From Scale-Oriented to Risk-Oriented: The Development of the China Insurance Solvency Supervisory System

In November 2013, the CAS formed a special task force on the China Risk-Oriented Solvency System (C-ROSS) to support the development of the China insurance solvency supervision regime and to acquire more details of the upcoming changes. Why does China intend to reform its current solvency supervisory system and what will its new insurance solvency supervisory regime be like? Follow our C-ROSS Task Force and you will find full and up-to-date information on these topics.

China’s insurance market is a developing one and continues to maintain sound momentum. In 2013 the gross written premium of China’s non-life insurance market amounted to U.S. $107 billion with a growth rate of 17.2% compared to last year. Additionally, by the end of 2013, the number of property-casualty (P&C) insurance companies had reached 64.

Solvency supervision is the core of an insurance supervisory system whose emphasis is on the protection of insurance policyholders’ interests. As an emerging market, China is highly attentive to international insurance solvency supervisory reform, actively explores an appropriate solvency supervision model for its domestic insurance market and promotes insurance solvency regulatory reform in the country.

China’s current insurance solvency supervisory system, also known as the first-generation insurance solvency supervisory system, was established in 2003 as a factor-based hybrid solvency system. On one hand, the valuation methods for assets and liabilities follow the U.S. National Association of Insurance Commissioners’ (NAIC) statutory accounting principles; on the other hand, for minimum capital requirements, China adopted the framework of the European Union’s Solvency I regime.

The reason for a hybrid system is obvious. At that time, Chinese insurance companies had not implemented the strict categorization of risks, with the result that the companies couldn’t adopt the U.S. risk-based capital (RBC) framework. The EU Solvency I regulatory system, in contrast, uses a relatively simple method to calculate the minimum capital requirement for an insurer. What’s more, the data and information needed could be directly obtained from financial statements and regulatory reports. Therefore, China’s first-generation insurance solvency regulatory system conformed to the reality of China’s insurance market at that time.

Under China’s first-generation insurance solvency supervisory system, the amount of the required solvency margin for P&C insurance underwriting is equal to the higher of two results. The first result is the sum of 18% of the net written premium up to 100 million yuan (U.S. $16.5 million) and 16% of the net written premium in excess of 100 million yuan. The second is the sum of 26% of the average net incurred claims during the past three years up to 70 million yuan (U.S. $11.5 million) and 26% of the average net incurred claims during the past three years in excess of 70 million yuan. Then the solvency adequacy ratio is calculated by dividing the actual capital by the required solvency margin of an insurer. The insurers are classified by the regulator into three categories according to their solvency adequacy ratios: Inadequate insurers whose ratio is lower than 100%, Type I Adequate insurers whose ratio is between 100% and 150%, and Type II Adequate insurers whose ratio is higher than 150%. The insurers in different categories are regulated by the regulator with different regulatory measures.

China’s first-generation insurance solvency supervisory system worked well in the early stages of market expansion. It does consider certain risk factors, but it is not a strict “risk-oriented” system; rather it is known as a “scale-oriented” regulatory system. With the growth and increasing complexity of the market, the current solvency regime falls short of reflecting the actual risks being taken. Therefore, as China’s insurance regulator, the China Insurance Regulatory Commission (CIRC) kicked off a project to establish a robust second-generation solvency supervisory system, known as the China Risk-Oriented Solvency System (C-ROSS), in March 2012. C-ROSS will be a true “risk-oriented” solvency regulatory system and is expected to be effectuated within three to five years. Its goal is not only to accomodate the reality of the Chinese insurance market but also to meet the international regulatory standards such as the Insurance Core Principles and Standards published by the International Association of Insurance Supervisors (IAIS). For the construction of C-ROSS, CIRC has set up 15 working groups to research different special topics, as shown in the following table. Some completed research projects have assessed that China’s current solvency supervisory requirements are more stringent than the U.S. RBC system but looser than EU’s Solvency II regime.

The CIRC carried out the first quantitative impact testing for the life and P&C insurance industries in the second half of 2012. Then CIRC officially released the conceptual framework for C-ROSS in May 2013, which consists of three components: system characteristics, three supervisory-pillars (quantitative capital requirements, qualitative supervisory requirements and market discipline mechanism) and supervisory foundation. The overall framework of C-ROSS is compatible with the international standards on one hand and, on the other hand, it reflects the local characteristics of the Chinese insurance market. CIRC wants to achieve a balance between the costs and benefits of the new solvency supervision regime in the initial phase of implementation, so the insurers will be using standard formulas to calculate their quantitative capital requirements under Pillar I. Internal models will gradually be encouraged when the market matures.

This year is a critical one for the implementation of C-ROSS. CIRC hopes that the C-ROSS standards can be formed by the end of June for P&C insurance companies and by the end of September for life insurance companies. Then the second quantitative impact testing will be carried out. Thereafter, CIRC will amend the “Rules on Administration of Solvency of Insurance Companies,” which were enacted six years ago, and upgrade its Solvency Supervisory Information System. Shortly thereafter, CIRC will research and establish the scheme and timetable for the transition from the first-generation insurance solvency system to C-ROSS.

As to whether the second-generation solvency supervisory system will call for more capital in China’s insurance institutions, it depends. Generally speaking, riskier insurers will be required to put up more capital and less risky insurers will require less capital, regardless of the scale of the insurers. “Risk-oriented” is the direction of insurance solvency supervision development, not only for China but also for the

Xiaoxuan Li, FCAS, is the assistant general manager of the actuarial department for China P&C Reinsurance Company Ltd. in Beijing, and he serves as a CAS University Liaison. Dr. Li Zhang, FCAS, MAAA, is director of the Insurance Experience Research Center for China P&C Reinsurance Company Ltd. He is currently a member of the CAS Syllabus and Examinations Committees.