Chinese insurance companies have long grumbled about a paucity of investment options. With little but the equities markets to rely on, insurers have found diversification and risk management difficult.
Now their complaints have been addressed.
In early September, Beijing announced a long-awaited initiative to expand insurers’ investment channels to include private equity and real estate. The deregulation comes less than a month after the investment ceiling for insurance firms in stocks and funds to 25% from 20%, reflecting government eagerness to bolster the industry.
Under the proposed arrangement, insurers would be allowed to invest up to 5% of their total assets in private equity and 10% in real estate. Based on total industry assets of US$671 billion as of June 30, insurers may invest up to US$67.1 billion into real estate and US$32.8 billion into private equity.
The plans look significant in terms of capital available for investment. However, given the considerable restrictions – not to mention close regulatory oversight – on new investments, the contribution to insurers’ profit may be limited. While US$100 billion could theoretically be unleashed into the housing and private equity markets immediately, it will actually come in increments.
One major caveat to property investments is that they are limited to commercial projects, an indication of Beijing’s concern about price volatility in the residential sector.
Insurance companies are also prohibited from directly participating in real estate development or owning controlling stakes in property firms. Investments in property-related financial products such as real estate investment trusts (REITs) are capped at 3% of assets.
For the private equity business, investments are restricted to other financial services enterprises as well as insurance-related businesses including pension, medical and auto services. Venture capital is off limits as are investments in high-polluting or high energy-consuming industries
"The rules would enable insurers to better match their assets and liabilities, improve asset allocation, ease investment pressure, diversify risks, and protect asset safety as well as the interests of policy-holders," the China Insurance Regulatory Commission said by way of explanation.
The initiative ultimately reflects government concern about insurers’ ability to maintain profit growth during periods in which the economy slows and the stock market is lackluster. The likes of China Life Insurance (LFC.NYSE, 601628.SH, 2628.HK) and Ping An Insurance (601318.SH, 2318.HK) saw investment gains slow considerably in the first half of 2010 as equities struggled.
Allowing greater investment diversity is certainly in the long-term interests of the insurance industry. Companies including China Life, Ping An and China Pacific Insurance (601601.SH, 2601.HK) announced at their interim shareholder meetings that many property and private equity projects are already in the pipeline, but nothing can really change overnight.
Income from these new investments is therefore unlikely to be reflected in 2010 or even 2011 earnings.
One thing insurers must do as soon as possible is boost their investment and risk-control abilities, which will the key factors deciding their long-term returns. The overriding priority should still be to maintain the safety of their assets and pursue a stable return. Private equity and property plays can be fraught with risk: difficulties securing quality projects being a problem in the former and the volatile policy environment an issue in the latter.
The launch of the new businesses will likely push insurance conglomerates towards additional share offerings as their solvency ratios tend to decline. Moreover, expanding investment channels may eventually prompt a spate of mergers and acquisition as the industry consolidates. Those same insurance conglomerates would be the direct beneficiaries.
The impact on the two sectors concerned, though protracted, will be significant.
Fresh funding will help sustain the commercial property boom as it extends into second- and third-tier cities in the next couple of years. Some observers have expressed concerns that insurers’ money will find its way into the residential market, but the government is likely to impose severe punishments on infringers. A failure to do this could cause serious damage to both the property and insurance sectors.
Private equity has already been growing rapidly in China recently. In the first half of this year, private equity funds raised more than US$19 billion, up 616.9% year-on-year. Insurers represent another source of capital and perhaps also profile-boosting opportunities by signing up big names like China Life and Ping An as investors.
As with most regulation in China, implementation remains more challenging than rule drafting. It is important that the different regulatory bodies find a way to work together to ensure strong oversight and prevent insurers from straying into overly risky investments.