At present, the recently adopted China Risk-Oriented Solvency System (C-ROSS) is the only regime which regulates mainland Chinese insurers' capital adequacy. Following the implementation of China's 13th Five-Year Plan in 2016, the China Insurance Regulatory Commission (CIRC), as the industry's sole regulator, published an outline of the plan, which included several goals relating to the reformation, innovation and regulation of the insurance industry. This draws interesting comparisons with the overseas capital adequacy regimes of other major jurisdictions – notably, the EU Solvency II regime. These reforms mark a fundamental shift towards a risk-based, market-oriented approach to estimating capital requirements, as they are geared towards individual insurance entities, rather than following the previous one-size-fits-all approach. This is expected to improve market efficiency in managing risk and enhance consumer protection. For China, it marks a renewed focus on both volume and value for the domestic insurance sector, implicitly recognising that stronger risk management includes all product profitability drivers, including product terms and conditions, guarantees, pricing and underwriting.(1) As a result, the transition towards fully implementing, supervising and enforcing C-ROSS is already having far-reaching effects.
By appropriating the most useful features of existing global regimes, C-ROSS has formulated a risk-based supervision regime that is on a par with global standards, yet remains tailored to the specifics of the Chinese insurance market. Like Solvency II, three key pillars underpin C-ROSS:
- quantitative capital requirements, which set out how much capital insurers must hold;
- qualitative supervisory requirements, which concern internal governance and formal supervision; and
- disclosure requirements, which enable the market to assess insurers and supervise unregulated risks more accurately.(2)
C-ROSS is structured as follows.
The effects of fully implementing the system are manifold. M&A activity is set to benefit from the increased emphasis on diversification and, to this end, a number of acquisitions have already been consolidated or are underway. Smaller insurers may be encouraged to merge and work together to offer a wider portfolio of products and services to their consumers and service channels, while simultaneously sharing the compliance burden regarding modelling and reporting requirements and lowering their overall capital requirements. Further, increased disclosure requirements may make for a more open and transparent market, whereby the market plays a greater role in capital allocation.
The reallocation of risk to individual insurers has seen similar knock-on effects in the European Union's more mature insurance markets, where an increase in de-risking activity looks set to continue. Insurers looking to hedge longevity risk in respect of pension scheme deficits and annuity books has, intentionally or not, resulted in an increased volume of reinsurance activity. In China, while the private pension and annuity market is less comprehensive overall, it has still been embraced by its domestic life insurers with the CIRC's support. However, the application of risk charges under C-ROSS is significantly higher for international reinsurers than their domestic counterparts. The European Union has a single market at its core, and the Solvency II rules are designed to harmonise the industry throughout its member states. Conversely, C-ROSS is designed to operate according to the unique features of its own single market, giving rise to its own divergent outcomes.
This can be further explained by the different stage of growth of the Chinese insurance market compared with its counterparts in the European Union, the United States and Japan. To put this growth into perspective, in 2016 premium volume stood at more than Rmb3.1 trillion, with an annual five-year growth rate of 16.8%. The levels of insurance penetration and insurance density at the end of 2015 were 3.59% of gross domestic product and $271.77 per capita, respectively. These are projected to reach 5% and Rmb3,500 per capita, respectively, by 2020.(3) This projected expansion should not be unduly shackled by restrictions on sustainable growth, which is a stated goal of the C-ROSS rules.
Market monitoring, consumer protection mechanisms and reputational risks also take on greater primacy in the Chinese market, in order to:
- address a lingering culture of mis-selling, lax client practices and fraud and overall customer satisfaction levels; and
- carry out a reputational risk assessment as part of the C-ROSS Pillar II qualitative assessment.
The CIRC's mandate to develop and oversee this assessment and other consumer protection mechanisms is indicative of its status as a single regulator, again emphasising that the rules are tailored to China's own unique system and development path. Under the fractured nature of EU supervision, such elements may differ from the Solvency II regulations and be more in line with the rules of other supervisory bodies – for instance, the UK Financial Conduct Authority's Treating Customer's Fairly regime.
C-ROSS also employs simpler risk management and governance procedures and techniques,(4) including the quantitative measures used to determine capital adequacy under Pillar I. C-ROSS adheres to fixed formulas based on easily measurable parameters – for example, ratio factors for reserves and sum at risk for life insurers. Under Solvency II, more complex calculation methods are adopted, and insurers can provide their own internally developed models to meet the relevant standards.(5) Such measures are impractical in a Chinese insurance industry that has fewer auditing resources and solvency-trained risk management personnel.
The Solvency Aligned Risk Management Requirements and Assessment (SARMRA) is another key Pillar I variant where simplification is inherent. Under SARMRA, the CIRC alone is required to provide the assessment and annual score. This score can then be used to determine the level of any applicable capital add-ons or reductions, providing insurers with a defined and certain process for determining this variance. In comparison, the Own Risk and Solvency Assessment under Solvency II allows for insurers to carry out their own risk assessment, and the capital add-ons are discretionary. The overall effect of SARMRA is to provide Chinese insurers with a defined process for determining capital variances, without the responsibility of carrying out their own assessments.(6)
Overall, C-ROSS and Solvency II both represent fully integrated regulatory and managerial systems that are designed not only to identify and prevent risk, but also – more fundamentally – stimulate the industry's own risk management ability through a reward and penalty mechanism,(7) thereby driving market efficiency. Themes of deregulation, financial innovation, strict supervision, corporate governance, competition and sustainability run through each of them. However, C-ROSS is marked in the way that it reflects the characteristics of its market and the market's existing maturity level during its implementation.(8) Meeting the insurance needs of a growing nation the size of China is a complex task, but C-ROSS will better equip the industry in this regard.
For further information on this topic please contact Hao Zhan, Wang Xuelei, Pan Xiang or Sharif Hendry at AnJie Law Firm by telephone (+86 10 8567 5988) or email ([email protected], [email protected], [email protected] or [email protected]). The AnJie Law Firm website can be accessed at www.anjielaw.com.
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Endnotes
(1) Further information is available here.
(2) Further information is available here and here.
(3) Several Opinions of the State Council on Accelerating the Development of the Modern Insurance Service Industry.
(4) Further information is available here.
(5) "Where, for instance, the standard formula for calculating risk based capital requirements (the Solvency Capital Requirement) under Article 114 of the Solvency II Directive is calibrated to seek to ensure that insurers hold enough capital to cover a 1 in 200 event i.e. with a 99.5% confidence level, for the next 12 months", EU Solvency II Directive (2009/138/EC), available here.
(6) Further information is available here.
(7) Further information is available here.
(8) Under Solvency II, firms had to implement the rules by January 1 2016.
