Although China has a national insurance regulator – the China Insurance Regulatory Commission (CIRC) – Chinese insurers must be licensed in each province or independent municipality in which they wish to operate. The current Chinese insurance industry law is the Insurance Law of the People's Republic of China (2009 Revision), which was first released in 1995, amended in 2002 and further amended 2009.
All foreign insurance companies must meet the following three qualifications in order to establish a foreign insurance company in China. The insurer must (1) have been in business for 30 years, (2) have had a representative office in China for two consecutive years and (3) have total assets greater than $5 billion at the end of the year prior to application. Foreign companies that do not meet the three prerequisites may acquire up to 25 percent of an existing Chinese stock insurance company. The CIRC has licensed 17 foreign property and casualty (PC) insurers to do business in China, the largest of which is American International Group Inc.'s Chartis Inc. unit.
This decentralized means of regulation is similar to the state-by-state regulation of insurers in the United States: insurers must be licensed by individual states, the top regulators of which belong to the National Association of Insurance Commissioners (NAIC). Wilson Elser prepared this article to assist our clients and potential clients in China in understanding the insurance regulatory framework in which they would have to operate in the United States and, further, to provide basic information as to possible structural and formational parameters. In addition, we have provided information on the laws of two major U.S. industrial states in which Chinese insurers may consider beginning their insurance operations.
Population and Competitive DynamicsAccording to the 2010 United States Census, the three metropolitan areas with the largest Chinese American populations are the Greater New York Combined Statistical Area at 682,265 people, the San Jose/San Francisco/Oakland Combined Statistical Area at 592,865 people, and the Greater Los Angeles Combined Statistical Area at about 473,323 people. New York City is home to the largest Chinese American population of any city proper (486,463), while the Los Angeles County city of Monterey Park has the highest percentage of Chinese Americans of any municipality at 43.7 percent of its population or 24,758 people. The San Gabriel Valley region of Los Angeles County in particular has one of the most prominent groups of U.S. suburbs with large foreign-born Chinese-speaking populations, ranging from working-class immigrants residing in Rosemead and El Monte to wealthier immigrants living in Arcadia, San Marino and Diamond Bar. Conversely, the suburbs of New York City within the state of New Jersey are notable for their widespread and increasing prevalence of Chinese Americans with general affluence and a propensity for professional occupations.
Therefore, for purposes of this discussion only and given that most foreign insurers with operations in the United States have historically commenced operations in California or New York, we have assumed that these would be the two states under consideration for Chinese insurers when formulating plans to begin operations in the United States, since those two states combined represent over 50 percent of the Chinese American population. [It is of note that Michigan is historically a popular state of entry for foreign branches of Canadian insurance companies due, at least in part, to proximity.]
Chinese businesses may not automatically locate in states with the largest Chinese American population centers; among other considerations are (1) which states’ court jurisdictions would be preferred by a Chinese carrier and (2) which states’ insurance regulators are most business-friendly to foreign insurers. Neither of these is central to this article; however, they should be considered before making the final decision as to where a Chinese insurer might establish its domestic operating base.
Structures for Entry of Alien Insurers into the U.S. Insurance Market as a New Company
Under both California and New York insurance law, Chinese insurers would be characterized as “alien insurers” since they are organized under the laws of a jurisdiction other than a state of the United States.
As alien insurers, Chinese insurers may establish operations in one of two ways – either opening what is referred to as a branch office in the United States (U.S. Branch) or by forming (incorporating) a subsidiary or subsidiaries in either California or New York, which would become qualified to write the applicable insurance policies permitted by each such company’s charter and certificate of authority. It is significant to note that California and New York, as well as all other jurisdictions, separate the life and health functions from property and casualty functions. Therefore, two separate branches or subsidiaries would have to be created for a Chinese insurer to underwrite both life and health insurance and property and casualty insurance.
Unlike a subsidiary corporation, a U.S. Branch is not a distinct corporate body with shareholders, officers and directors. It is an unincorporated division of a non-U.S. corporation. As such, a U.S. Branch has no shareholders, officers or directors. As stated in section 107 (a) (44) of the New York Insurance Law, a U.S. Branch is:
The business unit through which business is transacted within the United States by an alien insurer, or the assets and liabilities of such insurer within the United States pertaining to such business or the management powers pertaining to such business and to such assets and liabilities or any combination of these three.
Generally, the state in which the alien insurer (1) is first admitted, (2) establishes its U.S. branch office and (3) complies with trusteed asset-deposit requirements is known as the insurer’s “United States port of entry” or the “port-of-entry state.” The port-of-entry state is treated for most purposes as the domiciliary state, as would be the case with a foreign applicant.
Under both California and New York law with respect to a U.S. Branch, Chinese insurers, as alien insurers, would have to deposit in trust substantial dollar amounts equal to or greater than the capital required of a subsidiary insurer. These amounts could be invested in securities authorized for investment of the assets of domestic insurers for the benefit and security of all of the insurer’s U.S. policyholders. The deposit may be made with either (1) the insurance authority or general fiscal officer of any state in which the insurer is admitted or (2) an authorized bank or trust company serving as trustee for policyholders or policyholders and creditors, and would be known as “trusteed assets.”
Advantages of a Subsidiary Corporation
A subsidiary is a stock corporation owned by a sole shareholder parent. Unlike a U.S. Branch, a subsidiary corporation is a separate entity with officers and directors. The advantages of operating as a subsidiary are as follows:
- A subsidiary can enter into reinsurance contracts with its parent.
- A subsidiary can invest in stock of corporations both in the United States and abroad.
- Liabilities of a subsidiary may not be ascribed to the parent unless the court applies the concept of “piercing the corporate veil,” which is based on failure of the subsidiary to maintain requisite separate corporate formalities and is rarely allowed. [On the other hand, a judgment entered against a U.S. Branch may be readily enforceable against the head office from which the U.S. Branch is inseparable.]
- A subsidiary does not have to file trusteed surplus statements. These are filed by U.S. Branches and are a supplemental reporting requirement in addition to annual and quarterly statements filed by both stock insurers and U.S. Branches. Thus, financial reporting requirements are more extensive for a U.S. Branch, and more costly.
- A subsidiary has more flexibility in its operation.
- Additionally, a U.S. Branch licensed in multiple states would need to undergo a process known as “domestication” in order to sell its licenses if it wished to withdraw from the marketplace. In this process a “shell” corporation would be created that would assume the assets and liabilities of the U.S. Branch. This would be a costly and time-consuming process.
For all of the above reasons, it is recommended that a subsidiary corporation be established for each of the separate insurance operations – life and accident and health, property and casualty – if a Chinese insurer opts to create such new insurance operations.
Use of an Intermediate Holding Company
Generally, the shares of subsidiary insurance corporations would be held by Chinese insurers in an “insurance holding company,” which would be required to register and file financial and other reports with its state of registration – either New York or California. [A Chinese insurance holding company might be required to register and file financial and other reports with both California and New York, depending on the amount of business it was producing in a particular state. If such business were significant under California or New York laws over a three-year period, then such company could be viewed as being “commercially domiciled” in either state, subjecting the operations to further regulatory burden.)
The holding company can be organized in any state, including Delaware, where the business environment and corporation laws are particularly favorable. An alien insurer must be certain that the insurer subsidiary raises and maintains capital and surplus as prescribed by the state’s insurance law. Adequate capitalization maintained by the parent company, a Chinese insurer or a holding company is not relevant to satisfying those requirements. However, under both California and New York insurance law it is possible for the subsidiary to declare and pay dividends to its parent out of earned surplus. There are special regulatory requirements for the payment of extraordinary dividends, generally exceeding 10 percent of capital and surplus.
A holding company structure provides financial and operational flexibility as well as the opportunity to assign certain management responsibilities to personnel employed at the holding company level and an opportunity to acquire subsidiaries through the holding company.
Each insurer that is a member of a holding company system must register annually with the state insurance commissioner and must submit for approval all contracts with members of its holding company system.
Establishing a “Pup” (Subsidiary) Company
Assuming a Chinese insurer selects a corporate subsidiary structure, it is also necessary to select a state of domicile or a state where the insurance subsidiary would initially be incorporated and qualified to conduct an insurance operation. Following its qualification in the state of domicile, the insurance subsidiary would then seek to become qualified as a foreign insurance company in one or more states. Whichever state is selected, it is always recommended that the representatives of the new insurance entities meet initially with the representatives of the applicable department of insurance (e.g., the California Department of Insurance or the New York State Department of Financial Services) to “brief” them on the proposed plans of operations and projected premium volume and to ascertain any problems or impediments that may be anticipated in any application process.
Generally, both California and New York present significantly challenging regulatory environments for the admissions process, usually resulting in a process that could take a year or more depending on whether there are any significant problems posed by the contemplated operations and the projected volume of net premium writings when measured against the proposed level of capital and surplus. As part of the application process for admissions, the applicant is required to file a “plan of operation” containing financial projections of the business to be written over the ensuing three to five years.
Due to the very stringent regulatory environment for life insurers in New York, it has become customary for life insurers in particular to establish a separate New York life insurance company for its life and accident and health insurance operations as a subsidiary of the parent company or of a holding company and not to qualify that company in other jurisdictions. In the past, the very strict regulatory environment with respect to New York life insurance companies has placed those companies at a competitive disadvantage. Over the past few years, the New York Department of Insurance has undertaken efforts to soften some of the harsh regulatory environment. As some of the restrictions in the past have related to agent compensation and expense limitations, it would be necessary to understand the nature of a Chinese insurer’s contemplated distribution system with respect to the manner in which it would offer its life, health and annuity products.
As California or New York present significant regulatory difficulties equally challenging to the admissions process, selection of either California or New York as the state in which it would want to commence operations really depends on a Chinese insurer’s marketing perspective. However, whichever state is first selected, additional obstacles to qualification of the insurance entities in another state are posed by the requirement of “seasoning” discussed below.
Seasoning (Experience) Requirements
All states subject insurance company applicants, regardless of their state or country of domicile, to what are commonly known as “seasoning requirements.” The basic seasoning requirement is that a foreign applicant (in this case subsidiaries of Chinese insurers initially domiciled in either New York or California that would be applying for admission to any other state for a certificate of authority to do business) must have actively transacted for three years the classes of insurance for which it seeks to be admitted. (New York appears to have seasoning requirements only for property and casualty companies according to NYIL § 4119, although it may apply similar rules to other insurance operations during the admissions process.) New York can waive or reduce the requirement if it is determined it is not necessary to protect the interests of the public or policyholders. Financial strength of the ultimate parent company, in this case a Chinese insurer or other Chinese corporation, may carry significant weight in this determination.
California has a more elaborate seasoning exemption structure that includes an exemption if 51 percent of the voting shares is owned by a reputable insurer or noninsurer admitted in California for at least three years or by the successor company by merger (Ins. Law § 716). Thus, as will be discussed below, acquiring an insurance operation already in existence in the United States might be a better solution for Chinese insurers in terms of entering the marketplace more quickly, given these seasoning requirements.
Entry into the U.S. Market by Acquiring an Existing Insurance Operation as a Subsidiary
“Form A” Change in Control Filing
As alternatives to establishing its own insurance subsidiaries or branches in New York or California and qualifying such insurance operations in either state, respectively, Chinese insurers could:
- Acquire “shell” insurance subsidiaries (entities that have little or no assets other than licenses in certain jurisdictions and the minimum “capital and surplus” to conduct business required by the insurance departments of the states where such corporations do business) or
- Acquire insurance companies as subsidiaries that are actively doing business in one or more jurisdictions.
In either case, Chinese insurers would need to file with the insurance companies’ state of domicile an “information statement” (commonly referred to as a Form A change in control filing), which must include, among other things, the background and identity of all persons by whom or on whose behalf the acquisition of control is to be effectuated. The Form A change in control filing must also disclose the source and amount of funds or consideration used or to be used to accomplish the acquisition of control. Both New York and California would require the filing of plans of operations projected over a three-year to five-year period. Although some states require formal hearings prior to approving the transaction, it appears that neither New York nor California would require such hearings except under unusual circumstances, such as a contested acquisition.
It is the goal of all the states to complete their review of Form A applications within 60 calendar days of receipt. The 60-day review process includes two weeks to determine if the application is complete and acceptable. During the remaining 45- to 60-day time period, the application will receive a financial and operational review. The 60-day processing goal may not be achieved in instances where substantial follow-up is required or in states with limited resources or in instances when applications are filed during peak business periods, such as year-end and annual statement filing periods.
Although California has a 60-day time period within which the Insurance Commissioner must act to disapprove the proposed acquisition, the time period does not start until all required information in connection with the proposed acquisition is submitted. New York does not appear to have a formal time period within which to approve or disapprove a proposed acquisition, although in either California or New York timing of the filing of any proposed acquisitions for control of insurance companies is critical as year-end transactions tend to be more difficult to accomplish due to the volume at that time, as noted above.
Whether a Chinese insurer opts to purchase “shell” corporations or insurance operations actively conducting business, it would in ether case be valuable for its representatives to meet with representatives of the department of insurance in the state where the insurance operations are domiciled in order to understand whether there will be any state-specific problems involved in the acquisition process.
Pros and Cons of Acquiring a Shell or Active Insurance Operation
With respect to the acquisition of either a shell or an active insurance company operation, the major concern would be the cost. Generally:
- Shell companies are priced based on the number of licenses they possess.
- Property and casualty insurance company shells run anywhere from $100,000 to $200,000 per state license (exclusive of capital and surplus) depending on the state, with certain jurisdictions such as New York and California being higher.
- Life company shells can be less expensive, depending again on the location of the licenses.
There are a number of brokers who specialize in marketing shell or active insurance companies. A more definitive pricing analysis can be obtained at the time a Chinese insurer decides to acquire either shell or active insurance operations.
The obvious advantage to acquiring either shell or active insurance operations would be the speed to market. Although there are still major regulatory hurdles to overcome in terms of applicable insurance department approvals (e.g., the Form A change in control filings and approvals discussed above) with an active insurance operation, generally the seasoning requirements would not be an impediment or require the applicable insurance department to grant a waiver or exemption.
In addition to the possible speed to market in acquiring shell or active insurance operations, such operations, particularly an active insurance company, would have a rating issued by A.M. Best as to its claims-paying ability. A higher rating (an A or better) would facilitate the marketing of a Chinese insurer’s insurance products, particularly for annuity products that would be sold through financial institutions. A newly created insurance operation would not be able to obtain a rating from A.M. Best until it had established its credibility, which could take some time. However, the higher the A.M. Best rating held by an insurance operation, the higher the purchase price would likely be.
Evaluating the purchase of either a shell or active insurance company will cost both time and money. Great care must be taken to ensure that there are no hidden liabilities that would cost Chinese insurers more money in the future or, what is worse, create bad publicity. The quality of the seller is therefore critical. Buying a shell or an active insurance operation from an established and well-regarded seller possessing significant financial resources is important, especially when looking to any protections under a contract to purchase such operations.
Because of the strong demand for life insurance coverage in the Chinese American community, which is largely based in New York and California, the seasoning requirements would impede a newly organized subsidiary of Chinese insurers in meeting its financial goals in one state or the other for a significant period of time.
In weighing the pros and cons with respect to creating insurance operations and buying shell or active insurance operations, Chinese insurers must balance the timing to enter the marketplace with the possible costs associated with buying a “going concern.” Establishing an insurance operation from the beginning does not carry the risk of hidden or undisclosed liabilities but may slow the speed with which Chinese insurers are able to enter or significantly compete in the marketplace, due to the seasoning requirements.
Statutory Minimum Capital and Surplus Requirements
Both New York and California have minimum capital and surplus requirements for each type of insurance operation contemplated by Chinese insurers. These are minimum requirements for licensing purposes. It is not possible to calculate the exact amounts required, as they depend on the extent of the “lines of business being written.” It should be noted that in both states (and most states of the United States) a single authorization is available for both direct and reinsurance business.
The NAIC’s risk-based capital rules require every insurer to calculate its “risk-based capital” as of the end of the prior calendar year. That figure is compared with the company’s actual capital. Companies that fail to meet the minimum standards are subject to increased regulatory scrutiny. In calculating “risk-based capital” the following elements of risk are considered: (1) risk with respect to the insurer’s assets, (2) risk of adverse insurance experience with respect to the insurer’s liabilities and obligations, (3) interest rate risk with respect to the insurer’s business, and (4) credit and other business risks.
As discussed above, there are numerous business and strategic decisions to be made when a Chinese insurer decides to enter the U.S. insurance market. Each of these considerations results in different regulatory and financial consequences. Therefore, it is critical to have experienced counsel who can explain all the options and assist with the process of entering the U.S. insurance market.
For years, Wilson Elser’s partners have organized subsidiary insurers and U.S. Branches in a number of states and have handled and/or supervised regulatory compliance for many insurers licensed in New York and California and most other states. In addition, this firm has an active practice representing U.S. Branches and subsidiaries of alien insurers, particularly, but not limited to, Japanese and Korean insurers. We have reorganized U.S. Branches as domestic subsidiaries in New York and have acted as general counsel to numerous U.S.-based subsidiaries of alien insurers.