is increasingly shared by more and more players.
China had 82 insurers as of the end of 2005, 42 operating in the life segment and 40 in non-life insurers. Foreigners represented around half of all companies with 23 operating in the life market, and a further 18 in the non-life segment.
But just three domestic players dominated 70% of the life industry, including China Life with 43.5%, while the top three non-life insurers claimed 72% of their market, with PICC in top spot with a massive 51.5% market share.
"Collectively the MNCs (multinational corporations) are doing well, but that is cold comfort to individual companies," said Glen Sedgwick, lead partner for Asia Pacific insurance at consultancy Accenture. "MNCs don't compete at a collective level, but as individuals. They care more about what their share of the market is."
Part of the dominance of domestic companies can be explained by restrictions on geographic expansion of foreign insurers, which until December 2004 were only entitled to operate in 15 major cities.
In places that were opened up earlier, such as Shanghai and Guangzhou, the market share of foreign-invested insurance companies had reached 15.3% and 8.2% respectively in 2004. China Life, is not so successful in these cities.
These are also the areas where people are most likely to already have insurance, making it harder for new entrants to capture market share. While Shanghai represents just 1.3% of China's population, it accounts for 6.8% of premium revenues. In Guangzhou, 0.8% of China's population account for 3.2% of its life revenues, while Beijing-based insurers earn 10% of all life premium revenues from only 1.1% of the national population.
"For MNCs it is still pretty much a land grab," said Sedgwick. "They are all very small relative to China Life, to Ping An, so they need to create viable market shares from which they can grow and put stability in the business."
With first-mover advantage gone in the main centers, most foreign insurers are now rapidly surveying China's second and third tier cities, measuring demographic factors and economic growth, and discounting the result for existing competition. But here, consumers are less likely to have the disposable income the insurers are after.
Penetration statistics can be misleading, said McKinsey's Binder. "The statistics take 1.3 billion potential customers into account, but around 870 million people live in the countryside and have no savings. Wealth is geographically concentrated in the seaboard cities."
Though short-term gains will be elusive because of the huge capital outlay required to establish new operations, there is no substitute for first mover advantage.
"In the end, people have to take the view that, if we believe in the urbanization story of China, then the second and third tier cities will eventually grow a lot faster compared to the first tier cities," said UBS's Ng.
For ING Insurance Asia-Pacific CEO Jacques Kemp, expansion does not necessarily mean setting up in a virgin territory.
ING was one of the early arrivals, teaming up with China Pacific Insurance to form Pacific Antai Life Insurance Company (PALIC) in Shanghai in October 1998, and starting a second joint venture, ING Capital Life, in Dalian in July 2002 with Capital Group of Beijing.
PALIC, the fifth largest life joint venture in China by premium, operates in Shanghai, Guangzhou, Dongguan, Nanhai and Shun, while ING Capital Life is active in Dalian, Beijing, and Shenyang, and is now establishing operations in Jinan, the provincial capital of Shandong.
But it is not alone. ING Capital Life faces stiff competition from CITIC Prudential Life and Aviva-COFCO, China's third and fourth largest joint venture life insurers by premiums, which have also been granted a license to sell insurance in Jinan this year.
Facing aggressive competition throughout China, Kemp said ING was concentrating on expanding its distribution channels, looking particularly at the bancassurance market, which is becoming an increasingly important sales channel in China. In January and February of this year alone, premiums sold through banks grew 121% to US$3.2 billion, 34% of China's total life insurance premiums for the period.
In March, ING Capital Life signed a distribution agreement with Hong Kong-based Bank of East Asia's (BEA) Dalian branch to distribute insurance products.
The company also has bancassurance agreements with China Construction Bank and Bank of China in Dalian. It has also secured a 19.9% stake – and a valuable distribution channel – in Bank of Beijing.
"One of the reasons we wanted a major stake in Bank of Beijing was to get access to their customer base," Kemp said.
Time to diversify
The industry also needs to start diversifying its product base, which is dominated by simple single premium, short-term, low-protection products, which provide an attractive substitute to bank deposits, but do little to develop a strong long-term base for the industry.
"What we have seen in China is MNCs providing a lot of short term products because of demand from headquarters for growth," said Accenture's Sedgwick.
"There are a lot of single premium three and five-year maturity products, which have been snapped up and given a lot of apparent growth. But it turns over quickly. You need to resell or find a better way."
Given the shortage of suitable long-term investment vehicles in China with which insurers can offset their liabilities, there is little appetite for branching out into higher-yielding, higher-protecting and higher-risk products. Official statistics revealed that Chinese insurers had about US$200 billion in gross assets by the end of April, most of it in low-yielding government bonds and bank deposits.
Since 2004, the government has been working to liberalize investment classes to create an environment in which insurers will be able to back more sophisticated products with higher returns and longer-term protection.
New regulations are expected to be released soon allowing insurers to raise their investments in the domestic stock market, which are currently capped at 5% of total assets. They will be able to invest in asset-backed securities, property, and venture capital projects, and take stakes in strong-performing local banks.
Investment will also be permitted in state-level infrastructure projects to 15% of total asset value.
In addition, the regulator is set to revise rules on overseas investment. In April it gave the green light for insurers to buy foreign exchange quotas in order to invest in overseas fixed-income and money market instruments, capped at 15% of total assets. This is expected to be expanded to cover other overseas products, including equities and funds.
Linbo Fan, Greater China senior research analyst for fund intelligence agency Lipper, said the regulator could also allow insurers to invest in higher-risk assets like private equity or hedge funds. But he expects changes to be introduced gradually.
"Safety is most important for them," he said, citing the relative immaturity of China's capital markets and a lack of investment experience among insurers as grounds for caution
Accounting for risk
However, UBS's Ng believes that risk can be built into the system, with the regulator considering moving to a risk-based capital framework in which solvency requirements are matched to asset risks. What the final regime may look like is still uncertain, but any increase in solvency requirements is expected to be gradual, and thus relatively acceptable to insurers.
As a result of this switch, smaller players could well push to raise more capital, opening up opportunities for foreign investors looking for China insurance assets. Domestic listings are also likely, said Ng.
"If the [unlisted insurers] don't go for [A-share] IPOs there could be a big problem. It looks like the capital-raising time is on the cards for a number of them."
She believes that opening up investment channels holds the best hope for sustained growth in the industry. It should serve to release the brakes on insurance companies, enabling them to offer a higher return to policy holders, and hence grow demand.
"If they can pursue this path of improving investment channels, with affluence levels still rising and GDP growth at 8-10% I think it is pretty likely that the premium growth of the industry can be sustained at 18%," Ng said.
With domestic players already well in the lead, and now taken off the regulator's leash, it remains to be seen what share of new growth foreign players can nab – but they need to move quickly. "We know this is going to take time, we have to invest for the long run but at the same time we have got to get there as fast as we can," said Accenture's Sedgwick.
"The question is, how do you create a footprint in the market which will allow you to sell the products you can sell today and develop the portfolio and the customer base into those other spaces?"
For ING's Kemp, it is simply about meeting a need. "We will not only be in the mass market but we will also move up the scale with special products for the emerging generation of people who have more money than just to buy a car," he said.
"As China evolves and grows there will be a vast range of opportunities to keep growing and expanding."
Old but not yet rich
As China struggles to modernize its traditional company-financed "iron rice bowl" cradle-to-grave welfare system, its rapidly aging society is casting the country's economic and social future into doubt.
"If I was old now, had my own flat and didn't owe money to the bank, I think I would be satisfied with the current government pension and health insurance scheme," said Fiona Mao, a 24-year-old Shanghai software engineer who receives private insurance cover through a scheme run by her employer.
"But 70% of Chinese people live in the country. They are not considered in the government welfare system, and when they get old, they can only depend on their savings and their children."
This traditional form of old-age insurance, children, is soon going to be one of China's scarcest commodities.
As a result of the one-child policy enforced in 1978 to control China's rapidly expanding population, the world's most populous nation has found itself grappling with the "4-2-1 problem", where one child will be expected to support two parents and four grandparents.
Put simply, it is a nation at the brink of an historic demographic transition that will see it become the first significant country to get old before it gets rich.
According to a report released this year by the China National Committee on Aging, the aging population in China is growing by 3.02 million annually. By 2051, there will be 437 million elderly people, with three out of 10 Chinese aged over 60. At the same time, the percentage of China's population that is working will peak by 2010 and the ratio of workers to retirees will decline dramatically, from six to one in 2000 to two to one in 2040
Holes in the system
While China is not alone in its predicament, the lack of a fully-funded pension scheme will magnify the age-care burden.
China currently has three main types of government-sponsored pension system: the government's basic enterprise pension system covers around 108 million workers; 27 million are protected by special occupational schemes for civil servants and employees of state organizations and institutions; and approximately 60 million rural workers belong to voluntary pension insurance schemes.
But according to the World Bank, these pension schemes only cover 23.5% of China's eligible working-age population, or 196 million workers between the ages of 15 to 59. There are also roughly 300 million Chinese people who don't even qualify for these meager government programs – the urban poor, landless peasants and former farmers who have moved to the cities in search of work.
The basic enterprise pension scheme is already under pressure. Employers pay about 20% of wages toward a guaranteed schedule of benefits and employees contribute 8% of wages into personal accounts that are supposed to be invested in government bonds and bank deposits.
But a lot of those payroll taxes have been "borrowed" by the provincial governments to pay so-called legacy pensions owed to the millions of employees laid off and allowed to retire early when China began to restructure its state-owned enterprises in the 1990s.
Including these legacy pensions, China's implicit pension debt is now some US$1.5 trillion, according to the latest estimates by the World Bank.
Even without the legacy problems, the new system is deficient, with contributions falling behind withdrawals. According to research by McKinsey & Partners, the growing imbalance between payouts and contributions has taken the system to the verge of bankruptcy, creating a gap that reached US$15 billion in 2005 and is expected to rise to US$110 billion by 2010.
As urbanization sees the proportion of people living in the cities rise from 30% today to roughly 58% by 2050, the scheme will absorb an increasing share of the nation's pensioners, putting it under even more pressure. By 2066, the World Bank estimates it will cost the government 70 basis points of GDP every year to finance the deficit between worker contributions and pension payouts
Last chance saloon
Recognizing the problem, in 2000 the government set up the National Social Security Fund (NSSF) as a fund of last resort.
While it shows promise, the execution has so far been weak, largely due to limits on offshore investment opportunities. To its credit, the regulator has recently called for foreign help in investing these assets offshore, but by the end of 2005, the fund's assets were only US$26.5 billion, the majority of which was languishing in low-yield Chinese bank deposits.
Not only do state pension schemes fail to cover those most in need, payouts are low for those who do receive coverage. At only 20% of the average employee's wage, the average pension is disappointing by developed world standards, where pensions reach 40-60% of the average wage.
Stephan Binder, a partner in McKinsey & Company's Shanghai office, believes flaws in the state welfare system provide opportunities for private insurers. "Life and health insurance products are a means for the individuals to protect themselves and make the system more efficient."
There is also a golden opportunity for insurers to work directly with Chinese companies to create additional welfare schemes for employees.
Last month, computer giant Lenovo announced the country's first corporate pension program, teaming up with corporate pension service provider Ping An Endowment Insurance Company. Lenovo said about 70% of its Chinese employees have applied to join the pension program, which would boost monthly pensions for the average retiree from US$160 to US$450, or 60% of their previous salary.
Chen Liang the Ministry of Labor and Social Security's Fund Supervision Department director, called for corporate welfare programs to become an essential part of China's pension system, and flagged an intention to provide incentives to encourage companies to follow suit, including tax-free contributions.
Many foreign insurance providers are already taking this route, particularly those who have formed joint ventures with large, state-owned employers.
This strategy paid off for Italy's biggest insurer Assicurazioni Generali, which entered China as recently as 2002 in a joint venture with China National Petroleum Corporation (CNPC), one of China's largest state-owned enterprises.
Generali China Life secured one of the single largest immediate annuity contracts in the world with a group contract covering 390,000 former CNPC employees. The single non-recurrent US$2.4 billion premium propelled the company into the top spot among foreign insurers in China.
It also puts the insurer in a strong position to corner the lucrative group insurance market, which was only opened to foreigners in December 2004, offering local and multinational companies a complete range of life, health and pension products.
British insurance giant Aviva is another that has recently entered this space, offering a group scheme to its joint venture partner, China National Cereals, Oils and Foodstuffs Import and Export Corporation (COFCO), one of China's largest state-owned enterprises.
While the deals have propelled these insurers into the top ranks of foreign players in China, it remains to be seen whether the model will be lucrative in the long run, said Glen Sedgwick, Asia Pacific insurance lead partner at consultancy Accenture.
"For the moment there is a bit of a watch on how the Generali deal works. We are not seeing a lot of people desperately rushing at that space yet. Everyone is watching it with interest but we are still not quite at the tipping point."
But as the Lenovos and Fiona Maos of the Middle Kingdom increasingly turn to private pension schemes to give themselves, and the government, a helping hand, that tipping point cannot be far away.
Driving over the non-life roadblocks
While much of the world's attention is on China's life insurance market, the country's rapid industrial and commercial growth is also creating significant opportunities in the non-life business.
Not only is the segment under-served in terms of volume, with the US$15.2 billion in premium revenues last year representing only a quarter of the total insurance market, the existing product mix offered by domestic insurers is dominated by mandatory motor vehicle insurance. The remainder is fairly basic, providing room for the innovative products that experienced foreign providers are in the best position to provide.
According to projections by financial services technology consultants Celent LLP, non-life premium revenues will grow 25% annually over the coming years, while life insurance revenue will grow at 10%.
The forecast may be ambitious, with revenues rising only 17% in 2005 to US$15.2 billion, and slowing further to 15.3% in the first half of this year. However, when held against revenue growth in developed markets, opportunities in China should provide a strong lure to foreign insurers squeezed for expansion opportunities by competition or regulation in their own countries.
So far, they have been slow to move, controlling only 1.3% of the country's business last year. Foreign market share in the main commercial centers is much higher, reaching more than 6% in Shanghai, for example. But even here, foreign companies tend to restrict themselves to under-writing overseas multinationals in China, providing continuity of service to the insured while protecting themselves to some extent from a market of uncertain risk.
The slow start comes despite non-life insurers having more freedom to operate than their life insurance counterparts. In addition to joint ventures and strategic investments, they are also permitted to set up branches and operate them as wholly owned subsidiaries.
However, as Stephan Binder, a partner in McKinsey & Company's Shanghai office, points out, the market is not as open as generally perceived.
Foreigners are still barred from the compulsory insurance market, which includes motor insurance. With domestic car sales climbing 46.9% year-on-year during the first half of 2006, and motor insurance making up 65% of the non-life market, the ban represents a significant lost business opportunity for foreign insurers.
Insurance Australia Group (IAG), Australia's largest home and car insurer, has found a way around the obstacle, agreeing in June to buy a 24.9% stake in China Pacific Property Insurance (CPPI), for up to US$280 million, with an option to increase the stake to 40%.
CPPI, one of five insurance subsidiaries of state-owned China Pacific Insurance, controls 11.3% of the domestic property and casualty market. Importantly, 60% of its portfolio is tied up in the auto business, giving IAG a valuable entry point into the compulsory insurance market.
The move is not without risk. Credit Suisse analysts warned in February that inadequate premium rates in China and a lack of quality data with which to assess risk cast doubt on the investment.
"In our view, given the highly competitive nature of the Chinese insurance market, we view the potential investment as carrying significant risk despite the strong growth appeal of the market," they said.
IAG's share price dropped 1.5% when it confirmed the acquisition in June.
Benefits of experience
An IAG spokesperson downplayed the risk, citing the company's nine years as an insurance broker for customers of the China Automobile Association (CAA), a roadside assistance company in Beijing. "This has allowed us to gain a good understanding of risk profiles associated with the Chinese insurance market, as well as local industry practices, sales methods and take-up rates," the spokesperson said.
Asked why the company chose to take a stake in a domestic insurer rather than set up individually, they claimed a tie-up with a local provider simply provided a better entry point than going it alone, a policy that the company had also adopted in acquisitions in Malaysia and Thailand.
But analysts maintain that the company's hands were tied by the ban on foreign entry into compulsory insurance.
There is little doubt that IAG has its eye on the compulsory motor insurance business, in which case its timing is impeccable. From last month, cover for property damage, injury and death was made a requirement for the owners of China's 130 million motor vehicles.
With only 35% of business vehicles currently covered, according to CIRC figures, CPPI's market dominance gives the Australian insurer a lucrative foothold it could not have won on its own.