Chinese insurers continue to enjoy a lower cost of capital when they buy reinsurance in Hong Kong but things may change once Hong Kong adopts a new risk-based capital (RBC) regime in two years' time.

The China Banking and Insurance Regulatory Commission (CBIRC) and the Insurance Authority in Hong Kong reached a consensus in July 2018 that under the China Risk Oriented Solvency System (C-Ross), the capital requirement on mainland insurers would be reduced when they ceded business to qualified Hong Kong professional reinsurers.

“The CBIRC has agreed to extend the preferential treatment under the C-Ross for one year until June 30 next year. This will help maintain the competitiveness of our insurance sector and provide a sound risk management foundation for Hong Kong to participate and assist in the Belt and Road Initiative,” the Constitutional and Mainland Affairs in Hong Kong said in a note last week.

Chinese insurers face a higher capital charge if they find an international reinsurer to transfer part of their risks, instead of a domestic one. But under the preferential treatment, the capital charge is substantially lower when mainland insurers work with foreign reinsurers with subsidiaries in Hong Kong.

C-Ross is not applicable to foreign players. It’s difficult to assess the capital strengths of foreign players, so a higher capital charge is placed on them, Frank Yuen, senior analyst for financial Institutions group at Moody’s, told AsianInvestor.

In a 2018 announcement by CBIRC, the counterparty risk factor under the special treatment is 0.087. AsianInvestor was unable to ascertain the former level, but Terrence Wong, senior director for insurance at Fitch Ratings, told AsianInvestor that it is much lower under the treatment.

POTENTIAL CHANGE

Hong Kong’s RBC regime is slated to take effect in about two years’ time. Faced with these drastic regulatory changes, Hong Kong insurers have been urged to optimise their portfolios and review their asset allocations to improve their solvency ratios.

Yuen believes the looming regime has implications for preferential treatment rules too.

The lower capital charge for global reinsurers continues to be implemented in the form of preferential treatment instead of a regular arrangement, partly because Hong Kong is going to adopt the new RBC regime soon, Yuen said.

“If it is a regular arrangement, C-Ross versus RBC will be more meaningful, because RBC is a more long-term capital regime,” he said.

Wong of Fitch Ratings is not convinced that the upcoming RBC regime is the main reason why the arrangement remains a temporary one. But he believes it may lead to some changes in the preferential treatment, potentially the capital charges, if it is to be extended agian.

“We don’t know how the development of RBC [in Hong Kong] will end up … the framework is not rolled out yet,” Wong said.

MAINLAND INSURER BENEFITS

The preferential treatment is seen to benefit both mainland Chinese insurers and global reinsurers.

The lower cost of capital is just one incentive for domestic insurers to use global reinsurers in Hong Kong. Another is that global reinsurers have some technical expertise that cannot be matched by domestic ones, Wong said.

Local insurers may not have too much experience and data points to develop new products. Most of them partner up with foreign reinsurers so they can better study the pricing models, product designs or other new insurance policy features. They can’t do it without enough data points, he said.

Yuen agreed. International reinsurers are more developed; they have more mature pricing and data points, he said.

Traditional motor and fire insurers are more inclined to stick with domestic reinsurers. But life insurers have more interest to join hands with foreign reinsurers as their products are more complex.

“There are now more life annuity products and health insurance products … Longevity risks are relatively new to domestic life insurers and they do not have a lot of data about them. From this perspective they have increasing need for global reinsurers,” Yuen said.

If the reinsurers are more diversified for mainland insurers, it will also help to reduce the systemic risks in the sector, he added.