C-ROSS is right for China

Benjamin Ang, 10 Dec 2014

Leading players in China’s insurance industry say the time is right for the introduction of the China Risk Oriented Solvency System. As Wang He, Executive Director and Executive Vice President, PICC P&C, said, the internal and external factors of China make the timing of implementing C-ROSS appropriate. Externally, the globalisation of China’s economy and overseas expansion of Chinese companies and insurers mean that there is a need for more international regulations in line with international standards. Internally, China’s insurance industry has undergone phenomenal growth over the last 30 years “from nothing to something”.

The right time

“You have to be big first before you become strong,” said Mr Wang, adding that having grown bigger, the time is apt for the industry to grow stronger.

Concurring, Chen Sen, Deputy General Manager & Chief Actuary, China Re P&C, said that previously, there was a higher priority to promote the growth and development of the nascent industry. But now that the industry has reached a certain volume – with China’s P&C market being the fifth largest in the world – the time is right to place an even greater emphasis on risk management.

Qin Lu, President of Swiss Re China, also said that the China market’s development is “unprecedented in the industry’s history”. The market has experienced incredible growth, becoming the third largest insurance market globally as of 2013.

But with the strong growth, some issues associated with a fast growing market such as the lack of risk management practice, the lack of sophisticated approach to risk versus capital management, inadequate premium rates, and poor CAT exposure control may also be observed, said Mr Lu.

“I believe it is the right time for the industry to adapt to a solvency regime which is geared towards risk-based framework. We anticipate the market will continue its strong growth for years to come. It is imperative for the industry to put in place a sound risk capital management practice to sustain a healthy growth path,” he said.

Setting the stage for future growth

The first-generation solvency supervision system which was established in 2003 has played a very important role, said Steven Sun, CEO, Cigna & CMB Life Insurance.

“But with the rapid development of the market in recent years, it is not able to fully adapt to the new situation, especially in three areas. First, it cannot fully reflect risks and risk measurement is not scientific; second, there are certain existing defects in the current framework; and third, qualitative supervision needs to be strengthened,” he said.

Chen Liang, CEO of Allianz China Life, concurred: “The current solvency regime is very simple to apply but is also quite restricted as it is simply based on the business scale without reflecting the company’s risk profile and how well the company is managing these risks. Companies with a sound risk management framework are being ‘penalised’ with the same capital requirements as another which may have adopted a more aggressive product and investment strategy.”

The current solvency regime worked well in the early stages of market development, but can no longer benefit the industry going forward, especially after the “国十条” (“New National 10 Guidelines”), he added.  The guidelines were announced by the State Council earlier this year to further accelerate the insurance sector’s development.

This is great news for all the players in the market but it needs to be based on a more competitive and healthy market environment.  Thus, now is just the right time to introduce C-ROSS, a risk based solvency regime, said Mr Liang.

On the “New National 10 Guidelines”, Eric Chang, President of ICBC-AXA Life Assurance, said it is the first time the industry has received such high-level guidance. “The goal of having the industry play an increasing role in helping society means that the mechanisms to guide industry behaviours need to be stronger. C-ROSS is an important step consistent with that, and CIRC had the foresight to begin the work on C-ROSS even before the National 10 was released.”

“If you look at the old regime, it is like the insurers are together in a small box. It is an ‘insurance box’ with its own rules,” said Grace Jiang, Partner, Actuarial Services, PwC. But the impending rules take into account and are complementary to the financial market as a whole.

The right model

While there are various solvency regimes globally, C-ROSS is more tailored for developing markets, balancing regulatory solvency and risk management needs, said Shirley Shao, Chief Financial Officer, AIA China, in a view shared by the industry players Asia Insurance Review spoke with.

“C-ROSS follows the risk-oriented framework in line with the international standards but also recognises the current development stage of the China insurance industry,” she said. Some of the key features’ suitability for China and emerging markets include avoiding complicated modelling and huge implementation costs, and avoiding mandatory complex quantitative measurements on risks hard to measure.

Mr Wang alluded it to the saying – “all roads lead to Rome”. The general goal and direction is similar to other regimes, but the path taken by C-ROSS is most suitable and adapted to the needs and dynamic nature of a developing market like China.

Different markets have different needs as they are at different stages of development, said Ms Jiang. Developing markets may be more volatile and market data may not be on par with developed ones, she said. Victor Shi Xiaokai, Senior Vice President, Investment Banking, CITIC Securities, added that developing markets typically lack complete historical information and data, and also lack a complete credit rating system.

C-ROSS serves the practical needs of China’s insurance market development, said Mr Sun. “It is a system with distinct Chinese characteristics, very close to the reality of China’s insurance market. It fully reflects Chinese insurers’ risk control capability, and sets a clear and pragmatic direction for insurers to continue enhancing risk management capacity,” he said.

Balancing risk management and growth

C-ROSS’ emphasis is not only on risk management, but also the healthy development of the industry. “There needs to be a balance for the industry’s sustainable growth. If there’s an over-emphasis on risk aversion and just making sure nothing will go wrong, it will not be healthy for the industry at the end of the day,” said Mr Wang.

Capital is very valuable, especially in developing markets, said Chen Sen. “There shouldn’t be overly strict capital standards that most cannot meet. Reasonable standards taking into account the market’s stage of development are needed for sustainable development to avoid a capital crunch.”

Mr Shi concurred on the greater need for capital in developing markets. He said the insurance markets in developed countries are growing at around 5%, but in developing markets the rate of growth is easily double or triple that. Hence, insurers in developing markets are “hungry” for capital to grow.

In the quest to strike a right balance and design the right model that best fits the China market, CIRC had examined risk-based capital solvency regimes around the world, said Mr Lu. “CIRC has avoided the pitfalls of mandating complex quantitative measurement of some risk categories, which may be difficult to quantify such as operational risk.” C-ROSS also does not require internal models at this point, enabling fast development of the framework and also in keeping the cost down, “although large insurance groups will most probably develop their own internal model for more efficient capital management, but not in the near future”, he added.

The right approach

Scheduled to be implemented by 2016, industry players expect the process to be smooth. “Sure, there will be challenges. For insurers who have not established an internal enterprise risk management (ERM) model and economic capital model, for example, they will find it challenging. But they will have to overcome the difficulties and adapt to be ready,” said Chen Sen. (See Preparing for C-ROSS below.)

While some industry players may be concerned about the pace at which C-ROSS is progressing, Ms Jiang said the market is ready technically as evidenced by the trial tests conducted. Likewise, Mr Shi agreed and said CIRC had already conducted rounds of quantitative impact studies. “The market will be ready and the transition will be smooth,” he said.

“Concerns are understandable. Nothing will be perfect in the beginning, but improvements and fine-tuning can be made along the way. The process can be painful and challenging but once over, the journey for the healthy and sustainable development of the industry will be really worthwhile,” said Ms Jiang.

CIRC’s leadership

While other regimes may still be caught up in debates and uncertainties, C-ROSS’ progress from design to implementation-ready in a short three years is largely due to CIRC’s leadership, a view echoed by the industry players we spoke with.

For example, Mr Sun said his confidence in a successful implementation lies in his confidence in CIRC from three aspects. “First, the CIRC carried out a great deal of publicity, testing and discussions during the C-ROSS development process, enabling the industry to be familiar with the overall framework and technical standards; second, the CIRC has sufficient experience in the implementation of large-scale transition of regulatory policy, for example the CAS (China Accounting Standard) reform in 2007; and third, the CIRC has already begun planning for C-ROSS transition implementation.”

“CIRC’s strong leadership in delivering all key milestones on schedule and its open attitude to communicate with the industry will pave the way for a smooth implementation,” said Ms Shao. “CIRC had organised three rounds of QISs (Quantitative Impact Studies) and three rounds of consultations for standards. Every time, CIRC had considered a lot of valuable opinions from industry.”

Any change presents challenges, said Mr Chang. “There may be some unanticipated consequences on implementation. So there will be learning and probably some further evolution.”  Having the benefit of a single regulator and relatively homogenous company structures and strategies means China can efficiently manage these evolutions compared to other markets where the market and regulatory structures may be much more complex, he said.

 “One must not think that the end goal is to design one perfect regime and that’s it. In a dynamic market like China, improvements can and will be made by CIRC if and when needed,” said Mr Wang.

And one must not lose sight that “it is not C-ROSS for C-ROSS’ sake”. “C-ROSS itself is not the purpose. When faced with problems or technical issues, solutions can be worked out and we shouldn’t dwell on them. At the end of the day, we look forward to a successful implementation as it will push the industry to the next level and ultimately benefit society as a whole,” he concluded.

How will C-ROSS impact the industry?

The introduction of C-ROSS will push the insurance industry towards the next stage of development where there will be higher quality and sustainable growth, said Wang He, Executive Director and Executive Vice President, PICC P&C.

“The industry has developed so fast over the past decades that regrettably some may have forgotten its insurance fundamentals, purpose, and how an insurance operation should be run. C-ROSS is an important tool to remind the industry of its role and promote sound management,” he said.

“Cleaning up” the industry

Grace Jiang, Partner, Actuarial Services, PwC, also said the new solvency regime will push the market to be rational. The last few years had seen a lot of new insurers. This will help new insurers understand the industry and the risk-oriented capital management needed in the industry. “This can serve as a ‘clean-up’ of the industry. The distinction between the good and bad, the professional and not, will be obvious,” she said.

Agreeing, Shirley Shao, Chief Financial Officer of AIA China, said: “Those companies that understand risks/rewards will do much better. Get well-prepared for C-ROSS, not just to be compliant but to use this opportunity to upgrade risk management capabilities in order to compete with other financial institutions domestically and globally.”

Promotes market-oriented reforms

C-ROSS helps promote market-oriented reform of the insurance industry, said Steven Sun, CEO, Cigna & CMB Life Insurance. “C-ROSS promotes a more scientific and effective system of capital regulation, and it is a necessary condition for the success for market-oriented reform of the insurance industry in the next steps.”

With the new capital regulatory system, the insurance company can reasonably evaluate the risks and benefits of its operating and investment behaviour, and make rational decisions and take the initiative to curb irrational competition and bad behaviours by blind investments, he added.

Eric Chang, President of ICBC-AXA Life Assurance, gave the example of the Chinese life insurance industry’s large sales volume of “high cash value” products in recent years, where such products typically have short product terms of one year or even less. “The current solvency regime does not view these products unfavourably, although CIRC has put in place some attempts to discourage their sale. But C-ROSS may be able to effectively discourage these sales through higher capital requirements.”

The higher capital requirements may also see the number of IPOs increase in future, said Victor Shi Xiaokai, Senior Vice President, Investment Banking, CITIC Securities. There will be more publicly listed insurers, although it is too early to tell if M&A will also increase as the industry is not at the consolidation stage.

CNY 500 billion capital release

The results of the second round quantitative test showed that C-ROSS will help to release around CNY 500 billion (USD 81.45 billion) capital requirements from the life insurance industry, said Chen Liang, CEO, Allianz China Life. Companies with superior risk and capital management strategies will enjoy improved capital efficiency and higher returns for the shareholder. This will definitely benefit the long term and healthy development of China’s insurance industry, he added.

But while it is good news for “those insurers who would benefit from such relief”, Qin Lu, President of Swiss Re China, said: “Such relief is merely short term. The long-term development of business requires more sophisticated approach towards capital deployment. Essentially, the industry will need to look at capital and risk, and develop a methodical way of planning around these key elements.”

Change in reinsurance purchase strategy

As for the impact on the reinsurance front, Mr Lu said: “C-ROSS has forced the industry to consider the economic risk situation in its solvency ratio calculation, which provides an immediate challenge to insurers to evaluate the effectiveness of the reinsurance program due to the lack of an ERM system and an internal model.”

“We foresee that under C-ROSS solvency regime, the reinsurance purchase strategy will change. The cost of capital will be considered for each line of business, thus impacting the reinsurance strategy. For example, insurance companies will be more reluctant to cede motor business than other lines of business. Although quota-share treaties are currently common in China, we expect excess-of-loss to become more common. In addition, on-shore reinsurance will generally be favoured,” he said.

Reinsurance strategy is not a standalone decision within insurance companies. It should be embedded in the enterprise risk management framework with clearly defined risk appetite and risk limits. “We, at Swiss Re, are supporting our clients to build internal capabilities on ERM, risk and capital modelling, etc. We are also working with our clients to jointly optimise their reinsurance programs,” said Mr Lu.

Chen Sen, Deputy General Manager & Chief Actuary, China Re P&C, also said that currently, business is ceded to reinsurers based on premium volume, regardless of lines of business. With C-ROSS, the capital requirements of the different lines will differ.

Reinsurance programmes may have to be redesigned, and there could be more programmes targeted at the high volatility and high risk lines, he said. “Reinsurers will need to adapt to the new reinsurance environment. China Re will work with our business partners for a win-win to meet their risk mitigation requirements, and to create products to meet and tap the market opportunities,” said Chen Sen.

Preparing for C-ROSS

Similar requirements already in place

“AIA has formed a working committee to track the progress, identify gaps, improve modelling capability, analyse potential impact, increase risk governance, provide input to CIRC and take management actions to close gaps.  We are perhaps more prepared as our AIA Group Office has already implemented risk requirements that are similar to those of C-ROSS,” Shirley Shao, Chief Financial Officer, AIA China.

Improving capital efficiency

“The calculation method under C-ROSS is more complicated.  Our actuarial, risk management and finance department have been working closely to study all the new rules.  Going forward, it’s more important for us to consider how C-ROSS will affect our company’s product strategy, investment strategy etc. so that we can improve the capital efficiency by using lower capital but achieving higher value for our shareholders,” Chen Liang, CEO, Allianz China Life.

Ready technically and psychologically

“China Re has participated very actively in C-ROSS working groups and design actively since the project started. We also began designing and improving our processes and models as C-ROSS took shape, with the top management regularly updated and kept in the loop on its development. China Re is well-prepared both technically and psychologically and will be fully ready to embrace C-ROSS,” Chen Sen, Deputy General Manager & Chief Actuary, China Re P&C.

Formulating strategy to tap opportunities

“We are strengthening learning and understanding of the C-ROSS system; studying and formulating a clear development strategy to enjoy the policy benefits, such as in product development, investment, asset-liability matching, and channel development; and further improving the level of risk management capabilities, including talent introduction and department restructuring in finance, actuarial, investment, risk management and other aspects,” Steven Sun, CEO, Cigna & CMB Life Insurance.

Strengthen abilities

“It is very important for insurers to strengthen their risk management and capital budgeting abilities. In the past, some may ignore risk management, but it will be reflected in their balance sheets and capital in the future with C-ROSS,” Victor Shi Xiaokai, Senior Vice President, Investment Banking, CITIC Securities.

Global and banking perspectives

“We have the advantage of being part of a global family in AXA, and so have gained from their experience in the many years of preparing for European Solvency II and operating as well in the US and other countries’ regimes.  In addition, ICBC brings us the perspectives of global banking solvency management.  Even with those advantages, careful study of the impacts of the new system on different product and investment strategies is important, as well as communication across all the management team and Board,” Eric Chang, President of ICBC-AXA Life Assurance.

Work already in progress

“PICC is the oldest and biggest P&C insurer in China. Having been very involved in the process of C-ROSS’ development, we will be well-prepared for its implementation as we are already working towards the requirements and making the necessary adjustments,” Wang He, Executive Director and Executive Vice President, PICC P&C.

Communication is key

“At the technical level, the understanding is there on what is going on and the impact on products etc. But at the management level, it may take more time to understand what is going on when they are presented with the results from the technical team, as previously they may be more focussed on areas such as sales and profits, rather than risk management and risk capital. Communication with the management team will be very important. Likewise with shareholders,” Grace Jiang, Partner, Actuarial Services, PwC.

Tapping on global experience

“I expect the industry will boost risk management capabilities in a substantial way. However, the availability of such expertise in the market will become a hindrance. As to Swiss Re, we are positioned strongly in the market given our own growth in this market and our global experience in dealing with such regulatory changes,” Qin Lu, President of Swiss Re China.

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Formulating strategy to tap opportunities

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Author

Benjamin Ang

Deputy Editor, Asia Insurance Review

Benjamin Ang is the Deputy Editor of Asia Insurance Review, which has served as the voice of Asia’s insurance industry for close to 25 years. An insurance journalist with industry experience, Mr Ang is in his 10th year in the insurance industry. Regularly interviewing insurance regulators, and regional and global CEOs of re/insurance companies, he is known for his insightful articles on the industry’s developments.

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