AM Best expects the revised quantitative and qualitative requirements under the China Risk-Oriented Solvency System Phase II (C-ROSS Phase II) to have significant impacts on the various insurance market segments.
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“AM Best views these changes to be credit positive as they drive a more thorough understanding and accurate assessment of investment risk, and seek to improve insurers’ capital management strategies”
The Best’s Commentary, “Changes to China’s Solvency Framework to be Credit Positive for Insurance Market,” states that this recent revision to China’s solvency regime should allow for greater transparency in risks and capital quality. Most insurance companies are likely to observe various degrees of decline immediately in solvency ratios, depending on their product mix, capital structure, and aggressiveness investment strategy. Under the updated solvency regime, capital recognition has been tightened and the industry is expected to see a drop in admitted capital in solvency calculations. Specifically, the regulator has changed the recognition of real estate held for investment purposes from fair value to value at cost, while insurers are required to make adequate provisions for impairment and apply timely and appropriate reductions to their capital. Another key update is the mandatory application of a “look-through” approach in calculating minimum capital to support investment risk.
Insurers will also face higher capital requirements arising from long-term equity investments, particularly for investments in non-insurance subsidiaries that give the insurer controllership, which will be 100% risk charged.
“AM Best views these changes to be credit positive as they drive a more thorough understanding and accurate assessment of investment risk, and seek to improve insurers’ capital management strategies,” said Christie Lee, senior director, analytics, AM Best.
The report notes that the implementation of C-ROSS Phase II will extend greater support to small- and medium-sized non-life companies in the form of relatively smaller increases in the motor insurance risk charge amid the challenges from the motor comprehensive reform. The regulator has abolished favourable treatment for large insurers based on the premium size on the motor insurance risk base factor; this allows for fairer competition between large and smaller insurers in terms of the capital requirement to support business growth. A growth factor has also been included to better reflect the additional non-life insurance risk from rapid business expansion. In addition, the CBIRC seeks to promote sustainable growth in the agricultural insurance segment, by including discounts on the minimum capital requirement on insurance risks for insurers for whom more than 80% of their agriculture book in policy-oriented business.
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For life insurers, C-ROSS Phase II will lead to more stringent admitted capital recognition from long-term policies’ expected future profits. AM Best also notes that asset-liability management is likely to become more important in solvency management under the revised regime. In terms of product risk, the revised regulatory framework will introduce a morbidity development risk factor on critical illness products, in view of the deteriorating morbidity trend.
AM Best is of the view that the industry is able to mitigate the solvency pressure, given its current strong solvency. CBIRC is also allowing a transitional period for companies that are under pressure to come up with transition plans and implement the new rules in phases, with full compliance no later than 2025. Nonetheless, with the implementation of the revised solvency regime, it will be incumbent upon insurance companies to revisit their business and capital strategies as they seek to better deliver on shareholders’ expected return on capital.
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