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Analysis of the Systematic Risks of China’s Insurance Industry
2005-06-01
Zhang Chenghui, Research Institute of Finance of DRC Research Report No.028, 2005
Through more than 20 years of development, China’s insurance industry has made remarkable progress and so far has become the country’s fastest growing industry seeing the longest period of rapid growth. While paying tribute to the achievements of the industry, we should note that risks in the industry have also grown with the increase of the number of insurance entities and the rapid expansion of the market size.
I. Major Risks Facing the Chinese Insurance Industry
1. General classification of insurance risks
There are a number of methods for classifying insurance risks. By internationally recognized practice, we divide insurance risks into four categories, namely, asset risk, liability risk, asset-liability matching riskand operation risk, as shown in the following diagram.
Of the four categories, asset risk is controllable in most cases and may be avoided by diversifying investment, optimizing portfolio structure, providing re-insurance and improving financial systems and appraisal methods (but the risk will be difficult to evade, when the financial market or environment is not sound enough, the types of financial products are limited, insurers are less competent in making investment and the investment of insurance funds are too much regulated). Liability risk is also controllable to some extent, and the risk is most often triggered by external factors. So in preventing and eliminating the risk, what is more needed is the concerted effort from the environment outside the insurance industry. The key to address asset-liability matching risk lies in improving the asset structure, enhancing investment management and making efforts to intensify internal management and expand investment channels simultaneously. Although operation risk is much affected by external factors, this category is basically predictable or identifiable and may be substantially mitigated by improving internal risk controls of enterprises and strengthening supervision.
Classification of insurance risks:
2. Outstanding risks in China’s non-life insurance sector
Major risks in China’s non-life insurance sector comprise mainly liability risk and operation risk, including:
(1) Under-pricing risk
The risk is mostly caused by the weak actuarial capability and over-competition of insurers, which are manifested in irregular underwriting practices such as acceptance of a gambling nature, over-capacity acceptance, acceptance on reduced conditions, solicitation for policy with indemnity in return and insurance gifting. Since the pricing level is obviously low, the premium revenue is hard to cover risks insured. In 2003, the insured amount of property insurance policies stood at RMB29,085.1 billion, a year-on-year increase of 23.19%. In contrast, the property insurance premium revenue grew by only 11.53%, an 11.6 percentage points lower than the growth of the amount insured (data source: statistics of China Insurance Regulatory Commission). Also for the year, the average premium rate reached a record low of 3.07‰, down by 0.022 percentage points from 3.29‰, after a slide for five consecutive years. At present, the premium rates for property and transportation insurance in China are far below the international market level. For some large projects, the premium rate has even dropped below one ten thousandth. Take Shenzhen Diwang Building, a large property with an investment of as high as over HK$4 billion, as an example, the premium received was only over two hundred thousand yuan. Again, certain insurers cover aircraft liability insurance at the premium of only RMB2.8 million for the whole airport. Under-priced premium will greatly shake the operating stability of insurers and lead to three consequences:
First, the relatively low premium revenue makes it difficult for insurers to allocate sufficientprovisions according to risk management requirements, and thus increases the underwriting risk;
Second, insurers are brought to bear higher pressure of fund operation, which sometimes impel operators to engage in speculation on the financial market in order to yield high return to make up for the losses from insurance business. This runs counter to the prudent principle on the operation of insurance funds. Moreover, the defects and high risk on the Chinese financial market will cause the speculation to face extreme danger;
Third, it is difficult for insurers to divert the risk beyond its capacity by means of re-insurance to, in particular, international re-insurers. As a result, they are just trying their luck rather than relying on scientific management to maintain the operation. Once big disasters occur, quite many insurers certainly can hardly bear them.
(2) Credit risk
In recent years insurance frauds occurred frequently, and their tricks and manner have gradually become more technical and concealed. Take auto loan insurance as an example, statistics of Guangdong Insurance Association show that by October 2004, Guangdong-based non-life insurance companies recorded an average loss ratio of 4546% for auto loan cases, and the ratio even hit as high as 8543% at some companies. Basically all of the insurers providing such insurance suffered losses. Judging by the insurance claims cases occurred, deliberate repayment delays and malicious frauds were the majority. Again, according to conservative estimates of Beijing non-life insurers, around 20% of vehicle insurance indemnities have been fraudulent so far. During the four-year period between 2000 and 2003, losses from cheated indemnities stood at about RMB1.3 billion (Economic Information Daily, April 14 2004).
(3) Claims risk
Loss of insurance funds is still widely occurring due to the lack of tight underwriting procedures and administration systems. Because of failure to reasonably determine the loss, insurers sometimes have to fulfill the responsibilities outside those stipulated in insurance contracts.
(4) Risk of Liability Over-concentration
As shown in the following table, the concentration in China’s non-life insurance sector is considerably high. Among major types of non-life insurance, the top one, motor vehicle and third-party liability insurance, continuously maintains the market share of over 60%, followed by the enterprise property insurance with a share of 14%. Other types post a proportion of below 5% each. Since the promulgation of the country’s Law on Road Traffic Safety, many local law enforcement authorities are inclined to treat insurers as the defendant or codefendant and to require insurers to pay accident-related expenses beforehand as the result of advance execution. This approach has heavily impacted some insurance companies, which began to see the liability concentration risk.
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