Wang Zhiwei, 34, works in the administration department of one of the smaller brokerage firms in Beijing’s Financial Street district. His daughter has just started high school. While China wasn’t hit hard by the global financial crisis, he says the meltdown was a reminder that economic stability is not guaranteed.
To ensure his family’s financial security, Wang took out a private life insurance policy two years ago. "I thought it was a good idea – I probably should have done it before," he said. "I’m getting older now and should anything happen to me, I want to know my wife and my little girl will be OK. It is also a good way of saving money, which will come in useful when I retire. The economy is strong, but sometimes I worry about what the future will be."
Wang may not be comforted to know that his worries are shared by the very companies he trusts to protect him: In recent months, China’s insurance firms have raised concerns about the industry’s growth prospects. Their gloom is rooted in a recent period of faltering investment returns. China Life (LFE.NYSE, 601628.SH, 2628.HK), the country’s biggest life insurer, booked a net profit increase of just 3.4% year-on-year in the third quarter to US$1.03 billion. It was rescued by the recent rebound in domestic stock markets after a weak first half.
Ping An (601318.SH, 2318.HK), China’s second-largest insurer, has been even less impressive. The Shenzhen-headquartered firm, which sells life as well as property and casualty products, recorded a 26% drop in net profit for the July-September period to US$471 million. Both Ping An and China Life, as well as smaller players like China Pacific Life (2601.HK), China Taiping (0966.HK) and PICC Property & Casualty (2328.HK) have expressed misgivings about their growth outlook.
In September, the China Insurance Regulatory Commission (CIRC) made an announcement that could significantly alter that outlook. In new provisional regulations, the CIRC offered insurers wider avenues for investment exposure – in particular, real estate, unlisted equities and private equity funds.
The rules were widely greeted as a positive and very necessary move, but the industry’s struggles are by no means over.
According to the CIRC’s figures, China’s insurance sector had assets totaling US$672 billion by the end of July. Aggregate premium revenues were US$136.5 billion for the period, US$101 billion of which was generated from the life sector, with the remainder coming from property and casualty.
With an annual premium growth rate of 20%, Chinese insurers are fretting about their ability to cover liabilities as life policies, which account for the majority of the domestic insurance market, begin to move closer to maturity. China’s insurance penetration is currently only 2.3% nationally and around 4% in first-tier cities. That compares with a rate of 10% for the UK and 7.8% in Japan. The mainland life market is only going to continue to expand; insurers’ growing asset-liability mismatch will weigh down performance until investment targets and yields are increased.
"Historically in China, the number of investment products has been quite limited," explained Phillip Smith, a partner at law firm Mayer Brown in Hong Kong whose clients include one of China’s top insurers. "We believe the regulator is giving insurers wider avenues to park funds until life policies mature, so that when they do mature, they can be met by these insurance firms."
Traditionally, Chinese insurers have funneled their investments into fixed income products such as bonds and deposits, with some exposure to equities. Ping An, for example, had 86% of its investment portfolio in fixed income and 9% in equities by the end of the first half. Adding to insurers’ woes have been falling bond rates, low interest rates in an environment of relatively high inflation, as well as the relatively low short-term returns on government paper when compared with insurance policy demands.
"There’s a limited amount of corporate or financial bonds available in the system," noted Sally Yim, senior analyst at Moody’s Investors Service (MCO.NYSE) in Hong Kong. "The total amount of outstanding bonds is relatively small. Insurers actually find it quite difficult to find non-dated assets to match their liabilities."
Subject to solvency requirements, the CIRC’s rules will allow insurers to invest up to 10% of total assets in real estate. Under the 10% cap, insurers can invest 3% of assets in real estate-related financial products such as real estate investment trusts (REITs).
But REITs do not yet exist in an official capacity and the channels for real estate investment are limited to commercial and office-related projects. Insurers will still be barred from residential projects and from direct involvement in real estate development. Still, the new rules are aimed at lengthening the lifespan of investments and diversifying risk in the hope of higher returns.
"Right now, it is difficult to say what the increase in yields will be from real estate investment," said Darwin Lam, China insurance analyst at Citigroup (C.NYSE, 8710.TYO). "Different regions and different asset classes – Grade A, Grade B offices – means it’s hard to quantify, but it’s definitely a positive for insurers."
Opening real estate for investment will in any case increase the duration of returns, explains Lam. Investments in deposits are typically over a one- to three-year period, or over five years with negotiated deposits – deposits in which the terms, such as rates, are negotiated between the insurer and the bank. Government bond holdings last three, seven or 10 years.
"This is not long enough to match liabilities," said Lam. "Investment in properties or infrastructure projects would significantly lengthen the duration of investments and would help match the long maturity of liabilities."
The option of investment in REITs remains held up in Beijing. For years, the central authorities have talked about launching a REIT and creating an investment environment in which mainland REITs could be listed on domestic or overseas bourses. The government has formulated several trial runs, but each time it has come close to finalizing rules, the property market has entered a phase of overheating followed by government-induced cooling – as in the downturn after the 2007-2008 bubble, and today. Speculation has been mounting that the CIRC’s approval for insurers to enter real estate investment products marks a significant step toward finally launching REITs. Yet Moody’s Yim discredits this theory.
"The launch of a REIT would depend a lot on the regulator’s feeling about the readiness of companies to get involved," said Yim. "The number of investors who would be qualified to invest in such products may not be enough to support a REIT market yet. It may take more time for this market to develop."
She added that both the insurance and real estate regulators feel that there might not be enough industry or investment knowledge to invest in REITs. Even if such products were launched, initial investment would therefore be quite low.
The situation is much the same for insurers’ investment in private equity. "I think insurers will first start with a very small amount of their investment in private equity because it’s a very risky sector for them," Yim said. "It could take years before they realize gains from these investments. The regulator is quite cautious about these risks as well."
The CIRC said insurers will now be permitted to invest up to 5% of total assets in direct equity investments in unlisted companies, or up to 4% of total assets in private equity funds. Insurers had previously been allowed to invest in infrastructure companies and commercial banks under a pilot program, but the scope for private equity investment seems to have been widened greatly. According to Smith of Mayer Brown, however, the gates have hardly been thrown wide open.
"You have to remember that the majority shareholder of the biggest mainland insurers is still the Beijing government, even though [insurers] have been listed on domestic and foreign stock exchanges," said Smith. "We expect there will be a focus on investments in sectors in the mainland that have been prioritized by the central government."
The CIRC has said that favored private equity investments would include those targeting low-polluting industries, infrastructure, green energy and other sectors contributing to public welfare.
For now, China’s insurers have an aggregate US$68 billion to invest in property and property-related projects, and US$34 billion available for investment in private equity under the new rules. However, the CIRC has set several qualifying criteria, including profit, asset values, and asset management competencies, that must be met if insurers wish to take advantage of the looser regulations.
A solvency ratio of 150% has also been set, limiting access to property and private equity investment to China Life, Ping An and China Pacific Life. The country’s two biggest non-life insurers, PICC Property & Casualty and Ping An Property & Casualty, do not qualify for some investments under such solvency rules.
The issue of asset management capabilities could also further limit the number of insurers able to enjoy the CIRC’s new investment regime. Historically this has been a problem affecting smaller insurers, which do not have the internal human or capital resources to effectively manage assets without external assistance. Insurers are still mulling over whether to scout around for investment opportunities on their own, or whether to recruit experts in real estate or private equity onto their existing teams.
Smith from Mayer Brown believes another option lies outside insurers’ office walls.
"One possibility is to mandate a third-party asset management company that is qualified to manage the company’s assets," said Smith.
An insurer could give the asset manager full discretion over the investment portfolio. That asset manager would then go out and source investment opportunities and add value to the deals. "The ultimate upside would go to the life insurance companies," said Smith. A further possibility would be to form a joint venture asset management company in which the insurer would hold a major stake and jointly manage the newly created investment entity.
Favoring the giants
But these investment capabilities largely reside within the confines of the country’s top-end insurers, observed Leslie Mao, director of investment service at management services firm Towers Watson.
"It will be comparatively easier for the bigger insurers to operate and increase investment holdings under the [CIRC’s] new rules," said Mao. "Smaller insurers may not have the capabilities that their larger competitors currently have."
This does not necessarily mean that the life sector will be controlled solely by China Life and Ping An, or the property and casualty industry by PICC. While the top insurers for the most part have the ability to establish competent investment or asset management teams, the CIRC’s new investment program will raise the bar high enough to motivate smaller players to build on their own risk management capabilities. If they want in, they’ll have to improve competencies, not just revenue. All of this will take time.
"Even though the new rules sound like a big deal for insurers, the benefits will only come over a much longer-term basis when the market is more mature and more developed," said Moody’s Yim.
"The industry has changed a lot over the last five years. Maybe in another few years the market will be ready. Risk management practices will likely have improved by that time."
Citigroup’s Lam is more upbeat. He acknowledges that only the "big picture" rules have been announced, but even they are grounds for optimism – and detailed guidelines are forthcoming.
"The new investment guidelines are long-term positives. It will take time, but it’s definitely a step in the right direction."
No questions asked
The CIRC knows that the industry is coming under greater pressure to perform. Until recently, the thought of maturing policies was a relatively abstract one. But with policy-holders like Wang in Beijing increasingly looking to take greater care of their families’ futures, the need for solutions to unblock insurers’ investment streams is ever more real and urgent. The last thing the government wants is for customers, or the market, to doubt insurers’ liability coverage.
Sitting in a Financial Street coffee shop, Wang noted that things have changed a lot over the last several years. "When I graduated from university we never heard of things like insurance policies. But now with school costs, higher living costs and a mortgage to pay for, having a back-up plan like insurance makes sense."
Glancing toward China Life’s new headquarters two blocks down the road, Wang said he had sensed a feeling of relief when he took out his policy, and intends to top up his payments. "It’s good to know your money is safe."
Even if it takes some time, the CIRC is more keen than ever to make sure his trust isn’t misplaced.