By Fan Yu
Beijing's recent decision to crack down on activities of Chinese insurance companies could push insurers toward riskier asset investments and create a liquidity crunch within the industry.
Industry regulator China Insurance Regulatory Commission (CIRC) announced strict new rules late December, curbing an industry that has been flush with cash. The new rules are choking a main source of funding and growth for insurers by lowering their allowed investments into stocks (to 30 percent), and barring insurance companies from using customer deposits to fund large equity purchases.
The regulations come after a period of unprecedented growth for the Chinese insurance industry. From 2012 to 2016, China's insurance sector grew 14.3 percent overall and non-life insurance grew 16.5 percent in premiums volume, according to data from Munich Re. Last year, China overtook Japan to become the world's second biggest insurance market by premiums.
Traditionally, insurers are considered to be bastions of security by holding conservative assets such as government securities and corporate bonds. But not in China. Sensing opportunity in a low interest rate environment, Chinese insurers have expanded outside of traditional insurance activities. They have been the biggest issuers of wealth management products called universal life policies. These products, which offer high interest rates and are a hybrid between a bond and a life insurance policy, have been extremely popular with consumers dissatisfied with bank deposit rates of around 1 percent.
Flush with cash, but saddled by promises to pay high yields, Chinese insurance companies poured money into assets not traditionally associated with insurers. These firms took large positions in Chinese publicly listed companies and snapped up overseas assets, including foreign companies and real estate.
For example, Evergrande Life - a unit of property developer China Evergrande Group (OTC:EGRNF) - saw its premiums increase more than 40-fold in 2016. It used the proceeds to accumulate a significant stake in rival developer China Vanke (OTC:CVKEY) last year.
As an industry, insurance has been a major driver of Chinese foreign acquisitions. Anbang Life is at the forefront of such purchases. It made headlines in 2015 for purchasing New York's Waldorf-Astoria hotel for nearly $2 billion. In 2016, it bought Strategic Hotels & Resorts from Blackstone Group (NYSE:BX) for $6.5 billion. Most recently, Anbang has been in negotiations to purchase U.S. life insurer Fidelity & Guaranty Life (NYSE:FGL) for $1.6 billion, a deal which has been put on hold for New York insurance regulatory review. Anbang's biggest gambit was a failed $14 billion bid to acquire Starwood Hotels & Resorts Worldwide.
Riskier assets, such as equities, accounted for 49 percent of the insurance industry's assets at the end of November 2016 - a 27 percent increase from the end of 2013, according to a report by Moody's Investors Service.
"In particular, the industry's rising exposure to single-name equity investments is increasing concentration risk, and leaves the insurers' profitability and capital profiles sensitive to capital market movements," analyst Kelvin Kwok wrote in the Moody's note.
Cash Flow Problems
Chinese regulators are concerned about the size of stock investments on insurers' balance sheets. Such stock investments are risky and volatile, and could put depositors' capital at risk. CIRC's fears are not unfounded.
Traditional insurers manage their business by attempting to match projected payouts of liabilities - such as annuities and insurance payouts - with assets whose cash inflows are stable and predictable enough to fund the outflows.
But the explosive growth of universal life policies, and the insurers' acquisitions of riskier, longer-dated assets, throw this model out of the window. Insurers such as Evergrande Life have marketed universal life policies with very high yields (up to 8 or 9 percent). And to attract even more customers, these products often have no penalty for early withdrawal.
As such, insurers are forced to buy riskier assets to grow their capital enough to fund such high promised returns. But with insurers holding such large stakes in Chinese-listed companies, if depositors withdraw their capital en masse, it could suddenly force the insurers to sell their stakes and cause the stock market to plunge.
China Life (NYSE:LFC) holds a 44 percent stake in China Guangfa Bank and a 30 percent stake in Sino-Ocean Group (OTCPK:SIOLF). Foresea owns large stakes in Gree Electric Appliances and China Vanke. If they are forced to sell their stakes, the Chinese stock market could see a sudden downturn.
Insurers such as Anbang, who own several entire foreign companies, have trapped cash and will find it even more difficult to raise money quickly.
This means that to stay liquid, insurers are forced to sell more universal life policies in the short term - with new proceeds used to pay interest on existing policies.
But that source of capital is quickly drying up, and a liquidity crunch could ensue. Anonymous sources told Chinese-based 21st Century Business Herald that CIRC is preparing to block sales of certain universal life policies entirely. The CIRC temporarily suspended a handful of insurers late December, including Evergrande and Foresea, from selling universal policies over the internet.
Buyers of new policies are finding the returns have lowered. Marketing a 4.7 percent return on a two-year universal product, an Anbang customer service agent in Shanghai told a reporter from the South China Morning Post, "It could be the highest return on the market nowadays. Next time you come, you might not get hold of a product with no fees on early surrender of two years."
Some insurers have already felt the squeeze. Evergrande Life, according to regulatory filings, reported that its solvency rate dropped from 180 percent to around 110 percent at the end of 2016. A solvency rate of 100 percent is the minimum threshold for insurers in China.
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