Cautious Opening Seen for China’s Variable Annuity Market

For foreign insurers interested in China's fledgling variable annuity market, slow and steady will be the required pace.

A gradual opening of the variable annuity market in China will be more effective than quick development, as variable annuities entail advanced risk management tools and technical hedging systems that domestic Chinese insurers are generally not ready for and will need time to study, according to Clarence Wong, Swiss Re's chief economist in Asia, based in Hong Kong.

Wong said variable annuities involve complicated risk analysis and management, requiring insurers to have dynamic hedging tools and specific risk management instruments. Most Chinese players at present are unfamiliar with those advanced tools, which he believes would increase their risk management difficulties.

Variable annuities are a "very complex" derivative driven by many capital market factors and should be priced and hedged with the combined skills of financial engineering and actuarial science, said Frank Zhang, president and senior consultant at U.S.-based Actuarial Financial Risk Management LLC, in a report.

"Risk management is one of the most important functions for variable annuity products, while hedge profit and loss attribution analysis is a critical tool to measure risk management performance," he added. "Integrating product design with risk management is one of the most effective methods to ensure success."

According to consultancy Celent, because the requirement for effective risk management is high for variable annuities, companies that are experienced in selling variable annuities in global markets are proactively entering the Chinese market while most other types of insurers are adopting a "wait-and-see" approach.

Last May, the China Insurance Regulatory Commission introduced a variable annuity pilot program in five economically developed districts: Beijing, Shanghai, Guangzhou, Shenzhen and Xiamen.

The scheme is only open to insurers with a solvency ratio of at least 150% for the latest two quarters and at least three years of experience with investment-linked insurance products, along with a proper variable annuity administration system.

Insurers can only offer one product, which must have a minimum policy term of seven years. Insurers are also required to set the sales ceiling amount either at 8 billion yuan (US$1.3 billion) or an amount not to exceed four times of their actual capital solvency in the most recent quarter, whichever is lower.

Currently, four types of variable annuity guarantees are allowed in China: guarantee minimum death benefit, guarantee minimum maturity benefit, guarantee minimum accumulation benefit and the guarantee minimum income benefit.

The CIRC requires insurers file internal guidelines on sales, finance, disclosure and product risk management under the pilot program. A chief actuary must be responsible for pricing, risk management techniques and reserves. A chief investment officer must be responsible for implementing risk management, said Leon Cai, deputy general manager and chief actuary at Huatai Life, in a report.

Following the financial crisis, the CIRC concluded that "reasonable pricing and rational guaranteed interests" for insurance products are necessary. Insurers are required to provide a transparent and controllable risk hedging mechanism and cannot overly rely on financial derivative instruments provided by third parties such as banks or reinsurers as risk management tools, the regulator said.

Last November, Beijing-based Huatai Life won regulatory approval to offer a variable annuity product under a pilot program, with sales subsequently amounting to 4 billion yuan (US$629 million). This is the third Sino-foreign life insurance joint venture cleared to develop variable annuity products in China, following two other Shanghai-based insurers: Axa-Minmetals Assurance and MetLife China.

The CIRC introduced variable annuity products to increase product differentiation, move competition away from price and commission and raise the appeal of insurance in an under-penetrated market in the absence of tax advantages, said HSBC in a research report.

Industry consultants have said this market opening would help policyholders hedge against inflation and provide a potentially big market in China, but they question whether the market will see rapid and sizable growth in the short term without tax incentives (Best's News Service, May 24, 2011).

One challenge is there are limited distribution channels for variable annuity products in China, as Celent's senior analyst Wenli Yuan indicated that sales of these products are not allowed through savings counters at bank branches or through telemarketing, which will hinder fast market growth in the short term.

Sales forces in China may not be entirely equipped to sell such sophisticated products, while the general public may be unable to grasp the full benefits of a variable annuity product, according to Sharon Khor, head of insurance in greater China at consultancy Accenture.

Yuan said insurance companies in the pilot program may develop products that do not have high guarantee features, and put hedging or reinsurance procedures in place to control risk effectively.

Although there is no time frame for the existing pilot program to end, Cai said it is expected there will be more derivatives development in China's equity markets and greater development of annuity products, along with development of more risk management techniques like dynamic hedging and more sophisticated constant proportion portfolio insurance.

(By Rebecca Ng, Hong Kong news editor: [email protected])