More pain is on the way for China's insurers. The life insurance sector is already stuck paying out on guaranteed returns on some policies that are higher than current market returns. This asset-liability mismatch is set to worsen amid a larger than expected fall in interest rates and volatile market conditions.

S&P Global Ratings anticipates tough medicine will be applied to solve this and other problems in the broader industry.

To complicate matters, the operational burden for insurance management will intensify given regulatory calls to tighten risk control systems and provide more affordable insurance to the masses. Concurrently, insurers are expected to deploy funds to meet China's strategic interests and development, which potentially lower returns.

That said, the longer-term dynamics remain compelling. China's insurance market is still underpenetrated and its huge population and economic base points to significant insurance needs. We foresee a baptism of fire for the next generation of insurance company leaders, who will be grappling with much-needed improvements.

Life Insurers Can No Longer Hope To Grow Out Of Their Problems

China's slower macroeconomic settings are aggravating the life insurance sector's weak spots. These include asset liability mismatch, suboptimal risk pricing, and heightened sensitivity to capital market volatility. Specifically, the pain on small and midsize life insurers is set to intensify. Concurrently, rising unemployment could contribute to slower top-line growth and higher lapses in life insurance policies – affecting profitability of life insurers. The pain is coming from all directions.

Unfortunately, the insurance sector was underprepared for the country's rapid decline in bond yields. The sector is now grappling with a mismatch between their promised payouts and the returns they are currently making on assets. We first flagged the mounting concerns of interest rate mismatches in 2015, and turned our sector view to negative.

To avoid repeating the pitfalls of high interest guarantees, which also occurred for some years before1999, the regulator imposed tighter caps for pricing interest rates. However, we believe a lower cap is required, amid falling government bond yields.

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To manage interest rate burdens, we expect insurers to promote life insurance products with floating returns. Such products include participating, universal life, and unit-linked policies. These policies, which involve the sharing of investment risks with policyholders, come with much-lower embedded guarantees.

While this product shift will also contribute positively to life insurers' value generation through lower liability costs, it might not be as popular with customers. Floating-return policies have an element of uncertainty. Also, sales of such products have higher mis-selling risk. Regulators could call on tighter sales process, posing higher compliance costs to insurers.

Consequently, we anticipate softer demand for such life insurance products--dampening the growth outlook. We expect life premium growth to slow to 5%-8% over the next two years, compared with 10.2% in 2023 and 13.1% in the first seven months of 2024.

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Change in the making

The Chinese government's effort to push insurance as part of the social safety-net has been decades in the making, however the lure of higher investment returns from alternative wealth management products dimmed the attractiveness of insurance policies. Now, we see a change in the making.

Saving for retirement.  Concerns about adequacy of government pensions for retirement needs is prompting individuals to start saving for retirement early. Furthermore, the push out of retirement age to 63 for males (from 60) and to 55-58 for females (from 50-55) likely means later access to government pension savings. We anticipate annuities and private pensions will benefit strongly, albeit from a low base.

Providing coverage to those with pre-existing health conditions.  Regulators, in their latest guidance, reiterated the need for "inclusive insurance" that is affordable and doesn't discriminate against less-healthy individuals. While this promotes insurability, concerns of adverse selection could hit margins for insurers.

Overseas investments could diversify exposures; this will be gradual.   With China now having lower interest rates than some key markets, some Chinese insurers might increase overseas investments to boost investment yields. China's asset allocation to overseas assets will likely remain less than 5%, well below the limit of 15%. This contrasts with both Japanese and Taiwanese life insurance markets, which invested heavily in overseas markets when coping with low interest rate challenges in domestic markets.

P/C Insurance Has Similar Aches And Pains

Slowing growth in China is also a constraint on P/C insurance premium growth. A slower pace of new car sales, a reduction in construction projects (including those associated with government initiatives) and falling consumer confidence hinders the growth outlook for the sector. We expect underwriting premiums to rise 4%-5% over the next two years, versus 6.7% in 2023 and 5.1% for the first seven months of 2024.

Meanwhile, China's sharper-than-expected decline in interest rates, and volatile capital markets, have also exposed P/C insurers to earnings swings and narrowing capital buffers. Our negative credit trend on China's P/C insurance sector reflects the market pressure and added volatility on underwriting results from competitive pricing.

Underwriting in 2024 is likely to be in losses, amid increased frequency of extreme weather events (such as flooding and typhoon events). Examples include the recent Typhoon Yagi in Hainan province and Typhoon Bebinca in Shanghai, with economic losses broadly estimated at Chinese renminbi (RMB) 90 billion, and RMB6.0 billion-RMB8.0 billion in insurance losses from the catastrophe insurance pool, properties, and agriculture insurance. We expect the sector's combined ratio to sit at around 100%-102% over the next two years.

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Catastrophe coverage: Balancing commercial viability and serving the masses

China's diverse and expansive landscape, which exposes the country to various perils such as flooding, earthquakes, and typhoons, will support greater demand for catastrophe insurance. Concurrently, the rapid electrification of the auto-sector points to need for new auto insurance pricing models.

Like the life sector, the government is asking the P/C insurance sector to shoulder more responsibilities to provide safety nets against catastrophes, while keeping it affordable for the masses. However, we believe the onus is on insurance companies to balance between underwriting margins and national service.

So while government-initiated programs (such as catastrophe insurance, agriculture insurance and inclusive health insurance) could offer growth opportunities, these may come with thinner margins. To cope, China's P/C insurers will likely need to refine the design of catastrophe insurance coverages, as well as working with reinsurers and the government on risk-mitigation plans. Considering the country's rapid urbanization, more frequent updates to the catastrophe models are crucial for effective risk assessment for P/C insurers.

EV insurance pricing still in trial-and-error phase

China's leading position in EV manufacturing has propelled its growth into the world's largest EV insurance market-place. That said, insurers continue to struggle with the underwriting of such risk. Amid limited historical data to support actuarial pricing, and higher repair costs than for traditional cars, a new underwriting and pricing model may be required.

To cope, P/C insurers could explore partnerships with EVs and battery manufacturers down the value chain. This cuts out the middleman-associated expenses, while getting first-hand knowledge about specific EV models. However, this learning process will be a baptism of fire for the P/C insurers. We expect the EV insurance segment to remain in underwriting losses over the next two years. Consequently, only the giants or specialized writers might be able to develop viability in this segment.

Will Insurers Make It Through The Coming Tough Patch?

In short, yes. However, things could get worse before they get better. Insurers, like many other investors, are adjusting investment strategies in search for yield. However, some need to contend with prior investment mishaps by writing down assets or realizing losses. Insurers that lack the capital and liquidity to absorb this additional risk will likely face eroding credit quality.

Likewise, a test of lasting power could see some exits from the markets. With regulators strengthening barriers to new domestic entrants, the giant insurance companies will likely cement their foothold. A focus on underwriting could come at the expense of top-line growth. Given the long-term potential for this still underpenetrated insurance market, the incentives are strong to stay in the game.

Related Research

• China Insurance: Change Is Painful, June 20, 2023
• China Insurance 2021: Balancing Growth With Governance, Feb. 2, 2021