Last July, a little-known Chinese insurance company started buying up shares in China Vanke, one of the country’s largest property developers. Qianhai Life Insurance, a subsidiary of conglomerate Baoneng, was created just four years ago. But it did not take the company long to cause a stir.
Qianhai’s hostile bid for Vanke ultimately failed, but it generated a great deal of publicity in the process. Vanke’s chairman Wang Shi, apparently exasperated by the sheer audacity of a hostile takeover in China of all places, derided Baoneng as a “barbarian”.
Regulators seems to be thinking along the same lines. Over the last five weeks, they have issued a series of rule changes to clamp down on fast-growing insurers, limiting their scope for acquisitions and forcing them to look beyond the equity market for returns.
That is a smart move. China’s emerging insurers have changed the industry dramatically; the barbarians are not so much at the gate inside the walls causing trouble. But China’s regulators can still do much to direct their energy where it is needed.
Price war
China’s new breed of insurers have engaged in a price war with more established firms. They have won business by offering investors eye-catching returns with so-called ‘universal life insurance’, which in reality is little more than a short-term wealth management product.
They have also grown exponentially. Hexie Health, a life insurance subsidiary of conglomerate Anbang, had annual premiums worth around $14.5 million in 2013, according to CLSA. By June, the company’s premiums had grown to $9.79 billion. Qianhai’s premiums have grown 3,475% over the same period.
It is hard not to find such numbers alluring. After all, isn’t this sort of disruption good for an industry?
Perhaps. But it is not good for a country.
China’s emerging insurers have moved so far beyond the conventional notion of insurance that instead of helping reduce volatility, they are only making it worse. These insurers are often taking large exposures in single stocks. They are taking many times more equity market exposure than their older peers, and eschewing the relative safety of fixed income products.
CLSA analysts Patricia Cheng and Lloyd Xu considered the risks of this approach in a report last September. They were damning.
“The asset allocations that unlisted players have created is a recipe for disaster,” the analysts wrote. They said the risk of such concentration was that “just one stock having trouble may be enough to destroy their capital position”.
It should come as little surprise that China’s regulators have taken notice.
The China Insurance Regulatory Commission has announced a raft of changes to the sector over the last five weeks.
First, the CIRC tried to reduce the control conglomerates had over insurance companies, limiting the possibility insurers would be used as glorified acquisition vehicles. On December 29, it set the maximum individual shareholding in an insurance company at 33%, increased its oversight of major shareholders, and lengthened lock-up periods.
Next, the regulator went after asset allocations. The CIRC told firms equities could not make up more than 30% of their assets. Nor could any one stock represent more than 5% of a portfolio.
These regulations appear aimed solidly at China’s emerging insurers. Anbang Life has 48% invested in equities and mutual funds, including long-term equity investments, according to CLSA. Huaxia has 52% equity exposure, and Sino Life has a whopping 68% exposure to equities. (Qianhai’s numbers are a little fuzzy, thanks to 25% of its assets being billed as ‘available for sale’).
These firms are clearly going to have to reduce some of this exposure, but that may not happen from share sales. Instead, these insurers might decide to grow even larger, adding more assets to reduce the size of their single-stock exposures
This will be possible because it appears the CIRC is not planning to rush insurers to comply with the rules. There is no set deadline and regulators might instead impose firm-by-firm deadlines in private meetings, a credit ratings analyst focused on Chinese insurers told FinanceAsia.
Once these dealines have been agreed, what exactly should insurers buy?
China's emerging insurers have already shown a propensity for acquisitions, both onshore and at home. Anbang’s failed bid for US hotel chain Starwood may have grabbed the headlines, but plenty of deals have gone through successfully, including the same firm’s acquisition of the Waldorf Astoria in 2014.
But this is not part of the government’s plan. China recently tightened the rules on foreign acquisitions, and there is reason to think that insurers will get short shrift if they try to get new deals approved. They will also need CIRC approval before they complete any takeover in future.
What about property? It represents a relatively minor part of most Chinese insurers portfolio, but real estate — especially commercial real estate — could offer a great option for funds quickly hoping to shift their portfolio mix with new, big investments.
But China’s attempt to control the residential property market, and the likely inaccessibility of foreign real estate in the near-term, means this is not going to be the solution either.
No, the real beneficiary of the clampdown on Chinese insurers is going to be the country’s domestic bond market.
The name's bond
Insurance companies play a vital role in any capital market, even when they are not writing CDS contracts or offering credit wraps. By carefully matching their assets and their liabilities, insurance companies ensure a reliable pool of liquidity for long-term bonds. That can help fund infrastructure projects, or the construction of new factories.
In China, insurers have had little impact on the bond market. Instead, the commercial banks dominate. Commercial banks held around 62.84% of outstanding bonds last May, according to Deutsche Bank’s research. Local DCM heads, who include end-investors in funds in their calculations, say the real figure is closer to 80%.
That is an absurd source of instability for a country as important as China. Insurance companies can provide an essential release valve to bond markets, shifting credit risk outside of the banking system. This role is essential in reducing the possibility that any one bank fails in a crisis — which, in a modern financial system, could lead to the whole system coming down.
China’s big and boring insurers are already large bond investors. China Life, the country’s biggest insurer, holds around 46% of its portfolio in bonds, for instance. But more firms will need to allocate to bonds at this kind of level before there can be real relief for China’s over-exposed commercial banks.
The real change, though, is going to come if Anbang and its cohorts can pull off a masterful juggling act: keeping up their heady growth while shifting more of their assets to bonds. That is not going to be easy. But the huge opportunities available in China’s growing insurance market make it likely these firms will all try, according to analysts.
China’s government is right to clamp down on the new breed of swashbuckling insurers. Their risk appetite has gone too far. But by giving these firms the incentive to re-allocate towards bonds, regulators may be able to kill two birds with one stone — building a stronger insurance sector and a more resilient financial system.
