International insurer Sun Life has just received permission to sell life insurance in Beijing. Here its Asia President, Douglas Henck talks about the firm's strategy in China and India; and the challenges of the insurance business on the Mainland.

Tell us about your joint venture with Everbright in China.

Henck: It's coming along pretty well. We have a joint venture with Everbright that goes back a few years, but we didn't actually start writing policies until late April 2002, when we started in Tianjin. I suppose that it's quite an unusual place to begin, but we were the first foreign company to go into Tianjin. Shanghai was very saturated by that point, it probably had about a dozen companies by then and Guangzhou already had several. So we decided to go up north. A few weeks ago, we started in Beijing, which was our plan all along. Beijing wasn't open in 2002 and subsequent to that it did open and we've expanded down the road and now we're selling there. There are now three or four companies in Beijing that have started quite recently, and it has been our approach to sell there. Our joint venture with Everbright has been great; they've been extremely supportive.

With geographical limitations lifted under China's ascension to the WTO, are there any other regions that you're looking to move into?

The geographical limitations are being lifted in a sense, whereas we are going to be able to move into more cities, it's not going to be one every two or three years. I still believe that licences will be granted city by city, so to that extent there is still some restrictions. In India by contrast, we started selling business in 2001, opening up in two cities on the first day we started, and today we're in 33 cities. That's truly a nationwide coverage, you can go into any city without asking permission.

China is not quite there yet, but yes, we are interested in moving into quite a number of other cities. It's a balance of a couple of thing. The first reason is that the economically well-developed wealthier cities are those on the coast, the cluster around Shanghai, the cluster around Guangzhou, the Pearl River Delta. But there is also more competition in those cities. The western cities like Chengdu or Chongqing also have some appeal.

Like all of our competitors, we've got to balance the question of how saturated the market is compared versus what is the opportunity of the market. Then we look at how we move into them and which ones we'll go into. I think it is fair to say that they we are going to be in all of them, our competitors are going to be in all of them. It'll effectively be an Asian-wide licence for all of us.

With competition like China Life, do you ever see foreign firms improving their market share in the mainland?

The proportion of market share for foreign insurers is now at 2% but the 2% quoted is in force premium. What we report when we look it is new premiums, that's where the competition is. There is no competition on renewal premiums from five years ago because no one was in the market five years ago. Looking at new premiums and new sales is the way to do it. Secondly, we are only looking at those cities where we are competing. If you look like at it from that basis, then the foreigners have really captured a substantial share of the market from China Life. From a new premium viewpoint, in those cities with competition, China Life would be edging down towards two thirds or one half in those cities.

What kinds of products is Sun Life Everbright offering to customers in China?

It's a blend. Normally, in emerging markets you have a middle class for the first time buying insurance, so they don't really understand insurance. Also you have some natural barriers in China, as there is reluctance to buy anything you can't feel or touch. There is also a natural reluctance to gamble on your life. The notion of life insurance being part of a core financial package takes some education and for that reason in emerging markets generally, including China, the primary approach for insurance companies would be to sell very traditional, very straight forward products and policies that have been around for a long time and to do this through an exclusive agency force that sells your product, which gives you a face-to-face opportunity with the client. In China, it's so large and big, and has opened to knowledge around the world. Some of the more sophisticated products from North America and Western Europe are known in China. Some of the distributions such as Bancassurance or some other channels are beginning to be known. Whereas ten years ago, when places like Vietnam were beginning to open up there was a natural evolution where more sophisticated products or channels of distribution did not arise too quickly. In China by contrast, they're coming along quite rapidly. We tend to lean towards that latter approach, looking to where the market is going to be a few years down the road, which in China's case will be more like the mature markets and we tend to go for those. We do sell traditional products and sell through traditional channels, but we're also in the market with more sophisticated investment-linked marked products with a multiple distribution.

With the investment-linked products, what sort of penetration into the Chinese life insurance market are you seeing?

We weren't the first to introduce investment-linked products into China. Ping An were the first introduce the products and they were one of the early competitors with China Life in the late 80s and early 1990s when the government allowed them to start. Ping An was very aggressive in the investment-linked market and around 2000 and 2001, they sold a whole lot of it.

A couple of things happened by the time we started in 2002. Firstly, the China government became quite concerned about whether all the customers really understood what they were buying. So the government, I believe quite reasonably, began to put some constraints on the sales to say, what do they really understand and what kind of information are you providing to the customers. That was one thing that happened.

Another thing that happened in China and also in Hong Kong, was that markets didn't look great. Interest rates were low and equity markets weren't doing well, so investment-linked penetration went way down, if you looked at the whole country. But then it went from something like 2% in 2001 to 35% in 2002 from investment-linked products, and then it went down to 15-20% the following year.

Investment-linked products are growing in popularity but I think you have to take the noise out of the fluctuations early on. Maybe Hong Kong is better model. Hong Kong improved from 0-5% in 1995, steadily increasing year-by-year to 25-30% depending on how attractive the markets are in any given year. I would expect the same thing to happen in China.

You believe the market will mature?

Maturity will happen, people will become more aware of it. Customers will understand that they are taking the investment risks themselves, which is again a step more mature and sophisticated for what you would get with the traditional products, which would be all guaranteed. That's one of changes that happen.

In Hong Kong, 50% of your sales come from bancassurance. In regards to China, do you see bancassurance under performing in the Chinese market.

Bancassurance is a terribly interesting subject in its own right. Here in Hong Kong, you saw a very clear example of what happens to an emerging insurance market. Bancassurance around 1990-1995 was a very small segment of the market. Today, it would be upwards of one-third. You've seen banks really penetrate in a meaningful way against the companies that only offer the traditional, exclusive agency force. Here in Hong Kong, we're full steam ahead with that market and are quite pleased with that market.

In China, what has happened is that a number of companies were quite excited for the opportunity to work with the banks and the banks were excited about the opportunity for fee income. There is a fair amount of business being sold through the banks. The problem or the challenge is that there is also a level of maturing and sophisticating that comes with respect to the banking sector in China. Understanding that it is one thing to make the one-off sale to the customer, you scout around and get bids from different companies and get the cheapest product and you sell it to this guy this time and when and done it's all over.

But the banks here in Hong Kong have really developed a much more sophisticated and long-term approach. They are now effectively saying, 'We want to work with your customer, we want to provide you everything from the womb to the tomb in terms of your products. This is not a one-off sale; we want to make this one of an ongoing series of sales so you have to look at your bank for providing financial products over your lifetime. It's not just your checking account, but we're going to help you with life insurance, and later on with annuities, savings for education and all those sort of things."

A bank that is in that position is logically going to develop strategic partnerships with one or two or at most, three life insurance companies and say, "You need to want to work with us, we want to help you, we want to brand it ourselves, we want you to work with us to develop products that meet our needs." That is what is happening in Hong Kong, we're nowhere close to this level in China.

China is still on the one-and-done, whoever sells me the cheapest products, I'll pass it on. Insurance companies are right now scrambling for this business with a view to form a long-term relationship with the banks. What I'm hearing from competitors and others in the industry is that this process has not begun to happen yet, but it will happen. It is underdeveloped for that market, notwithstanding the fact that there is a fair amount of Bancassurance being sold. In my view, Bancassurance in China is not demonstrating a long-term commitment to the customer, it's not showing a long-term commitment to a strategic alliance.

Sales for Sun Life Everbright up around 70% for premiums last year, how do you see this panning out in 2004?

We should at least up around that number again this year. You're comparing 2003 to 2002 when we only began in April 2002, so that's comparing a full year to a partial year. This year we'll be able to add business from Beijing to what's going on. In general, when insurance companies go into a new market they look for triple digit growth, they look to double their business every year for a few years to get up to a reasonable size. I think all the insurance companies would be looking for that. In India, we're seeing around 250% growth year-on-year. In India, we're in the whole country, so we're understandably seeing some differences there.

Negative spreads in China continue to be a hangover from the 1980s and early 1990s, is the regulator doing enough to eradicate these spreads in regards to lifting limitations on investments?

Negative spreads have occurred throughout Asia and it's a global challenge for the insurance industry. If you look at Japan in 10 to fifteen years ago, guaranteed rates were at 6%, now you'd be lucky to get 1% in the Japan market. As these rates have gone down, the policies have stayed in force because the clients are getting great values. The companies have really been in dire straits trying to keep that in place.

Similarly in China, if you went back ten or fifteen years, interest guarantees of upwards of 7, 8, or 9% were being provided commonly by China Life and other insurance companies, including some foreign companies. As the rates came down, the companies were scrambling to do that. Has the government done enough? I think the government is keenly aware of the negative spread problem and with respect to insurance companies, requiring insurance companies to set up sufficient assets and to have proper liabilities set up on the books is really the first step.

Typically, in Asian countries when the domestic companies run into troubles with surplus, the governments don't crack down hard enough, they allow some sort of phasing approach. Korea, for example, rather famously allowed insurance companies to hang on for quite a long time before coming to grips with it.

I think China has taken some reasonable steps towards addressing problems of negative spreads. But as we recognise with the China Life IPO, it was not long after the IPO that they realised it was not fully recognising the challenge and the problem. Had those accounts been done on a basis from the US or Canada, the accounts would have looked very different from what they did in China. I think there is recognition and they are moving towards it, they're trying to keep some stability in the market place and insurance companies today are careful about how we're pricing those policies and how we're investing.

The other question is how do we really manage what we invest in and that gets us in to some sophisticated analysis of the duration of our balance sheet. The duration and liabilities for life insurance typically come out to 6, 7, 8 years or longer. The duration of the assets that we're able to buy, are shorter by contrast. The whole question of a mismatch between our asset duration and our liability duration is something that insurance companies have to deal with again. Particularly in China, where the level of the capital markets and the size of the capital markets in terms of trading and corporate bonds isn't really big enough to manage some of this.

That's a very real challenge for companies as we move forward. I would say markets that are opening up, like China, that it is an advantage to have foreign companies in there who understand who to deal with this kind of thing. We have an expression in the insurance business that you don't want your competition to be too uninformed. You really want really want them to understand the business so they won't come in and undercut too badly. In this case, the foreign companies understand that and the domestic companies have made a lot of progress.

How comfortable are you as an insurance company investing in the Chinese stock market?

The insurance companies in China have invested very heavily towards the fixed interest side, to the bond portfolio - bonds and fixed assets. The equity markets, I won't say they're thin in the sense of not being well capitalised, they're bigger than the Hong Kong market, but that's in terms of market capital. If you do look at the trades in equity markets in China, they are quite thin. You also have accounting issues, transparency issues,

I would say as general rule that insurance companies are not terribly comfortable investing in the Chinese stock markets. We've also been restricted from the investing in the stock markets and that would be because the regulators were fearful that with a relatively small supply of stocks being traded everyday if you suddenly had this flood of demand in their the challenges they're currently facing would be exacerbated. Like other insurance companies, we've tended towards state-owned deposits, government securities, bank deposits and there are some corporate debt issues that we're looking to go into.

In the US traditionally, the corporate debt segment is where the most majority of assets come from and so insurance companies developed quite a sophisticated credit analysis in terms of whether they're going buy Anheuser Busch or Microsoft debt. This all comes through the analysis that is done in house. We're not there yet in China, we still have a vast proportion of assets that is either government or bank.

If you compare your investment abilities in China and India, is it easier to be an insurance company in India currently than it is in China?

Yes, I'd say it is. In India, you have the nationwide licence, which means you're not worried about the regulations of the next licence and in regards to setting up. There has been some very healthy competition in that way. Secondly, in China they stopped selling life insurance for the three or four decades after 1949 and the communist takeover.

The People's Insurance Company of China only began again in the early 1980s to sell life insurance. You had a whole generation growing up without it. By contrast, India nationalised all the foreign life insurance companies in 1956, but they never stopped selling life insurance.

The Life Insurance Company of India (LIC) has an army of half a million agents or more around the country, so life insurance is quite well known in India. Similarly in India, you had what was called the Unit Trust of India, which was the state owned monopoly on mutual funds. That never stopped either. As we come into the Indian market in 2001 what we found was relatively more understanding of consumers for life insurance and mutual funds, which we are both involved with in India, than in China. In that sense it is easier.

Thirdly, because of the mutual fund business in India, the earlier opening of asset management businesses, and the introduction of foreign banks, you have a capital market that is relatively easier for us. I would still say think that the Indian capital markets are a challenge to us from an asset liability standpoint in a manner similar to China but not quite so much.

My perspective right now is that it has been easier for us in India than it has been in China. That is not to say that China does not have more potential for this market in the longer term. I think India is going to be bigger for us in the short term. Longer term they're both going to be huge insurance markets, but longer term they're going to be bigger than the US economy in the first half of this century. I think you do look at both of these nations from a longer term.

But some studies show that corporate governance is higher among some of the blue chip Indian companies, does that mean you'd invest in equities in India?

We have equities in India, but we also have this investment-linked business in India. We did the same strategy there that we did in China. But in India, because of the existence of mutual funds and the greater knowledge of the stock exchanges, there was much receptivity to that than in China. We have substantial tradings in equities on behalf of our clients in India, and there is a lot more trade. You're absolutely right, the governance in India is quite a topical conversation. Infosys is rather famous in competing on the world stage largely by its adamant support for good quality corporate governance practices. Similarly, some of the state-owned banks have been right upfront in talking about quality corporate governance. Yes, there are always challenges in these emerging countries, but in the corporate governance section, India has been able to make more progress.

In fairness, China has some issues that India does not have. India was a socialist country, but not a communist country. The largest parts of their manufacturing sector were still privately owned. They have been family owned, they may have been under the old licence raj, they may have been an oligarchy of sorts, but they were still privately owned. In China that was not true, they were all state owned. You had the iron rice bowl where the entire country was going to be providing, that wasn't true in India. In India you had the socialist policies where you had support but the corporations were providing basic benefit care. So India was really coming from a different place.

You mentioned LIC before and it's a huge entity. Is it now suffering from the competition from the JVs launched between foreign and local companies?

Yes, and no. The LIC, since 2001- we were within two or three months of starting at the same time as a bunch of other companies started- the market share, new sales, is down to 87%. In three years, the dozen or so private careers have taken 13% of that market. But the market has grown more rapidly since the foreign careers have been there. If you look at it strictly from a market share viewpoint, LIC has lost. If you look at it from a growth rate viewpoint compared to private years, it is gaining. That's typical actually.

The same thing happened in Taiwan in 1987 with Cathay Life who had over 50% market share. Today, it does not have over 50% market share any more but it's growth in those years in faster than when they controlled 50% market share. The whole markets starts to grow as you gain awareness, as the products get better, as the consumers are better served. It's a win-win situation in my view, as long as don't get hung up on market share. You've got to come down from 100%, don't you?