Chinese insurance companies are gearing up for the launch of the second phase of the China Risk-Oriented Solvency System (C-Ross II), which aims to push them to invest more cautiously when it comes into force next year. Yet they will arguably have an incentive to buy more domestic equity assets, assuming they meet the solvency requirements to do so.

The risk capital charges will rise for almost all types of assets under the latest proposals, as much as doubling for certain investments, such as infrastructure equity plans. The table below shows the  changes proposed by the China Banking and Insurance Regulatory Commission (CBIRC), as indicated by a document passed to AsianInvestor by an industry executive.

As a result, the rules may dampen appetite for complex investment products such as trust plans, asset management products and some alternative funds, said an Asia insurance coverage head told AsianInvestor on condition of anonymity.

C-Ross II also places a higher capital charge on insurers’ concentration risks, he added. This will have less impact on big firms because they tend to have a more diversified portfolio. But small and medium-sized players tend to have more concentrated risk exposure, so the new rules will force them to diversify further, he added.

CBIRC'S PROPOSED RISK CAPITAL CHARGES UNDER C-ROSS II

Asset Capital charge under C-Ross Capital charge under C-Ross II
Unlisted equities          28% 41%
Equity funds   25%     28%
Infrastructure equity plans   12%     25%
Unlisted investment plans and trusts        31%     41%
Listed stocks on main boards          31%    35%

The new C-Ross II framework will have “quite a big impact on insurers’ asset allocation and business structure”, the chief investment officer of a Shanghai-based insurer told AsianInvestor, asking not to be named.

Domestic insurers are now assessing their solvency levels based on C-Ross II capital charges proposed for various assets issued to them on July 20, while the CBIRC is inviting feedback on proposals designed to boost insurers’ capital adequacy. It issued a request for comment on July 30 on a so-called ‘three-parameter framework’ that aims to strengthen firms’ solvency management, with a deadline of August 29 (see box below). Any feedback is expected to be reflected in C-Ross II.

MIXED MESSAGES?

Yet despite its apparent desire to reduce risk in portfolios, the CBIRC seems to be sending a mixed message. On July 17, CBIRC raised the equity investment cap for insurers to 45% of their total assets from 30%, with the stated aim of providing more long-term funds to the real economy and capital markets. The CSI 300 index duly jumped on the trading day after the announcement.

Zhu Qian, Moody's

Still, the regulator did stress it would set different requirements for insurers on how much they can invest in equity assets. Only firms with sufficiently high capital adequacy solvency ratios will be able to take on high levels of equity exposure.

Ultimately, insurers will have to balance the yield of their investments versus the capital charge, and their asset allocation will be constrained by the new solvency requirements, Zhu Qian, senior credit officer in the financial institutions group at rating agency Moody's Investors Service, told AsianInvestor.

The solvency ratio is calculated by the available capital divided by the required capital, and the new rules will put pressure on both metrics, the unnamed head of Asia insurance coverage said. That is, reqiured capital will rise and available capital will fall.

For instance, real estate will be reported at book value instead of fair value for investment purposes, the executiive noted. Residual margin – the discounted value of the future profit from insurance contract – was previously reported entirely as core capital (the key measure of an insurer’s financial strength), but part of it will be categorised as only tier-two capital under the enhanced rules. These will reduce the available capital, he said.

According to the July 20 proposals, each insurer must report its solvency strength by seven metrics based on their portfolios on both June 30 and December 31 this year. By the latter date, the regulator may have made adjustments to the requirements, said the unnamed CIO. The metrics include insurance-risk minimum capital, market-risk minimum capital and credit-risk minimum capital.

Look-through treatment will be applied on market and credit risks, which means insurers will have to disclose risk associated with the underlying assets for almost all types of investment under C-Ross II.

THE THREE-PARAMETER FRAMEWORK

Under the proposed three-parameter framework, insurance companies that cannot meet the C-Ross II solvency requirements will face regulatory actions that include adjustments of their asset structures or investment limits, the CBIRC said in a consultation paper issued earlier this month.

Depending on the causes and levels of their solvency risks, insurers could also be ordered to increase their capital base or cut back on their business or asset growth, among other possible actions.

The planned framework is credit positive for China’s insurance industry, because it will allow better differentiation of insurers by their capital quality and risk management,  said Zhu Qian, senior credit officer in the financial institutions group at Moody's Investors Service.

The three parameters refer to comprehensive solvency ratio, core solvency ratio and comprehensive risk assessment. Comprehensive and core solvency ratios must be at least 100% and 50%, respectively, while the comprehensive risk assessment needs to be B level or higher.

The existing rules focus more on the comprehensive solvency ratio, but to satisfy the new solvency requirements, insurers must pass all three tests. This is a more comprehensive and dynamic approach than before, reflecting the spirit of C-Ross II, Zhu said.