How Chinese insurers are tackling IFRS 9

Two key reforms facing China's insurance industry – a new round of the China Risk Oriented Solvency System (C-Ross) and new accounting standards (notably IFRS 9) – have big implications for insurers' investment strategies. The challenge is not made any easier by the fact that they look set to create opposing incentives regarding equity portfolios.

Across much of the world, financial institutions have had to follow IFRS 9 since the start of this year. Insurers have been an exception, as they can choose to adopt them by no later than 2022. To date, Ping An Life is the only Chinese insurer to have braved them because of its equity holdings in banks, including HSBC.

Under today’s accounting rules, when the market value of a public security held by an insurer drops, the company can hide the unrealised investment loss in ‘other comprehensive income’ (OCI),  rather than showing it in its overall income statement. However, if the security rises in value, the insurer can sell it and reflect the gain in its income statement, an insurance analyst told AsianInvestor.

But under IFRS 9 insurers can no longer do this. Whenever they place a security as fair value through other comprehensive income (FVTOCI), they can only show its dividends in their income statement, and not any realised profit, said the analyst, who asked to remain anonymous.

Insurers that classify a large amount of assets as fair value through profit and loss (FVTPL) typically see more volatility in their investment income and overall earnings, because the securities are marked to market.

Ping An is one example. As of June 2018, it had Rmb503.5 billion ($72.6 billion), or 19.5% of its assets, categorised as FVTPL after adopting IFRS 9, which has increased volatility in the bottom line. The insurer will seek to increase allocations in long-term equity investments to reduce the impact of the secondary market on its financials, said a company spokesman.

REFLECT AND REVAMP

The trouble is that C-Ross phase II and IFRS 9 provide insurers with opposing incentives for long-term equities. The capital rules changes are set to level higher risk charges on such assets, but the new accounting standards appear to encourage insurers to use them because they will result in more stable earnings.

The CIO of the domestic insurer also pointed out that there are other potential difficulties between following C-Ross and IFRS 9. The China Banking and Insurance Regulatory Commission (CBIRC) regulates the adoption of C-Ross, while China’s Ministry of Finance oversees accounting methods. And while the C-Ross solvency requirements have existed for a decade and are widely accepted, IFRS 9 is a completely new set of rules for Chinese insurers.

This had caused inconsistencies between the two, he said, and means that a new round of policy review for reconciliations is inevitable.

There are already signs that the rules changes might have an impact on China’s insurers. Its three largest organisations reported a reduction of about one to two percentage points in overall equity investments as of June 2018 compared with end-2017, after reporting relatively large increases the year before.

But the three insurers may not continue to move the same way when reacting to the new regulations. Ultimately it will come down to their internal decisions on their risk appetites, and what they emphasise in how best to manage this risk.

Some management teams don’t like volatile books, and so choose asset classes that are less susceptible to market movements. But there is a trade-off on C-Ross capital risk charge on these asset classes, noted Eunice Tan, senior director on insurance ratings at S&P Global.

“We expect to see that insurers will need to revamp their strategies to cope with all these things, because you can’t go with the same old ways, unchanged on that count, because markets are changing,” she said.

The Ping An spokesman said the new regulations mean that it will strengthen research in the equity market and actively invest in quality fixed-income assets. China Life and CPIC Life declined to comment on the new rules.

The reaction of China’s insurers to these new rules will become clear in the months and years to come. The manner in which they correspond – and differ – could offer some interesting insights into their investing priorities.

This is the second part of a feature that was published in the October/November issue of AsianInvestor magazine. Click here to read the first part.