In recent years, the insurance market in China has witnessed significant expansion, accompanied by escalating competitionSmall and medium-sized insurance firms, in particular, are facing a plethora of challenges including pressure to bolster capital, increasingly stringent solvency assessments, and relatively low market shareThe pressing question remains: how can these smaller companies establish themselves amid fierce competition and find a path to growth? Industry experts and stakeholders have shared their insights on the matter.

One of the key strategies for alleviating solvency pressure is ensuring that insurance companies exhibit a robust ability to pay claimsRegulatory bodies mandate that insurers maintain a certain level of solvency as a safeguard for consumers purchasing insurance productsThis solvency is a vital indicator of an insurance company’s financial health and risk resilience

The implementation of the second phase of the “Solvency II” regulations has intensified the scrutiny in the insurance sector, compelling stricter compliance measures.

Solvency is primarily assessed through two metrics: Comprehensive Solvency Adequacy Ratio (CSAR) and Core Solvency Adequacy Ratio (CSCR). The CSAR measures the ratio of actual capital to mandated minimum capital, indicating the overall adequacy of an insurer's capitalIn comparison, the CSCR focuses on the ratio of core capital to minimum capital, emphasizing the sufficiency of high-quality capitalAccording to regulations, insurance companies must meet three core benchmarks: a CSCR of no less than 50 percent, a CSAR of no less than 100 percent, and an overall risk classification rating of at least B.

Many industry insiders have noted that since the introduction of the second phase of the “Solvency II” rules, insurance firms have to grapple with elevated capital requirements

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The new regulations have refined methodologies for calculating interest rate risks and optimized asset-liability managementAdditionally, more stringent monitoring has been applied to specific products such as critical illness insurance and long-term equity investmentsWhile these measures bolster the industry’s risk management framework, they simultaneously impose new challenges concerning capital management for insurers.

When comparing smaller insurance companies to their larger counterparts, it becomes evident that the impact of the current regulatory environment is significantly more pronounced on the formerAs of the third quarter of 2024, eight insurance firms were categorized as failing to meet solvency benchmarks, either due to a CSCR below 50 or a CSAR under 100. These companies grapple with difficulties in capital augmentation and risk management, leaving large insurers with marked advantages in terms of capital strength, brand equity, and market influence

By the end of 2023, the top ten insurance companies accounted for over 70 percent of the market share, solidifying a powerful status quo where smaller firms find themselves severely constrained.

The overall solvency ratios within the insurance sector have taken a hit in light of various factors since the implementation of the new regulationsBy the third quarter of 2024, the CSAR had dropped to 197.4 percent, while the CSCR fell to 135.1 percentNonetheless, a comparative upturn was noted from the previous quarter, where the CSAR and CSCR improved with gains of 1.9 and 2.7 percentage points, respectively.

“Several factors are leading to the tightening solvency issues for some insurers such as decelerating business growth, diminished profits, and increasing market and interest rate risks,” stated Chen Hui, director of the China Actuarial Science Research Lab at Central University of Finance and Economics

Fortunately, regulators have extended the transition period for the “Solvency II” rules until the end of 2025, providing a valuable window of adjustment for smaller firmsConcurrently, some insurance providers have navigated this landscape by recalibrating their operational strategies; firms like Bohai Property & Casualty Insurance and Ping An Pension have improved their solvency levels by fine-tuning their asset-liability management and capital replenishment strategies.

However, solely extending the transition period does not address the underlying capital challenges that beset smaller insurance firmsWang Xiangnan, deputy director of the Insurance and Economic Development Research Center at the Chinese Academy of Social Sciences, emphasizes that these companies must enhance capital supplementation and optimize risk management while also focusing on transformation and digital development as pivotal avenues for breakthrough.

Optimizing capital structure stands as a crucial aspect interlinked with the development of smaller insurance companies, given that improvements in solvency are directly dependent on the level of capital adequacy

Limited ability to raise funds through capital markets places smaller firms at a disadvantage when seeking to augment capital through methods such as equity increases or bond issuancesAgainst the backdrop of declining investment yields in a low-interest environment and a high ratio of capital-intensive business lines, the profitability of these firms faces mounting pressure.

Wang Xiangnan contends that reevaluating capital structure is not just a short-term fix for solvency inadequacies but also a strategic approach for fostering long-term sustainable developmentThis could involve engaging strategic investors, divesting in non-core assets, or leveraging digital technologies to enhance capital management capabilities in a bid to boost competitive standing and market stability.

A notable example of a company successfully reversing its solvency fortunes is Dubang Property & Casualty Insurance

In May of this year, the company made a strategic move by raising 244 million yuan, augmenting its registered capital from 2.7 billion yuan up to 2.944 billion yuan, thereby successfully enhancing its solvency positionFurthermore, by improving governance structures and bolstering their risk management, they elevated their risk profile rating to category B, a shift that has earned validation in the marketplace.

This year, there has been a marked emphasis on optimizing the synergies between assets and liabilitiesMechanisms to better transmit interest rates and adjust liability costs have been reinforcedThrough more judicious asset allocation, experts believe that smaller insurance firms can enhance investment returns, optimize their capital structure, and thereby reinforce their risk resilience.

For instance, China United Life employs an autonomous investment management model, fielding a team of nearly 60 professionals across various investment dimensions, including fixed income, equity, trading, credit, and compliance

Their investment strategy prioritizes consistent long-term returns, focusing on long-dated fixed income assets like government bonds and high-quality corporate bonds, which align with their long-term liability needsAdditionally, during periods of significant market fluctuation, they strategically allocate to high liquidity assets to further bolster their risk resilience and ensure asset growth remains consistentA representative from China United Life stated that their firm continuously aims to match assets with liabilities while refining their investment portfolios and enhancing the internal research framework, all enabled through technological advancements to drive investment efficiency, ultimately generating stable yields for their clients.

Exploring diverse financing channels has gained traction as a robust strategy in the current landscapeReinforcing counter-cyclical regulation has emerged as a vital initiative for the sustainable development of the insurance sector

Under the existing assessment frameworks, companies benefit from a transition period lasting up to three years when adapting to the “Solvency II” regulationsThroughout the current year, several insurance firms have turned to debt issuance as a means of capital supplementation to elevate their solvency ratios ahead of the transition deadlineTo date, at least 14 companies have successfully garnered funding through this avenue, amassing over 100 billion yuanFalling financing costs, typified by a decline in bond yields from 3.3%–6.25% five years ago to current rates of 2.15%–2.9%, have amplified the appeal of optimizing capital structures via debt refinancing.

Recently, the issuance of perpetual bonds has surgedFollowing the successful launch of the first-ever perpetual bond by Taikang Life in 2023, firms like Ping An Life and China United Life have similarly entered the market, with issuance scales ranging from 900 million to 15 billion yuan

Industry experts have highlighted that perpetual bonds present a compelling option compared to common or preferred stocks, directly enhancing core capital sufficiency with minimal dilution to equity, thereby bolstering their attractiveness in a declining interest rate environment, suggesting potential for increased issuance in the future.

“Issuing debt requires robust credit qualifications from insurers, which poses significant challenges for smaller firms,” noted Liu Ruiwen, vice president and board secretary of Beijing LifeThe inherent barriers associated with lower credit ratings hamper the ability of smaller companies to meet bond issuance criteriaThe perceived market credibility gap increases their difficulty in attracting investor interest, further complicating debt issuance endeavorsEven when these firms succeed in raising funds through bond sales, the elevated interest costs can compound their financial burdens.

Consequently, smaller insurance providers are encouraged to explore more nuanced financing strategies, including joint capital increases and asset securitization

In the wake of sectoral pressures, regulatory authorities have introduced measures aimed at easing these capital demands, such as enhanced solvency standards, differentiated capital regulations, and varying performance evaluation timelines for state-owned insurance firmsThese efforts collectively aim to mitigate capital pressures and stimulate long-term investmentsConcurrently, insurers are transitioning to new accounting standards to amplify financial performance and enhance solvency reports.

In summary, insurance firms currently grapple with considerable pressures on both asset and liability frontsSmall and medium-sized insurers, in particular, encounter substantive hurdles whether in attracting robust investors for capital increases or seeking to compile funding through bondsExperts advocate for regulatory policies that balance industry norms with a practical understanding of the sector's realities, promoting flexible adjustments and tailored supports to help the insurance industry achieve a trajectory of high-quality growth.