Insurance homework

If only every Chinese person would buy an insurance policy for US$1! Now that is a wet dream with insurance characteristics. The question is to what extent foreign insurance players will ever be able to participate in this dream of an insurance policy in every Chinese home.

Let there be no doubt, China's insurance sector has witnessed tremendous growth in recent years. The rapid development is a consequence of the dismantling of the cradle-to-grave social security and welfare system which until recently had been provided (at least for the urban population) through the planned economy and its state-owned enterprises. Today, individuals have no choice but to build up their own financial and social security through savings, investments in stocks and bonds and life and non-life insurance policies.

Here are some figures to illustrate the rapid growth of China's insurance sector: The average annual growth in premiums over the last decade was 23.6%. In 2002 China's insurance companies collected premiums worth RMB 305 billion (US$36.84 billion), a year-on-year increase of 44.7%. In comparison, global average growth was about 2.6% for the period 1999-2002. But from the perspective of insurance penetration, China still has a long way to go. Per capita spending on insurance policies in China in 2002 was just US$28, compared with US$1,473 in Germany in 2001.

Over the past decade, the insurance sector has changed from a monopoly run by the People's Insurance Company of China (PICC) to a diversified market place with a growing number of both Chinese insurers – some of which (like Ping'an) are invested with foreign capital – and foreign insurers such as AIG, Prudential, Allianz, ING and AXA. Chinese insurers have so far preserved their dominant positions in the market thanks to tight restrictions imposed by the insurance regulatory body on the activities and geographical presence of foreign insurers.

But while the growth figures are impressive, the Chinese players are living under the shadow of a daunting legacy, which may take years to resolve. Most Chinese life insurers are saddled with billions of dollars in potential losses arising from high guarantee policies offered in the 1990s. Standard & Poor's estimates that the life insurance sector needs to increase its capital by RMB 15- 20 billion and the non-life insurance sector by RMB 7-10 billion to achieve adequate levels of capitalization.

One way for the Chinese insurers to extricate themselves is to invite a foreign strategic partner to take a stake. Another way to address the under-capitalization issue, apart from a bailout from the central government, is to raise capital in a public listing on the overseas markets. PICC did it recently in Hong Kong, and China Life is in the process of being listed in Hong Kong and New York. Looking forward, things can only improve for foreign insurers. With China's entry into the World Trade Organization (WTO) two years ago the clock started ticking for the insurance sector to open up. Upon accession, China pledged to remove most, if not all, restrictions hitherto imposed on foreign insurers within five years. By 2006-2007, provided that China implements its commitments fully (which I personally have no reason to doubt), a new market scenario will emerge that is much more open to foreign participation. Assuming that growth of the Chinese economy and of the insurance sector continues to roar ahead at basically the same high levels as in recent years, it is likely that in 10 years' time China's insurance market will have become one of the major insurance markets in the world. Growth of the insurance sector from a regional perspective will be uneven, dovetailing with pace of macroeconomic development in different regions. The urban population in the coastal area will largely fuel the growth, whereas rural areas will remain too poor for most insurance companies to bother about. Most foreign insurers will probably target affluent and high net-worth individuals rather than going for the masses.

Those foreign insurers that plan to reach out to the rural areas (which will happen eventually) will have to devise basic and inexpensive products more accessible to the rural population, in a similar way to the process used to gain rural penetration for mobile telephones after the urban areas started to reach saturation. Foreign insurers' market share will of course remain small until restrictions are lifted. But after that, the foreign slice of the pie will grow at an accelerated pace, and in 10 years' time it is possible that they will account for a market share of 15-20% on the strength of very competitive products and high quality service.

But the peculiarities of the Chinese market will continue to test the patience and capital of foreign companies. Continued structural changes (mergers and acquisitions) and home market shareholder pressure on foreign insurers to refocus on core business in order to ensure profitability leads me to believe that in the shortterm it will be extremely difficult for all but the largest foreign insurers to continue to pursue the Chinese insurance market. If that is the case, what should the strategy be if you work for a medium-sized foreign insurance company considering the China market? My answer is: do your homework and think of the old Rolling Stones song "Time is on My Side."

It is a fair bet that Mick and Keith were not thinking of the predicaments of insurance investment in China when they wrote that immortal song in the 1960s, but time is definitely on the side of the foreign insurers, even the smaller ones. This market has such huge potential that there will be a place for all sorts of niche players. So learn the market, participate in a low-cost way, explore possibilities, make contacts, build relationships. Keep your eyes out always for the right opportunity.