To address solvency issues arising from the rapid growth of China’s insurance market and its increasingly complex risk environment, the China Insurance Regulatory Commission (CIRC) has recently introduced a new regulatory regime aimed at enhancing its supervision over the solvency of Chinese insurers.
The Administrative Provisions on the Solvency of Insurance Companies (New Provisions) came into force on 1 September 2008, replacing the Administrative Provisions on Solvency Levels and Regulatory Indices of Insurance Companies introduced by the CIRC in 2003.
The New Provisions are clearly inspired in part by standards published by the International Association of Insurance Supervisors and by current developments in Europe, where new standards are due to be adopted in 2013 within the Solvency II Project. Unlike the 2003 rules, which focus on solvency margins calculated as ratios of assets to liabilities, the New Provisions require the assessment of solvency on the basis of risks to which the insurer is exposed.
The new regime applies to Chinese incorporated insurance companies as well as Chinese branches of foreign insurance companies. Compliance with the New Provisions is critical for all insurers carrying on business in China. Insurers with insufficient solvency levels will be prevented from expanding their business and from declaring dividends to shareholders.
The remainder of this briefing provides an overview of the New Provisions and considers their implications for the future development of China’s insurance sector.
Who is responsible for solvency management?
What does this assessment involve?
The board of directors and the management team of an insurance company are responsible for its solvency management. In the case of the branch of a foreign insurance company, a senior manager will be tasked with the branch’s solvency management.
An insurance company is required regularly to:
- assess its solvency;
- compute its minimum capital and actual capital; and
- conduct dynamic solvency tests.
Furthermore, an insurer is required to forecast and comment on certain solvency trends and its future solvency.
An insurance company must assess its solvency on the basis of the risks to which it is exposed.
For the purpose of the New Provisions:
- ‘solvency adequacy ratio (SAR)’ (also known asbthe capital adequacy ratio) refers to the ratio between an insurance company’s actual capital and minimum capital;
- ‘minimum capital’ refers to the amount of capital that an insurance company must maintain to respond to the impact of asset and insurance acceptance risks on the solvency of the company; and
- ‘actual capital’ refers to the margin between the recognised assets and the recognised liabilities of an insurance company.
Foreign insurers must assess the entire solvency of all their branches in China on a consolidated basis.
A supplemental notice issued by the CIRC in October 2008 sets out the minimum capital valuation standards for implementing the New Provisions and helps to regulate issues such as valuation of consolidated statements of branches of foreign insurance companies.
The solvency report
In order to satisfy the solvency assessment requirements as outlined above, an insurance company must prepare various solvency reports. These include annual and quarterly reports and some temporary reports. The board of directors and the management team are responsible for their accuracy.
The annual solvency report is submitted after the end of the accounting year. It must be audited by an independent external auditor and approved by the board of directors. This report must include:
- statements of the board of directors and the management team. These statements include an undertaking signed by all the members of the board and the senior management and affixed with the company’s seal, on the authenticity, accuracy, integrity and compliance of the report;
- independent opinions from external institutions;
- certain basic information, which must usually cover: –– the shareholding structure between the insurance company and its shareholders, subsidiaries and affiliates; –– basic information regarding the shareholders;
–– the insurance company’s name and registered address;
–– the nature of its owner;
–– its business scope;
–– registered capital;
–– legal representative(s);
–– composition of the board of directors and the board of supervisors; and
–– capital adequacy ratio, assets, debts, revenue and net profit;
- discussions and analyses by the management team. These must usually cover the senior management’s presentation, assessment and analysis on the company’s solvency and their forecast of any future trends;
- a description of the company’s policy in relation to the management of internal risks; and
- certain information relating to minimum capital, actual capital and dynamic solvency tests.
What other circumstances trigger a report to the CIRC?
An insurance company must report to the CIRC within five working days of becoming insolvent. A report is also required within five working days of the occurrence of any of the following events, which have a significant adverse impact on the solvency of an insurance company:
- it suffers substantial investment losses;
- it faces significant indemnities, large-scale cancellation of insurance policies or a significant lawsuit;
- its subsidiary or joint venture faces financial crisis or is taken over by the financial regulatory institution;
- the headquarters of the branch of a foreign insurance company is subject to an administrative punishment or supervisory measure, or applies for bankruptcy protection because of a solvency problem. For these purposes, an administrative punishment or supervisory measure may include:
–– a warning or fine;
–– removal of permissions or qualifications to act as an insurer; or
–– a mandatory shut-down imposed by the regulatory authorities where the headquarters are located;
- the parent company faces a financial crisis or is taken over by the financial regulatory institution;
- its significant assets are frozen by a judicial body or it is subject to a serious administrative punishment imposed by any other administrative authority; or
- any other matters having serious adverse effects on its solvency. As this is new legislation, there are not yet any precedents on what these ‘other matters’ in this context include. We anticipate, however, that it is likely to cover circumstances such as a decrease in registered capital or a merger with or acquisition by another company that has a poor financial status.
Internal solvency management
All factors that may affect an insurance company’s solvency must be covered in its internal solvency management system. These include asset management, liability management and capital management.
For these purposes, effective asset management involves:
- strengthening the monitoring of capital flow in areas such as acceptance of insurance, reinsurance, compensation paid out for claims, investment and financing;
- establishing an effective capital utilisation management mechanism;
- establishing an investment management system based on a company’s investment policy and its internal growth structure, whereby the decision making, operation, custody and evaluation functions are separated from each other but are cross-checked with one another;
- intensifying the management of equities and of risks arising from its subsidiaries, joint ventures and associated enterprises and the management of affiliated transactions and monitoring the transfer and shift of risks within the group;
- strengthening the management of fixed assets and other assets in kind and establishing an effective asset separation and authorisation system; and
- establishing a credit risk management system and mechanism and strengthening the management of creditors’ rights investments, receivables reinsurance reserves and other assets highly exposed to credit risks.
Effective liability management involves:
- putting in place control procedures for the pricing and sale of products, checks on insurance and claims, reinsurance and other key controls so as to lower the insurance acceptance risk;
- establishing a sound reserve liability assessment system so as to ensure the accuracy and adequacy of the reserve liability assessment;
- establishing a financing management system and clarifying the risk control procedure; and
- tightening the procedures for entering into guarantees for non-insurance businesses and taking prudent risk control measures in light of the credit standing and solvency of the guaranteed parties. These must comply with the laws, administrative regulations and relevant provisions of the CIRC.
An insurer whose SAR is not higher than 150 per cent must adopt the lower of the following two items as the company’s base for distributing profits:
- the distributable profits as determined in accordance with the Chinese Accounting Standards for Enterprises; or
- the ‘remaining comprehensive proceeds’ as determined in accordance with the rules on the preparation and submission of insurance company solvency reports.
How does the CIRC supervise insurers?
The CIRC has classified insurers into three categories based on their solvency:
- Inadequate Solvency: insurers with a SAR of less than 100 per cent;
- Adequate Solvency I: insurers with a SAR between 100 per cent and 150 per cent; and
- Adequate Solvency II: insurers with a SAR higher than 150 per cent.
The CIRC conducts discretionary supervision of insurers. If an insurer is classified as having Inadequate Solvency, the CIRC may impose one or more of the following supervisory measures:
- order the insurer to increase its capital or restrict its distribution of dividends;
- limit the remuneration of directors and senior managers;
- limit its advertising
- restrict the insurer’s establishment of more branches, or its business scope;
- order it to stop writing new business and/or order it to transfer its business to another insurer;
- order it to auction off its assets or restrict the purchase of fixed assets. It is currently unclear what is meant by ‘fixed assets’ in this context. The term has different meanings under PRC tax law and PRC GAAP. We anticipate that it will include more that just illiquid assets;
- restrict the insurer’s use of capital;
- make personnel changes at board or managerial level;
- take over the control and management of the insurer; and
- take other supervisory measures that it considers necessary.
If any insurer fails to establish or implement a solvency management system, the CIRC may require it to do so. In serious situations, the CIRC may take supervisory measures as detailed above.
Solvency reporting by insurance groups
Supplemental rules issued by the CIRC in October 2008 to regulate the compilation of solvency reports by ‘insurance groups’, treating all members of the group as a single reporting subject. An ‘insurance group’ means a corporate conglomerate consisting of insurance companies and the companies under their direct or indirect control, joint control or subject to their significant influence. The criteria for determining control, joint control and significant influence are set out in the practice guidelines accompanying these rules and mirror the criteria adopted in the Chinese Accounting Standards for Business Enterprises.
The ‘parent insurance company’ is responsible for compiling the solvency report and submitting it to the CIRC. The ‘parent insurance company’ is an insurance company that has direct or indirect control, joint control and significant influence over all the companies in the insurance group.
These rules set out the various circumstances under which a report is required to be produced and the level of assessment that must be carried out. A regular report is to be submitted bi-annually and provisional reports are required to be submitted within five working days after a matter that will materially affect the solvency of the insurance group occurs or after the ‘parent insurance company’ comes to be aware of or should be aware of the following matters:
- its subsidiary or joint venture incurs a material investment loss;
- its major subsidiary or joint venture has a financial crisis or is taken over by other regulatory authorities; or
- any other matters occur that have a material adverse effect on solvency.
Compiling a solvency report requires the ‘parent insurance company’ to assess the capital adequacy of the insurance group and provide details of its minimum capital and its actual capital. Each member of an insurance group is responsible for providing their capital adequacy statement or financial statement.
Implications for the future
The new regulatory regime reflects CIRC’s willingness to embrace international standards on the corporate governance and risk management of the insurance sector. It addresses potential risk issues arising from the rapid growth of the Chinese insurance market. Most importantly, it demonstrates CIRC’s commitment to creating a more mature regulatory framework for the industry. This should help to achieve a key CIRC objective of promoting the sustainable development of strong domestic insurance companies and perhaps to create better conditions for foreign-invested insurers to participate more fully in the growth opportunities of the Chinese market.