C-ROSS under the market-oriented reform and economy globalization
10 Dec 2014
The outbreak of the 2008 financial crisis has generated a long-lasting impact on the world economy and the global financial system. However, instead of disrupting the globalized market, the crisis has brought different countries together to fight a common foe, and further strengthened their dialogues and alliances. As a result, the financial crisis and economic cooperation have pushed worldwide financial regulatory reform and regulatory coordination into a new phase. In line with the trend of economic globalization and the demand of market-oriented reformation of China's insurance industry, the China Insurance Regulatory Commission (CIRC) has actively explored various ways and models for the solvency regulatory reform of the industry, and officially launched the development of second generation regulatory regime, China’s Risk Oriented Solvency System (C-ROSS), in March 2012. After three years of research, testing and construction, China has, by the end of 2014, preliminarily put in place a new risk-oriented and internationally comparable solvency regulatory system that meets the need of the marketization of China’s insurance market, which is expected to be duly put into effect in 2015.
I. C-ROSS is a risk-oriented solvency regulatory system
Since China implemented the policy of reform and opening up in the late 1970s, the domestic insurance market has grown at an annualized rate of over 20%. In 2013, premium income amounted to CNY 1.7 trillion; total assets of all the insurance companies in the market reached CNY 8.3 trillion; the number of insurance companies was 168, including 54 Sino-foreign joint ventures. The annual premium of China's insurance market is ranked fourth, following the United States, Japan and the United Kingdom, and becoming one of the world's most important emerging insurance markets with the greatest potential.
The development of China's insurance industry would have been impossible without the market-oriented reform of the country. The rapid development of the insurance market over the last three decades was accompanied by the continuous progress of the China’s insurance sector and the deepening of the industry-wide market-oriented reform. Especially in November 2013 the central government of China further clarified the strategy for comprehensive and deepened reform, with the focus placed on adherence to the direction of market-oriented reform, practically and properly handling the relationship between government and market, and making the market play a decisive role in the resources allocation. The primary thinking of CIRC on the market-oriented reform of the insurance sector can be boiled down to "liberalize the front end, control the back end". "Liberalize the front end" means curtailing proactive regulation, changing the current regulatory measures of approvals, endorsements and other administrative licensing, and returning the main responsibilities of management and risk control to the market practitioners. Whereas "control the back end" means practically guarding the bottom line of risks and effectively protecting the interests of insurance consumers by improving and strengthening the solvency regulation.
In the last couple of years, CIRC has accelerated the implementation of the market-oriented reform in the key areas of the insurance market, continuously "liberalize the front end" and strengthened the inner impetus for the development of the industry. In 2012, CIRC pushed through a market-oriented reform on the use of insurance funds, substantially deregulated the areas in which insurance funds can be invested, loosened the ratio restrictions on investment product categories, transformed investment product regulation from an approval-based to a registration-based approach, and gave more investment options and decision-making power back to market participants. In 2013, the insurance regulator kicked off the reform of the life insurance premium rate pricing mechanism, loosened the 2.5% pre-set pricing interest rate restriction on traditional life insurance products, and stimulated the motivation of insurance companies for product innovation and their competitiveness. Furthermore, CIRC actively explored ways to reform the market entry and exit mechanism, and established a clearer and more transparent license management mechanism.
While "liberalize the front end", insurance regulation must focus on "control the back end", and guard the bottom line of risk. A scientific and effective solvency regulatory system is a crucial guarantee for "control the back end", and directly relates to the success of China's market-oriented reform.
Solvency regulation in China's insurance sector could date back to 2000, when CIRC gradually established China's first-generation solvency regulatory system by learning and drawing on the practices of Europe's Solvency I and the US' risk-based capital (RBC), and introduced the capital constraint concept to the China’s insurance companies, which played a pivotal role in preventing and mitigating risks and promoting the healthy development of the industry. However, with the development of the insurance industry, risks became ever more diversified and complex, which in turn exposed increasing problems about the scale-oriented first-generation solvency regulatory system and made it harder to meet the demand for risk regulation and deepening of the market-oriented reform. In March 2012, CIRC decided to launch the C-ROSS project, to realize transforming and upgrading solvency regulation from the scale-oriented to a risk-oriented approach.
By adopting the risk-oriented principle, C-ROSS covers seven major risk categories in relation to insurance companies, measures their risk profile more scientifically, and links their risk management capabilities to capital requirements, demonstrating the scientific nature and fairness of risk regulation. Firstly, by collecting the actual data of China's insurance industry and financial market in the past 20 years, and applying scientific methods like the stochastic model, all types of risks of China’s insurance companies were calculated. Many calibrations were performed to make sure the accurate reflection and measurement of the risk profile of the domestic insurance market. From the process, it is learned that the first generation solvency regulation system requires relatively conservative capital requirement due to the lack of scientific calculation of risk measurement. The risk based solvency system may release excess capital requirement and boost the capital efficiency of the industry. Secondly, C-ROSS has realized fair regulation (ie "All are equal before risks") with risk profile and risk management capability as the regulatory basis; that is to say, in the eyes of CIRC, all insurance companies, no matter big or small, new or old, Chinese or Sino-foreign, state-owned or private, domestic or overseas, are both risk bearers and risk managers. The most important criteria to assess an insurance company is the risk embedded in its business and management. For instance, C-ROSS has set higher risk factors for reinsurers outside mainland China than for those inside, which objectively reflects the relatively higher credit risk of overseas reinsurers relative to China’s policyholders. Being more scientific and fairer, the risk-oriented C-ROSS has provided a regulatory assurance for the market-oriented reform to “liberalize the front end". It will vigorously facilitate the market-oriented reform of China's insurance industry, and attract more domestic and foreign capital to compete and develop in the domestic insurance market.
II. C-ROSS is an internationally comparable solvency regulatory system
Economic globalization is an inevitable trend for the development of the world economy, with different economies integrated with each other. At the background of globalization, the development of C-ROSS follows international development trends, reflects the features of emerging markets, and finally forms an internationally comparative solvency regulatory system, so as to reduce the costs of cross-border capital flows, boost the attractiveness of China's insurance market to international capital, help China’s insurance companies allocate assets to the world market, emphasis insurance companies’ risk management, and better facilitate the domestic insurers integrating into the global insurance market.
C-ROSS follows the generally accepted risk-oriented principle, and adopts the widely-used three-pillar framework. Pillar I is quantitative regulatory requirements, mainly focusing on quantifying the capital requirements of three types of quantifiable risks, including insurance, market and credit risks; Pillar II is qualitative regulatory requirements which serve to appraise unquantifiable risks and risk management capabilities, conduct qualitative regulatory assessment of operational risk, strategic risk, reputational risk and liquidity risk through comprehensive risk rating system, and assess the risk governance and management capabilities of insurance companies by means of risk management requirements and assessments; Pillar III is market self-discipline mechanism, which serves to further prevent the risks that are difficult to be staved off by conventional regulatory tools. C-ROSS, so to speak, has not only realized international comparability in terms of regulatory framework and technical standards on the basis of reflecting the features of emerging markets; more importantly, it is an open, flexible and all-encompassing regulatory system.
The content of the three pillars of C-ROSS has fully considered the characteristics of China's insurance market, as well as the features of emerging markets, which are summarized below:
First, while measuring risks with advanced stochastic methods, the first pillar also takes into account the reality of China’s insurer’s capacity and pays attention to simplicity and practicality. After collecting the actual data of China’s market, C-ROSS has employed a series of mathematical models to measure insurance risk, market risk and credit risk, organized several rounds of industry-wide quantitative tests, and calibrated various model parameters. It has adopted the standardized factor based approach to calculate the minimum capital regulatory rules across the industry, and laid down the risk factors of all risk exposures based on the calculation results of the stochastic model. The scenario based method is adopted where it is impossible to apply the factor based method, like the minimum capital requirements for insurance risk and interest rate risk of life insurance companies.
The factor based method employed in the first pillar is not a simple factor method, but comprehensive factor method, which is a combination of elementary risk factors and specific risk factor. The elementary risk factors are set to measure the industry uniformed minimum capital whilst the specific risk factor adjusts the elementary risk factor according to the specified businesses or assets. Insurance companies calculate their respective minimum capital requirements using the comprehensive factor method to achieve better equilibrium between scientificity and practicality.
Second, it has enhanced the connection between Pillar I and Pillar II to fully reflect the risk profile and risk management capabilities of insurance companies. The minimum capital required under C-ROSS in the solvency ratio calculation not only includes the minimum capital for the three quantifiable risks under Pillar I, the control risk capital from risk management capabilities of insurance companies, but also the counter-cyclical supplementary capital and additional capital for the systemically important insurers. The results of the Solvency Aligned Risk Management Requirements and Assessment (SARMRA) of Pillar II determine the minimum capital for the control risk, that is to say, increasing capital requirements for insurance companies with poor risk management capabilities and decreasing capital requirements for those with strong risk management capabilities so that solvency regulation and the internal risk management of insurance companies can be combined to give insurance companies economic incentives to consistently boost their risk management capabilities.
Meanwhile, the Integrated Risk Rating of Pillar II combines the qualitative assessment results of operational risk, strategic risk, reputational risk and liquidity risk with the quantitative calculation results of insurance risk, market risk and credit risk of Pillar I so as to fully reflect the overall risk profile of insurance companies, and gives a regulatory rating for each of them on a quarterly basis (in four categories A, B, C and D, which apply to different regulatory policies and measures).
Third, the market discipline mechanism of Pillar III not only involves information disclosure requirements for insurance companies, but also places more emphasis on the establishment and cultivation of the market self-discipline mechanism. Unsound market discipline mechanisms and weak market discipline are the common problems with emerging countries and regions including China. However, besides raising information disclosure requirements for insurance companies, C-ROSS is more dedicated to the issue of how to build a more effective market self-discipline mechanism, and has come up with specific measures, including proactive information disclosure by regulatory authorities, regular information exchange and communication between relevant stakeholders, guiding relevant stakeholders to exert the role of supervision and constraint over the solvency risk of insurance companies.
Fourth, C-ROSS has reinforced and improved the regulation on insurance groups. In the wake of the 2008 financial crisis, all countries around the world have tightened regulation of insurance groups. Insurance groups have achieved significant development in China in recent years. C-ROSS has included all types of insurance groups into its scope of solvency regulation, including insurance holding groups and hybrid insurance groups. Such solvency regulation not only involves all the elements of the three pillars including quantitative capital requirements, qualitative regulatory requirements and the market discipline mechanism, but also designed new regulatory requirements for the non-transparency risk, concentration risk, and non-insurance risk based on the specific characteristics of the organizational structure of insurance groups.
III. China is willing to contribute its wisdom and strength, and reinforce exchanges and communication to realize win-win scenarios of China's and global insurance markets
China would like to see more countries participate in the development of its insurance market, welcomes exchanges and communication with other countries, share experiences in the solvency regulatory reform, facilitate further progress of international solvency regulatory standards, and jointly promote the sustainable and healthy development of the global insurance market.
i. China has become one of the world's most appealing emerging insurance markets
Seclusion is a dead end; only opening up is the key to development. China's insurance market has gradually grown to one of the world's highly globalised emerging markets. Efforts will be redoubled to further open up to achieve better effect and turn it into a more competitive, effective and fairer market that is respected by all.
After China's admission to the WTO in 2000, China’s insurance industry was fully opened up to the world by the end of 2004. In 2008, China further relaxed its restriction on foreign funded insurance companies to sell motor vehicle third-party liability insurance; since then they could run all the insurance businesses in all areas within the territory of China. Except for the rule that foreign-funded insurance companies shall not hold more than 50% equity interest in a life insurance company, they can establish wholly-owned P&C insurance and reinsurance companies in mainland of China. So far, basically all the world's major multinational insurance groups have entered China's insurance market.
Worldwide, China and other major emerging markets have become the key engine powering the growth of the global insurance market. According to statistics, from 2001 to 2011 the insurance industries of China and the world's other emerging markets delivered an annual growth rate of 20% and 11% respectively, far higher than the average 5.6% growth rate of the global insurance market, which has also shown the increasing attraction of emerging markets to global financial capital. It is foreseeable that with the transformation of China's economic development model, shifts of government functionality, reform of the social security system, and other significant systematic reforms, the Chinese insurance market will remain in a golden age of relatively rapid development for a long period ahead. The annual premium income of this market is expected to exceed CNY 5 trillion by 2020.
ii. China is proactively promoting international exchanges in the area of solvency regulation
Strengthening international cooperation and exchanges in financial regulation has now become a consensus of the world's nations and international organizations. And China has done a lot of work on international exchanges and cooperation in solvency regulation. Starting in 2012, CIRC has actively participated in the equivalent assessment of Solvency II of the European Union; carried out many rounds of negotiations with the European Insurance and Occupational Pensions Authority (EIOPA), which has completed its assessment report on China, and given positive comments. In July 2013, CIRC held an International Seminar on Solvency Regulatory Reforms and Cooperation in Beijing, which involved the regulatory authorities of emerging markets including South Korea, Thailand, South Africa, Singapore and Malaysia, and representatives from the International Association of Insurance Supervisors. At the seminar, participants discussed international solvency reforms and the construction of C-ROSS; CIRC proposed a four-point initiative for reinforcing international cooperation, which was well received among all the participants. During the construction of C-ROSS, CIRC has persistently adhered to the principle of openness and transparency, and carried out all levels of exchanges regarding C-ROSS, as it has drawn continued and close attention from overseas institutions, organizations and experts.
iii. International regulatory rules should be more inclusive, and further take into account and embody the features and needs of emerging markets
On one hand, the coordination and convergence of international insurance regulatory rules is an irresistible trend, and also favourable to the integration and mutual development of global insurance markets. On the other hand, it is difficult to address the issue of unbalanced development of the world economy and the global financial market in the short term, but a few developed markets have largely dominated the making of international regulatory rules. Therefore, to be truly universally accepted, these rules need to represent more demands of the "silent majority", fully reflect, coordinate and balance the concerns of both developed and emerging markets respectively. As an internationally comparable regulatory model derived from an emerging market, C-ROSS represents an exploratory contribution by China to the international solvency regulatory model. China seeks to join hands with all other countries to proactively participate in and facilitate the discussion and formulation of international regulatory rules, and promote the win-win development of the global insurance industry.