An Overview Of Legal Issues Facing Insurers In China

Wednesday, October 1, 2008 - 01:00

Helen Shen


The Chinese insurance market has grown considerably after China's accession to the World Trade Organization (WTO) in 2001. For example, China's annual premium income has increased from 210.9 billion yuan in 2001 to 703.6 billion yuan in 2007 and for the first half of 2008 insurers in China have collected premium income of 561.79 billion yuan which exhibits continuing growth. Furthermore, restrictions on the scope of business that foreign insurance companies can underwrite have been gradually eased and statutory reinsurance requirements came to an end in 2006. China is also honouring its commitment to further liberalize the country's insurance market. However, while China offers big opportunities for both domestic and foreign insurers there are challenges that come hand in hand with the opportunities.

Risk Awareness

Risk awareness is in its infancy in China. The survivors trying to rebuild their lives following the Sichuan earthquake are testament to this; few among the 28 million people living in the area affected by the earthquake had life or property insurance which has forced the majority to rely on government assistance. What makes things even worse is that those who had insurance in place are unlikely to be able to claim their losses from their insurers as the standard property policies in China exclude earthquake coverage. Earthquake coverage is an optional addition to the standard property policy in China demanding an extra premium for the coverage. However, many who had insurance would have realised this at the time they took out their policies.

Despite rapid economic growth over the last thirty years, the risk awareness in general is quite low both in terms of commercial entities and individuals purchasing coverage. At present people in China are simply not aware of the value of insurance as a risk-transfer tool. In terms of businesses or individuals affected by natural disasters, such as earthquakes or floods, most people know little about insurance and so are forced to rely on the government for assistance. Even when there is insurance, there is much misunderstanding as to what the products offered by insurance companies are designed to do, and this has led to many legal disputes between policyholders and insurers. Often, as China is still an emerging market, the insurance products available in the local market cannot meet the diversified needs of those who do understand insurance as a risk-transfer tool, and while there may be a recognition that insurance should be purchased, the precise coverage may not be available.

The recent devastating earthquake has highlighted to government, the business community and individuals the importance of insurance as a risk-transfer tool. In a statement issued by the China Insurance Regulatory Commission (CIRC) following the earthquake they said the loss of wealth caused by the earthquake "reveals the importance and urgency of establishing an earthquake insurance system." Given the size of the coverage required, any earthquake insurance program will probably involve both the government and those international reinsurance companies who have the global capacity to provide the coverage for such a scheme. In the aftermath of the Sichuan earthquake insurance has become a hot topic throughout China with insurance companies receiving more enquiries than usual because more and more people are seeking to purchase life and property insurance to minimise the losses from accidents or natural disasters. There is a school of thought that the earthquake will operate to heighten the interest in insurance as a risk-management tool, and as a consequence the growth of China's insurance industry in the long run.

Insurance Intermediaries

Although insurance intermediaries have a short history in China, they are expanding rapidly and CIRC statistics show that the premium income earned by insurers through brokers and agents reached 35.74 billion yuan in 2007 up 53.24% compared to 23.32 billion yuan in 2006. However, this accounts for only 5.08% of the annual premium income and this proportion is much smaller than that earned by their counterparts in the U.S. and European countries.

Insurance intermediaries (brokers and agents) play a pivotal role in the creation of insurance contracts they can also assist with claim services and provide advice on risk management issues. In an insurance market such as China, which in real terms has a relatively insurance-low penetration, the most significant aspect of the insurance intermediaries' role is ensuring that the product bought from the insurer meets all the client's requirements, and that if all the client's requirements cannot be met, the client knows this and is fully aware of the coverage provided. It is extremely important for insurance intermediaries to understand that getting this issue right at the outset will greatly reduce the potential for arguments between the insurers and policyholders.

Without the help of insurance intermediaries, buyers of insurance products may not be able to secure tailor-made insurance programs which address their specific risk-exposure concerns. Furthermore, as insurance products can be complex and many, without experience of such products, may find it difficult to understand insurance policies and identify the exclusions, warranties and conditions precedent which can lead to disputes, due to lack of insurance knowledge between insurers and policyholders. If insurance intermediaries are involved in the negotiations from the outset, a lot of problems which flow from coverage issues may be avoided.

As with risk management, given the short time that intermediaries have been operating in China, this sector of the insurance industry is also in its infancy and the degree of sophistication in terms of product knowledge and the ways in which those products operate can only improve with market penetration as the level of awareness of insurance as a risk-management tool grows. All the large international intermediaries have a presence in China and, with this experience to draw on the level of sophistication, will improve with the competition. There have been problems in this sector with insurance intermediaries misleading clients as to the coverage they have purchased. A dynamic, knowledgeable and professional insurance intermediary sector will help raise public risk awareness and improve the communication between the insurers and policyholders. With more sophisticated insurance intermediaries the insurance sector can only continue to grow.

Regulatory Changes

CIRC has recently introduced capital adequacy requirements for insurers meaning that insurers with less than a 100% solvency ratio will be considered insolvent. A failure to meet the solvency ratio will mean the insolvent insurers will face tighter regulation. For example, insolvent insurers may be forced to increase capital and/or be restricted in the way in which the management is remunerated and/or be prohibited from issuing dividends to shareholders. These capital adequacy requirements are intended to protect an insurance company's assets since CIRC has given insurers greater freedom with regard to investment for capital growth. Of course, the capital adequacy requirements are designed to protect the policyholder as well.

Since September 2006, the individuals who run insurance companies will, as a result of the introduction of CIRC regulations, be open to severe penalties for any wrongdoing in their capacity as directors or part of the senior management of insurance companies if they are found guilty of any wrongdoing.

In 2006 and 2007 CIRC issued a number of rules and regulations designed to manage, regulate and oversee the operation of insurance companies in China. While the Chinese government is honouring its commitment to further liberalize the country's insurance market, it intends to maintain over the industry very strict controls that are designed to strengthen CIRC's ability to regulate the industry, and as the Chinese insurance industry develops and matures, it is anticipated that CIRC will also develop and mature.

Legal Environment

China has recognised the importance of corporate governance in ensuring the healthy development of the economy as a whole and has implemented laws and regulations designed to strengthen corporate governance so as to ensure that relevant checks and balances are in place to promote further growth and investment. In 2006 China updated its laws relating to companies and securities. The Company Law as revised imposes duties of loyalty and due diligence on the directors and officers of the company and if breached, the directors can be held jointly and severally liable for their actions. These laws cover the entire corporate landscape and are not unique to insurance companies and/or their directors and senior management.

Special Forms Of Liability Insurance

On July 1, 2006 China introduced mandatory third-party liability insurance for motor vehicles. However, for the time being, the compulsory auto insurance business is closed to foreign insurance companies, as China did not agree to permit foreign insurance companies to write this class of compulsory insurance when it entered WTO. CIRC sets the benchmark premium rates for the compulsory auto insurance and controls the unified policy terms and conditions. Accordingly, it must be appreciated that not all classes of business can be underwritten by foreign insurers in China.

The mandatory third-party liability insurance for motor vehicles represents the first class compulsory insurance in China and there may be more to come, in particular fire insurance and school liability insurance may be candidates for compulsory status. The Chinese government is trying through regional and local governments to raise awareness of the benefits of insurance as a risk-transfer tool, thereby hoping to cultivate the demand for liability insurance in China. This initiative augurs well for insurance companies.


Although the Chinese insurance market is in its infancy, no one can argue that in a very short time China has become one of the largest economies in the world. If the growth in the Chinese insurance industry mirrors the growth the economy has experienced in a generation, then there can be no doubt it offers an excellent opportunity for both domestic and foreign insurers to benefit from the Chinese economy. Global insurers and reinsurers are exploring the opportunities in China. Chinese insurers and reinsurers are learning from their foreign competitors which can only be of benefit.

Every emerging market throws up its own unique challenges and China is no different. Before investing in China, insurers would be well advised to secure an understanding of China's legal and regulatory systems as they develop.

Helen Shen is an Attorney in the Shanghai office of the leading Hong Kong law firm Deacons. Her practice is focused on advising clients on the legal issues facing insurers in China.

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