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By George W. Russell

China is the world’s fastest growing insurance market and third largest in overall size. However, competition is intense amid lower margins and heavier regulatory scrutiny. George W. Russell looks at the state of the sector as it also gears up for major changes in accounting standards.

Along with Burberry scarves and imported baby formula, another must-have purchase has emerged for many middle-class Chinese consumers visiting Hong Kong. Record numbers of cross-border tourists are dropping in on local insurance agents to sign up for sophisticated policies.

This is just a small sign of the Mainland’s burgeoning insurance market. From life insurance to health policies to vehicle cover, China’s insurance sector is the hottest in the world with an expected annual growth rate of 15 percent in 2016-2020, according to a recent report by management consultancy McKinsey & Co.

Total value of insurance premiums reached 2.4 trillion yuan (HK$2.7 trillion) in 2015, up from 1.3 trillion yuan in 2010, China Insurance Regulatory Commission data show, making it the third largest market in the world overall, behind only the United States and Japan. Insurers’ total profits rose to 282.4 billion yuan from 83.7 billion yuan over the same period, CIRC notes.

“The rapid growth of the Chinese middle class, combined with the current low levels of insurance penetration, means that China’s potential as a consumer of health and wealth management products will increase substantially in coming decades,” says Philip Witherington, Chief Financial Officer, Asia, at Manulife and a Hong Kong Institute of CPAs member.

The big Chinese insurers – China Life, Ping An, China Pacific Insurance, People’s Insurance Company of China and New China Life Insurance – now comprise typical holdings of portfolio managers. Others have been standard-bearers for Chinese foreign investment with high-profile purchases such as the Anbang Insurance Group’s acquisition of the Waldorf Astoria Hotel in New York in 2014.

More than 200 Chinese companies are awaiting insurance licences, while China’s Internet superpowers have joined the fray: Alibaba has four insurance subsidiaries and Baidu and Tencent have two each.

Meanwhile, bricks-and-mortar insurers are harnessing the power of technology – Witherington says Manulife processes 11 percent of its Mainland medical claims through the WeChat messaging application – although the pace of adoption is slower than some analysts would like. (See Where insurance meets innovation below).

Regulatory wrestle

However, these growth dynamics coincide with regulatory upheaval, both in China and globally. On 1 January, the CIRC’s China Risk Oriented Solvency System went into effect, strengthening capital requirements, risk management and widening transparency disclosures, bringing China in line with global standards. The design and implementation of C-ROSS – with its three pillars and 17 technical standards – measures risks, strengthens solvency regulations and provides guidance on balancing risks and the cost of capital.

In addition, the International Accounting Standards Board announced at a meeting on 16 November that 1 January 2021 would be the tentative effective date of the forthcoming insurance contracts standard.

Both developments will affect Institute members who work in the insurance sector. “C-ROSS will enable authorities to maintain a modern level of regulation around capital, manage the way other risks for insurance companies are governed and make sure management properly implements them,” says Francesco Nagari, Global IFRS Insurance Leader at Deloitte in Hong Kong and a member of the Institute’s Insurance Regulatory Liaison Group.

Meanwhile, the forthcoming standard is designed to supersede IFRS 4. “There is going to be fundamental change in the way insurance contracts are accounted for, particularly in the life insurance sector,” Nagari notes.

The forthcoming standard will include differences in both liability measurement and profit recognition that is expected to result in volatility of profit and equity, according to a recent analysis by PwC Belgium. “We know from the extensive consultation process that the changes are significant, both in terms of measurement and disclosure,” says Witherington at Manulife.

It has been a busy year for insurance at the IASB. In September, the board issued amendments to the existing insurance contracts standard, IFRS 4, arising from implementing the new IFRS 9 Financial Instruments. “Both the new financial instruments standard and the upcoming insurance standard will improve quality and comparability,” says IASB Chairman Hans Hoogervorst.

Challenging incumbents

Accounting firms will be essential partners in ensuring that insurers implement the new standards. “The first task is building up the knowledge and the skills of the clients’ workforce, not just to be aware, but also to be operational,” says Nagari. “The second task is an impact assessment to look at the operating model against the requirements of the forthcoming insurance contracts standard and explain to our clients how to address those gaps.”

Another potential regulatory headache in the Mainland is proposed requirements that all data must be stored on Chinalocated servers. In June, more than 20 foreign trade associations sent a protest letter to the CIRC arguing that the proposals broke trade rules by unfairly discriminating against foreign insurers.

Multinational insurers already face access barriers in China, including ownership caps and licensing difficulties, and have less than 5 percent of the market. “China’s insurance market continues to be dominated by big domestic players and the new risk management and solvency rules are likely to more deeply entrench the positions of these incumbents,” says Jonathan Zhao, Asia-Pacific Insurance Sector Leader at EY.

However, Zhao adds that market liberalizations are creating opportunities for foreign insurance companies to compete with the domestic giants, and executives remain upbeat. “We believe that the prospects for future growth remain very positive,” says Luke Savage, Chief Financial Officer of Standard Life in Edinburgh and a member of the Institute of Chartered Accountants of England and Wales.

The Scottish company’s Chinese joint venture, Heng An Standard Life, offers Chinese customers both insurance and savings products through a network of agents in the Mainland and Hong Kong. “Both profitability and sales [in 2016] are ahead of H1 2015,” says Savage.

Cross-border currents

Innovation is likely to continue in the Mainland market too. The Shanghai Insurance Exchange, launched in June, recently debuted its first insurance-based asset-backed securities, a 5-billion-yuan issue that utilizes China Pacific Life Insurance policy loans as the underlying assets.

Insurers will be keeping a close eye on pension reform in China. Eva Ip, Hong Kong-based Chief Executive Officer of Zurich Insurance (Taiwan) and an Institute member, expects the development of private pensions in the Mainland to be a major driver of future growth.

Witherington at Manulife notes China’s substantial pension deficit, already estimated at more than 1 trillion yuan. “Manulife is keeping a close watch on China’s liberalization of the pensions market,” he says.

Some analysts are concerned that Mainland regulation could hinder Hong Kong’s role. According to the Office of the Commissioner of Insurance, offshore customers – virtually all from China – bought 47 percent of new premiums sold in Hong Kong in the first half of 2016, compared with 37 percent in the previous year.

“However, regulators have started to make a joint effort to control cross-border capital flows through the purchase of offshore insurance products,” says Leon Qi, Head of Greater China Financial Institutions Group Research at Daiwa Capital Markets (Hong Kong), noting transaction limits imposed earlier this year.

Qi says the high demand for hybrid savings and insurance products mean that Mainland customers will constantly seek to exploit loopholes in the law, such as the flood of online payments that resulted from the transaction limit. That loophole was later closed.

One reason for the demand is Chinese investors’ search for foreign-exchange assets. About 98 percent of insurance policies sold in Hong Kong in the first half of 2016 were denominated in U.S. dollars or Hong Kong dollars. “We believe this is the key catalyst for the growth,” says Qi.

That means Hong Kong’s sophisticated insurance sector is poised to play a significant role in the Mainland market’s growth, says Ip at Zurich, resulting in a boom for locally domiciled insurers that could last 10 years at least.That could mean many more Mainland shoppers crossing off insurance policies on their shopping lists.

This article was originally published in the November 2016 edition of A Plus. You can also read the digital version.

Where insurance meets innovation

In January 2017, some of the brightest names in innovation will gather in a squat redbrick warehouse in London’s St. Katherine’s Docks, in the shadow of Tower Bridge. There, in the Rainmaking Loft, dozens of insurance technology, or InsurTech, startups will pitch to potential investors.

For many participants at Startupbootcamp InsurTech, attracting attention will be an uphill battle. “Insurance is an extremely conservative industry,” says Ott Kell, Chief Content Officer of Insly, an insurance-broker software company in London that received €1 million in funding last year.

InsurTech is not the first attempt to revolutionize the insurance business. “Insurers have been trying to transform their organizations for decades,” says Gary Reader, Insurance Sector Global Head at KPMG in London. “First it was to implement big enterprise systems, then it was to respond to the Internet. Now the industry is focused on digitization and customer-centricity.”

Many new financial technology innovations are adaptable to the insurance sector. Various FinTech developments – from data collection prospects for blockchains, drones and wearables to novel ways of electronic payment – can be adapted by the insurance industry. Self-driving cars present huge opportunities and challenges for vehicle insurers.

New technology is being rolled out slowly and carefully. “The most promising use so far has been in areas like applications for price quotations, the development of pay-per-journey pricing in vehicle insurance and some claimsrelated communication tools,” says Peter Allen, Senior Adviser to Grant Thornton in Singapore and the firm’s former global insurance head. However, he adds, “InsurTech has yet to seriously threaten the conventional business model.”

Francesco Nagari, Global IFRS Insurance Leader at Deloitte, says InsurTech apps can help cement client relationships. “You can know customers better and more effectively using the information they have already posted in the public domain, such as on social media,” he says. “It results in a more engaging experience for customers and we’re clearly at the beginning of a fascinating journey for the industry.”