China’s Premier Li Keqiang has told the world’s fastest-growing major insurance industry to boost capital as rating companies warn of shadow-banking investments.
Policy providers will need cushions commensurate with their risks rather than just size, the industry regulator said Feb. 17 without specifying an implementation date. That will encourage sales of securities that count behind regular bonds in a default, under rules formulated in Basel, Switzerland similar to those governing banks. Presaging such offerings, China Taiping Insurance Holdings Co. sold $600 million of 5.45 percent subordinated perpetual notes in September.
Insurers are turning to shadow-bank assets amid sliding bond yields, deploying mounting premiums as the number of Chinese over the age of 60 exceeds 200 million. The industry’s trust product holdings rose 95 percent in the first half of 2014, watchdog data show. Similar opaque investments led to the near collapse of American International Group Inc. during the global financial crisis.
“Asset risk cannot be ignored as Chinese insurers are increasingly investing in risky assets,” said Terrence Wong, an insurance analyst at Fitch Ratings. “Insurers will need to think about capital charges when they make investments.”
Insurers, which rely on fixed payments from bonds to reduce long-term volatility, face mounting challenges locking in higher yields after the central bank cut interest rates for the second time in three months over the weekend. The yield on the 10-year government note has dropped 22 basis points this year to 3.4 percent, compared with its 3.98 percent two-year average.
While falling rates burnish the appeal of higher-yielding shadow-bank products, the new rules mean insurers “will need to have higher awareness of risk management,” said Connie Wong, Singapore-based head of insurance ratings for the Asia-Pacific region at Standard & Poor’s.
The median revenue growth for China’s listed insurers in the past five years was 141 percent, the most among the world’s 10 biggest economies, according to Bloomberg-compiled figures. While regulator data show trusts are only 3 percent of assets, they make the sector “vulnerable in times of stress,” S&P said last year.
Fifty-one percent of the 281 billion yuan ($44.8 billion) in the investments as of June 30 were in real estate and infrastructure-related products, regulator data show, increasing vulnerability amid a slumping property market.
New home prices dropped in 64 cities out of 70 tracked by the government in January from the previous month, and trusts pulled financing for the real estate industry as troubled developer Kaisa Group Holdings Ltd. missed payments. That’s adding to pressure on an economy whose growth slowed to the least in more than two decades at 7.4 percent last year.
The new rules were published by the China Insurance Regulatory Commission, under the State Council which Li leads. The premier is trying to balance efforts to prevent a sharper slowdown in economic growth with steps to wean the nation from total debt that McKinsey & Co. says reached $28 trillion in June last year, or 282 percent of gross domestic product.
Li’s push to beef up capital buffers mirrors steps at banks to comply with Basel III standards, and is part of efforts to reduce global systemic risks after the 2008 crisis. The International Association of Insurance Supervisors, a Basel-based body made up of regulators in almost 140 countries including China, completed drafting “the first-ever global insurance capital standard” in October, it said at the time.
“With the new rules, China is more aligned with the global regulatory requirement,” S&P’s Wong said.
Insurance companies had been issuing subordinated debt prior to the new rules. The portion of such securities, which must be repaid by a specified date, counted as capital drops by 20 percent every year after issuance, according to a Feb. 17 document on the regulator website.
By contrast, core Tier 2 securities, which have no set maturity, remain as capital with no annual loss of eligibility, the new rules stipulate. They can’t carry incentives for early redemption, making them more like common equity.
Insurers will issue the securities because they are “in need of capital to support their rapid growth,” said Sally Yim, senior credit officer at Moody’s Investors Service. Implementation of the new rules will likely be in the next one to two years, she said.
The changes encourage insurers to take a more dynamic approach to shoring up capital positions, including issuing different types of securities, Joyce Huang, a Hong Kong-based director for insurance at Fitch, wrote in a March 1 report.
“Chinese insurers will be in a position to issue hybrid capital securities that meet the requirements of the regulator and rating agencies,” said Sean Mcnelis, head of the financing solutions group for the Asia-Pacific region at HSBC Holdings plc. That will allow them “to optimize their usage of subordinated debt within the capital structure,” he said.
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