The introduction of new ALM regulations in March 2018 represents a major overhaul of how asset-liability matching risks are to be managed, disclosed and reported. From a practitioner’s standpoint, what was previously considered soft guidance with a fair degree of variation in interpretation has become hard adherence, largely to standardise risk management and reporting practices.
China’s approach to ALM is perhaps unlike any other major regulatory regime or international rating agency in terms of comprehensiveness and prescriptive detail. Under Europe’s Solvency II or Australia’s Life and General Insurance Capital (LAGIC) regimes, ALM generally involves a combination of quantitative calculations of market and interest rate risks, plus qualitative assessments of how ALM is managed under Pillar 2 requirements.
Similar to the Solvency Aligned Risk Management Requirements and Assessment (SARMRA) in C-ROSS, the CBIRC has adopted a detailed scorecard system to assess ALM across a number of areas (as shown by Figure 12). Quantitatively, it enforces matching across various dimensions identified by the regulator as being most susceptible: long-term economic value, mid-term underwriting profitability, short-term liquidity and overall solvency (see Figure 13).
FIGURE 12: SCHEMATIC OF CBIRC’S ALM ASSESSMENT: QUALITATIVE ASPECTS
FIGURE 13: SCHEMATIC OF CBIRC’S ALM ASSESSMENT: QUANTITATIVE ASPECTS
Taken together, these regulations cover the entire risk control process, from the ALM models used in risk monitoring and quantification to the actual implementation of these rules. For example:
- The sedimentary fund (typically the sum of net asset value and net reserves) needs to be greater than the combined value of medium- to long-term assets, to reduce the risk of any unexpected funding gap.
- The cost benefit gap is the difference between investment returns and costs of liability measured by underwriting results, under base and stressed scenarios. This is adjusted for the underlying riskiness of the assets to assess insurers’ dependence on investment income to cover underwriting losses.
These regulatory developments are intended to re-emphasise the importance of delivering stable underwriting margins. The implications for insurers are clear: it forces a major rethink of the investment-driven model (which is penalised with lower scores) and incentivises prudent asset allocation that is supported by a robust ALM framework. Top-tier insurers with economies of scale will be the least affected segment of the sector.
IMPLICATIONS FOR FOREIGN AND DOMESTIC M&A
Increased scrutiny on outbound acquisitions has contributed to a slowdown in overseas M&A activity recently. However, given the abundance of capital supply originating in China, M&A appetite among financial or insurance groups seeking yield and diversification will remain high, even under evolving market conditions.
Despite tighter credit conditions and increased regulatory hurdles, JLT Re believes that future M&A activity will be largely dependent on general business sentiment, noting that the vast majority of large acquisitions have been funded with cash on hand (see Table 3). Credit tightening will likely affect noninsurance corporates more heavily, as these tend to have higher financial leverage than their more strictly regulated insurance counterparts.
To date, foreign acquisitions have been focused on developed markets, particularly in the Hong Kong life and health sector. Whilst a protracted trade dispute with the US may divert investors’ attention towards the domestic market, we expect that Chinese acquirers will continue to target foreign groups that provide greater market access.
In August 2018, China Re announced its intention to acquire Lloyd’s insurer Chaucer for USD 950m. Such a move is not surprising, given China Re’s international ambitions, desire to expand in the Lloyd’s market and the substantial amounts of undeployed capital it has at its disposal. As a majority stateowned company and the leading reinsurer in its home market, China Re also has a huge advantage in demonstrating the strategic interest of such an acquisition to the CBIRC.
The potential for M&A from China will continue to be driven by long-term growth, business diversification and a desire to manage overseas business successfully. The CBIRC also understands the value that foreign expertise in actuarial and risk management fields can bring to the sector and is encouraging the use of acquisitions to gain this knowledge. As part of this growth, many carriers (especially larger insurers) have long recognised technological innovation as a key ingredient to achieving longer term success at home and are on the lookout for strategic partnerships and acquisitions within the technology sector.
TABLE 3: MAJOR FOREIGN M&A TRANSACTIONS INVOLVING CHINESE ACQUIRERS, AUGUST 2015 – AUGUST 2018