CIRC’s new ALM rules to force change on smaller insurers

The Chinese insurance regulator’s introduction of an overarching framework to reduce insurers’ asset-liability management (ALM) risk is set to drive up compliance costs for some market players but should help prevent systemic risk in the financial system, say analysts. 

The China Insurance Regulatory Commission (CIRC) announced the new regulation on March 1. Under a trial phase for the new rules, insurers self-evaluate their ALM capabilities over a set of quantitative and qualitative categories, with their final score consisting of a mean of these scores.

The rules aim to prevent insurers from mismatch in their investments and policies, the CIRC said. It follows a period in which  'platform insurers' like embattled giant Anbang have grown rapidly by offering high-yielding investments packaged as insurance products to raise funds, before using them to make acquisitions.

The CIRC will ultimately place the local insurers into four categories based on their scores, from A to D. Those ranked ‘A’ will enjoy the widest array of investment and product offerings, while those receiving a ‘D' facing the highest restrictions.

The new rules are credit positive for China’s insurers because they will allow for a more consistent and precise measurement of duration and liquidity of insurers’ assets, said Zhu Qian, senior credit officer at Moody’s.

However, she said the new rules will also increase compliance costs, especially for newer and smaller companies whose existing ALM systems are less developed and have limited resources, she told AsianInvestor.

The framework will only be officially introduced next year but insurers have to turn in their first self-evaluation according to the rules before August 31. When it is officially up and running, insurers will have to submit annual and quarterly reports to CIRC starting May 31 each year and the self-evaluations have to be audited by third-parties, the CIRC said. 

The regulator will encourage insurers ranked A to have real financial innovation, while those ranked C and D will face higher restrictions in areas like sales channels, Jia Biao, deputy director of the department of insurance fund operation at the CIRC, said in a press briefing on March 1.

QUANTITATIVE ASSESSMENT

Under the new ALM framework insurers are first required to disclose their basic information, including their asset allocation, credit ratings of fixed income assets, reserve capital for insurance policies, etc.

Then they need to evaluate their capabilities in duration matching (which accounts for 30% of the final score), cost-income matching (40%) and cash flow matching (30%), with different granularities in each category. Stress tests are required for cost benefit matching and cash flow matching.

The insurers also need to give breakdowns on their general accounts, traditional policy accounts, participating policy accounts and universal product accounts.

However, while an insurer's overall score is calculated from the above formulas, if its core solvency score at the end of the reporting period is lower than 50% and its comprehensive solvency score is lower than 100%, the overall quantitative ALM score is zero, effectively meaning it will be ranked 'D'. Solvency ratios determine an insurer's ability to pay its debt.

The new approach will force insurers to change how they operate, and assess risk.

Large and well-established insurers look set to have an advantage from the new rules because they have more established ALM systems and greater resources to support the new approach, said Zhu. Newer and smaller insurers will face more challenges, not just because of the potential wide mismatch in ALM that could be reported under the new rules, but also due to higher costs involved in bringing their operations into compliance. 

The CIRC's harder edged approach is already having an impact. In 2017, Chinese life insurers' premium grew by 20.04% compared with the same time in the previous year, while their assets rose by 6.25%. However, for the first month of 2018 (the latest available data), premium growth dropped by 25.5% year-on-year, while assets have expanded by 1.86% since the beginning of the year, according to the watchdog.

QUALITATIVE ASSESSMENT

A key issue for many insurers today is a lack of sufficiently close communications between their asset and liability divisions. Such governance requirements can help to bring about more well-defined interaction between the asset and liability sides and thus lower mismatch risk, said Janet Li, wealth business leader for Asia at Mercer.

“What’s most special about this ALM rules is the additional qualitative requirements. For instance, insurance companies are required to set up a committee to oversee ALM,” she told AsianInvestor.

The new rules state that ALM should receive high-level attention at the management level as it requires technical knowledge and involves many different departments. This means that the companies should have their chairman or general manager to be the primary responsible person for ALM and clearly define the duties of the high-level managers.

China’s insurers aren’t the only ones experiencing poor internal risk analysis and communication between departments. Senior insurance executives at AsianInvestor’s Insurance Investment Forum on March 1 highlighted internal communication challenges as some of the most important areas to improve. The executives said they are striving to improve the communication between their investment and product development teams in order to reduce balance sheet, cash flow and duration risks.

“In the last generation of product development, you just need to give one yield to the product development team and they handled the rest … Right now, we have full collaboration at inception,” Gregoire Picquot, chief investment officer (CIO) of Axa China Region Insurance Company and Axa General Insurance Hong Kong, told the audience at the forum.

REIN IN RISK

The CIRC’s move dovetails with the Chinese leadership’s increasing emphasis on financial reforms and the CIRC’s own dramatic move to take over Anbang in order to rein in financial risk. Its decision to do so offered a stark warning for Chinese insurers that they should not use insurance sales to fund asset acquisitions. 

“Insurance companies want to source overseas investments and are introducing more insurance products. Their business [liability] scales are also constantly growing,” Joyce Huang, director of insurance at Fitch Ratings, told AsianInvestor.

Some life insurers have been growing their asset base by selling universal life policies, which place more emphasis on yield than protection for policy holders, she said.

Insurers that have assets with durations that are much longer than their liabilities face higher interest rate risk in their portfolios, as there is a better chance that interest rates will rise over the long term. When investment returns fall short of expectation because of such risk, they might have to resort to dipping into their recurring premium income received from policy holders to fund their liabilities, making them resemble ponzi schemes.

The new approach is intended to discourage insurers from such malpractice and high-risk growth strategies, Zhu of Moody's said. The CIRC’s new rules are likely to mean insurers offer lower policy returns and take less risky investments, potentially reducing their level of asset gathering. 

“It will prevent insurers from taking an aggressive investment approach by investing long term illiquid assets for higher yields, while boosting scale by selling short term savings products with high crediting rates (another term for yield),” she noted.