China's insurers have recovery in their grasp. The end of mobility controls has made face-to-face sales possible. This is facilitating new business written, pulling entities back from a pandemic slump and pain from industry reform. S&P Global Ratings believes the life insurers are on a smoother credit path.

We expect life insurers' margins to steady in 2023 and 2024. The insurers will likely continue to finetune controls, at the prompting of regulators. Measures will include a more careful management of liability costs.

The property and casualty (P/C) sector is in more difficulty. Despite gains in 2022 and some players' steps to review their underwriting portfolio, entities are now incurring underwriting pressure. The strains are due to overly competitive pricing and the challenges for insurers to pass on higher reinsurance costs to customers.

Chinese insurers generally are contending with volatile markets, steep competition, and interest rate cuts by the People's Bank of China (PBOC), among many other tests. Regulators have been prodding insurers toward a greater focus on margins. Despite the modest topline growth since 2018, those that had relied on aggressive growth through the sale of short-term endowment policies are constrained.

As economic activities normalize, both the life and P/C insurance sectors' premium growth will likely return to high single-digit growth in 2023 and 2024.

As Risks Arise, Regulators React

We believe tightening oversight will continue. The National Financial Regulatory Administration (NFRA) replaced the China Banking and Insurance Regulatory Commission (CBIRC) in May 2023. The new body has overhauled the regulatory framework to fortify China's financial services sector against systemic financial risks, and address regulatory loopholes.

The market, together with the regulators, are closely monitoring the volatility of capital markets. We believe this calls for more focus on investment risks and product pricing.

Recent regulatory developments include the implementation of new accounting standards, which provides a more economic view of the financial statements. The improved transparency on financial disclosure could prompt insurers to revisit their business strategy and key performance indicators.

Life Insurers: Strains Before Gains

Life insurers have endured a tough few years. In 2018, the regulator urged market participants to shift the focus of the business to long-term protection. This hit growth. Then COVID arrived, creating substantial hurdles to the face-to-face marketing necessary for sales. In addition to reduced demand for long-term protection policies since early 2020 (following the revision of critical illness morbidity table), these factors had contributed to the decline in new-business margins.

However, China's low penetration rates suggests there is much growth ahead in the market. Rising insurance awareness and demand for protection in the country will likely facilitate secular growth in the sector. Interest rate cuts by the PBOC are fuelling demand for savings-type products. Though these products generally have a lower margin than protection-type policies, we believe entities will offset the thinner margins with higher volumes.

Challenges surrounding customer acquisition and retention during China's strict COVID controls prompted insurance agents to change their career path. At the same time, insurers shifted emphasis on agent productivity. These factors have cut agent volume. The number of agents fell to 5.2 million as of first half of 2022, compared with the peak of 9.1 million in 2019.

Firms are also increasing investment in services to support competitive advantage, which could squeeze margins on new business.

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Many market participants in the life insurance sector continue to untangle asset-liability mismatch, a key risk factor. Given the industry's heightened asset risks, the regulator is urging insurers to reduce the cost of their liabilities. It is doing this by capping the assumed interest rate of traditional products to 3.0% (from 3.5% previously). We believe this move likely led to a frontload of policy sales in the first half of 2023. For the first four months of 2023, life insurance market reported 9.6% year-on-year premium growth.

The change highlights the regulators' concerns over interest rate risks. China has cut its interest rates in recent years. The investment returns of our portfolio of rated life insurers was 4.2% in 2022. Historically this return has been over 4.5%. This has created reinvestment challenges for insurers.

China's slower economic growth underlines increasing credit stresses. For insurers, lower yields and higher risks will entail higher risk oversight. Life insurers have had to maintain large allocations of high-risk assets. These high-risk assets typically include equities, real estate, and alternative investments.

Product offerings to support demand

The regulator has allowed more diverse product offerings within the life insurance sector. This should better fulfill mass demand, particularly given ageing demographics. For example, the regulator has recently implemented a pilot program that allows benefits payable on life insurance policies to be converted into long-term care.

In 2022, regulators opened the pension market to supplement the current national pension system in light of a rapidly aging population. Under this broadened private pension scheme, individuals get tax breaks when buying insurance, wealth management products, and public funds that might bolster retirement income. China's shifting demographics will create incentives for consumers to buy retirement-focused products.

P/C Insurers: Resumed Mobility Will Rein In Margins

China's P/C sector has yet to bottom. Insurers' underwriting profit rose in 2022 stemming from reduced traffic amid strict COVID controls. However, we anticipate the underwriting pressure will return in 2023 and 2024. Normalization of traffic levels entails a pickup in auto insurance claims. P/C insurers will need to address the more challenging circumstances by honing their pricing models and otherwise strengthening their underwriting.

Regulators have in recent years focused on increasing oversight of aggressive competition (such as through acquisition-cost competition) and the adequacy of premium rates. This includes implementation of the second phase of its comprehensive motor reform and pricing guidance on insurance on new energy vehicles (NEVs), a source of growth for the sector. The regulator also has recently tightened oversight to curb aggressive competition within motor insurance.

Small and midsize P/C insurers could face more strain on margins. Such entities lack economies of scale and data infrastructure to support pricing and risk selection. Some smaller insurers have demonstrated in recent years an appetite for growth in insurance segments for which they are relatively inexperienced. We believe some insurers may had insufficient priced for the risks they had undertaken.

Meanwhile, P/C insurers will also gain growth opportunities as authorities promote to enhance coverage of catastrophe insurance, and other policy related coverage--such as liability, construction and agriculture. However, extreme weather-related insurance claims, such as those associated with climate change, could add to the challenges P/C insurers face, particularly the assessment of pricing adequacy.

Extreme weather events in recent years (flooding in southern China and Henan province, a drought in Sichuan province, etc.) have also reminded P/C insurers to manage their retained exposure.

Reinsurance costs are rising, and this is not easily passed on to the policyholder. Particularly for some small insurers that rely more on reinsurance support. The trend further squeezes margins. P/C insurers may also alter their risk appetite through greater retention amid rising reinsurance cost. This could lead to increased volatility in their underwriting results.

P/C insurers' reinsurance utilization has been on a gradual rising trend, along with their growing nonmotor exposure. The reinsurance utilization for top 15 selected P/C insurers, which represent over 85% of the market, sits at around 10%.

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What to look for…

Concentrated High-Risk Assets May Add Capital, Earnings Volatility

Insurers will likely enhance their controls managing concentration risk. Regulators' implementation in early 2022 of the second iteration of China Risk-Oriented Solvency System (C-ROSS II) takes aim at flagging the need for diversification by adding new set of risk charges for concentration risk. The framework also requires a "look-through" approach on insurers' investments. The upshot is that those insurers that take on more risk need to hold more capital.

This is particularly so for insurers that have tried to offset declining reinvestment yield with increased holdings of high-risk or high-yield assets, such as equity-related and alternative investments. Among other outcomes, insurers have had to manage rising credit and market risk, such as those direct and indirect exposures stemming from their investments into the local government financing vehicles (LGFVs) and property sector.

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Insurers have allocated 30%-40% of their investments to alternatives, and some of this allocation involves issuance from LGFVs. This exposes insurers to the possibility that LGFVs may restructure or otherwise default on their debts in a climate of weak local-government finances. The central government's ongoing policy to rein in highly indebted borrowers may also squeeze LGFVs, which are often aggressively leveraged.

The regulator has in recent years have issued notices about, or carried out inspections on, insurers' investment exposure to local governments' hidden debt.

We anticipate insurers will seek new asset types, such as REITs and ESG-related investments. Such investments also carry lower risk charges under C-ROSS II.

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C-ROSS II highlights the need for active financial planning among life insurers

Accelerating regulatory oversights will add to insurers' list of priorities. Tightened controls on the recognition of capital has also highlighted insurers' need for more active financial planning. This is particularly true for life insurers in China, following the implementation of C-ROSS Phase II.

Entities' financial leverage will be the next risk to look out for, as more insurers issue to supplement regulatory capital positions. For example, some life insurers are in the middle of a three-year transition period (2022-2024) for C-ROSS Phase II. We believe they will look to issue securities to uphold their regulatory solvency position, particularly the core regulatory solvency, with a sufficient buffer.

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While the sector will experience a mixed 2023 partly because of heavier regulatory controls, we view this dynamic as ultimately constructive. Entities innovate, while regulators closely monitor developments to ensure insurers' risks are manageable. Typically, a fortified industry emerges.

Appendix

Table 1a

Table 1b

Table 2a

Table 2b

Writer: Jasper Moiseiwitsch

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• China's Summer Struggle: Drought, Food Inflation, And Shortages, Aug. 31, 2022
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