A Review of China’s Prudential Solvency Regime

Episode Summary

China’s insurance market has emerged as the second-largest in the world and is on pace to become the largest worldwide by the 2030s. In the seventh episode of Skadden’s yearlong podcast series on global prudential solvency requirements, host Robert Chaplin and Skadden colleague Feargal Ryan explore China’s regulatory transformation from a centralized state monopoly to a sophisticated risk-based system. They highlight the establishment of the National Financial Regulatory Administration, the implementation of the China Risk-Oriented Solvency System (C-ROSS) and Shanghai’s recent growth as an international reinsurance hub.

Key Points

• Insurance Market On the Rise: Despite a suspension of insurance activities from 1958-79, China has grown to become the second-largest insurance market globally, accounting for approximately 10% of the world’s insurance activities. The market took in $794 billion in premium income in 2024.
• Risk-Based Framework: The China Risk-Oriented Solvency System (C-ROSS) represents a shift from simple compliance-based capital requirements to a sophisticated three-pillar approach addressing quantitative capital requirements, qualitative supervisory requirements and market discipline mechanisms.
• Doors Are Open: China’s insurance market is now fully open to foreign investment, with no caps on foreign ownership in life, non-life or reinsurance companies. Prior to 2020, foreign life insurers were allowed to only own a maximum 50% stake in a joint venture with a Chinese partner.
• International Reinsurance Hub: China is expanding its global influence in the reinsurance market with initiatives such as the Shanghai International Reinsurance Registration and Trading Center, which allows domestic and foreign reinsurance company branches to establish reinsurance operational centers in Shanghai.

Voiceover (00:01):
From Skadden, the Standard Formula is a Solvency II podcast for U.K. and European insurance professionals. Join us as Skadden partner Robert Chaplin leads conversations with industry practitioners and explores Solvency II developments that matter to you.

Rob Chaplin (00:21):
Welcome back to the Standard Formula podcast. Previously, we’ve touched on the insurance and reinsurance landscape in Asia, focusing on Japan and the Middle East. Today, we’re exploring another important market in Asia: China, one of the fastest growing economies in the world. This episode is the seventh in our yearlong podcast series on global prudential solvency requirements, which will form the basis of our forthcoming publication, the Encyclopedia of Prudential Solvency. I should say we’re grateful to our colleagues at the Skadden Beijing and Hong Kong offices for their assistance in preparing this episode of the podcast. A special thanks must also go out to our friends, King & Wood Mallesons in China, for their review and input. Joining me today is my colleague, Feargal Ryan. Feargal, it’s great to have you here to speak about this important topic. So, Feargal, to kick off, why don’t you give us some background on the development of China’s insurance market?

Feargal Ryan (01:30):
Thanks, Rob. Pleasure to be here. The Chinese insurance market has a relatively short history, but has rapidly evolved to become the second-largest insurance market in the world today. Shortly after the People’s Republic of China was founded in 1949, the Chinese government decided to centralize the insurance industry. It established a domestic insurance company, the People’s Insurance Company of China, or PICC, and all private insurers were consolidated into this state owned group. The domestic insurance market effectively came to a standstill as the prevailing view was that within a collective economy, the role of insurance had become redundant. Any insurance payouts were simply seen as shifting funds from one part of the state to another. As a result, the role of insurance in China was significantly undermined during the Great Leap Forward in 1958 to 1979, an economic and social campaign led by the Chinese Communist Party.

(02:53):
Most of the activities of PICC, the only insurance company, had been closed during this 20-year suspension, and even those which were not completely closed were downgraded. Following this, the Chinese government implemented the reform and opening up policy from 1978 onwards with the state council deciding to resume insurance business in China. PICC’s monopoly was broken in 1988 with the establishment of Ping-Ang Insurance Company of China. When China became a member of the World Trade Organization in 2001, the geographical barriers to trade significantly reduced and the Chinese insurance regulators adopted a more open approach. As a member of the World Trade Organization, foreign reinsurers were allowed to operate through joint ventures, branches, and subsidiaries within China. In addition, foreign equity restrictions in the broader insurance sector were gradually lifted, allowing foreign investors to hold increasing stakes in insurance companies, eventually permitting wholly foreign-owned subsidiaries. Despite the delayed start, China’s insurance market has grown rapidly and is the second-largest insurance market globally in terms of total premium volume following only the United States.

(04:37):
It is predicted to become the largest market globally by the mid-2030s. In 2024, China has recorded total insurance premium income of 5.7 trillion Chinese Yuan, equivalent to approximately 794 billion US dollars, which is an 11.15% year-on-year increase. China is home to approximately 10% of the world’s global insurance activities. The Chinese market serves as a unique opportunity for foreign insurers, especially considering the size of its population, demographics and rapid economic development throughout recent decades. Now that we have some background, it would be helpful to dive into the modern regulatory regime. Rob, please could you tell us more about this?

Rob Chaplin (05:36):
With pleasure, Feargal. In March 2023, the National Financial Regulatory Administration, or the NFRA, was established as part of the reform of the financial regulatory system of China. It became the primary regulatory agency responsible for overseeing the entire financial industry in China except the security sector. The NFRA operates under the state council, the core administrative authority in China. Before the establishment of the NFRA, the insurance and reinsurance sector was supervised by the Chinese Insurance Regulatory Commission and its successor, the China Banking and Insurance Regulatory Commission.

(06:19):
As the insurance regulatory authority, the main responsibilities of the NFRA include licensing and supervising insurance and reinsurance companies, formulating regulations to ensure market stability and consumer protection, monitoring solvency, market conduct, and risk management, and enforcing compliance with laws and regulations. At the same time, the People’s Bank of China, the central bank of China, coordinates with the NFRA to implement macroprudential policies and proposals to tackle cross-sector financial risks. If the insurer is listed or engages in capital market activities, it may also be subject to supervision by the China Securities Regulatory Commission, or the CSRC. So, Feargal, could you tell us more about the primary sources of insurance law in China, please?

Feargal Ryan (07:16):
Thanks, Rob. The core legislation governing the insurance sector in China is the Insurance Law of the People’s Republic of China, which was first enacted in June 1995 and has since been amended numerous times. As well as the Insurance Law of the People’s Republic of China, the regulator has issued and continues to issue a large number of regulatory rules regulating all kinds of matters relating to the establishment, operation, and insolvency of insurance institutions. Among these, the regulations on the administration of foreign invested insurance companies and its implementing rules are particularly important for foreign investors as they set out requirements for market access, ownership structure, business scope, and ongoing compliance obligations applicable to foreign funded insurers in China. Rob, what about the requirements for formation and licensing of new insurance and reinsurance companies?

Rob Chaplin (08:33):
Great question. Foreign reinsurers in China primarily operate through branch offices rather than as locally incorporated subsidiaries. This is largely due to regulatory preference as China permits and facilitates branch-based operations for reinsurers. In addition, reinsurance business typically involves fewer retail-facing activities and lower local operational demands compared to primary insurance, making the branch structure more cost-efficient and administratively straightforward for foreign reinsurers. To establish a foreign insurance or reinsurance branch office in China, certain requirements must be met. Shareholders must have a good operational and financial record, and there are specific asset and profitability requirements depending on the size of each shareholder’s and whether the company is domestic or foreign-owned. Foreign insurance and reinsurance branches must have a minimum operating fund of 200 million Chinese yuan, equivalent to approximately 27.8 million US dollars. That amount should be fully paid in monetary form.

(09:49):
Foreign comprehensive reinsurance branches covering both life and non-life require at least 300 million Chinese yuan equivalent to approximately 41.8 million US dollars. The NFRA approval process is a two-stage process: preliminary approval, then a year to complete preparations, followed by a final application for a business license. Foreign-owned insurers and reinsurers follow a similar process and investor qualification requirement. For example, both foreign-owned insurers and reinsurers are required to hold a specified total asset number in the year prior to their application. Feargal, can you tell us more about foreign investment and market access?

Feargal Ryan (10:40):
Of course, Rob. China’s insurance market is now fully open to foreign investment. There’s no longer a cap on foreign ownership in life, non-life or reinsurance companies. This is a fairly recent development as prior to 2020 foreign life insurers were only allowed to own a maximum 50% stake in a joint venture with a Chinese partner. A different regulatory approach was adopted for the non-life insurance sector, where foreign non-life insurers have been permitted to establish wholly foreign-owned subsidiaries in China since 2003.

(11:21):
Whilst China’s market is open to foreign investment, there are several restrictions that act as barriers to entry, including that foreign investors must invest via insurance operating companies, insurance holding companies, branches of reinsurance companies or other financial institutions. As you mentioned just now, Rob, there are asset and profitability requirements for foreign investors. Alongside this, the home jurisdiction of the foreign investor must have a sound insurance regulatory system, and the investor must prove it is subject to effective supervision by the relevant authority in its home country. And, the foreign investor must meet the solvency standards of its home jurisdiction, and the Chinese authorities may require evidence of compliance. Is it a good time to discuss the solvency regime, Rob?

Rob Chaplin (12:21):
Certainly, Feargal. Following the worldwide move towards risk-orientated solvency regulation, in 2016 the Chinese Insurance Regulatory Commission, as you may recall, the predecessor insurance regulator launched the China Risk-Oriented Solvency System, or C-ROSS, which introduced a risk-based capital solvency regime for insurers in China. This represented a shift from simple compliance-based capital requirements to a sophisticated risk-based approach that emphasizes the actual risk profile and management quality of insurers. Subsequently, phase two of C-ROSS, or C-ROSS-II, was officially launched in the first quarter of 2022 with the transition period extended to the end of this year. C-ROSS is structured around three main pillars, each addressing a different aspect of solvency and risk management. Feargal, could you tell us about these three pillars of the C-ROSS framework please?

Feargal Ryan (13:29):
Thanks, Rob. The first pillar is quantitative capital requirements, which sets out the minimum capital that insurers must hold calculated based on a comprehensive assessment of certain risk exposures including insurance risk, market risk and credit risk. C-ROSS sets out the predefined weights of these capitalized risks with additional buffer for other systemic risks that may arise. The second pillar is qualitative supervisory requirements, which concerns four types of uncapitalized risks that are difficult to quantify, including operational risk, strategic risk, reputational risk and liquidity risk.

(14:19):
Insurers are required to have robust risk management frameworks and internal controls with the board of directors bearing ultimate responsibility for risk oversight and the NRFA conducting regular and ad hoc assessments of insurers’ risk management practices, and requiring remedial actions if weaknesses are identified. The third pillar is the market discipline mechanism, which aims to enhance transparency and market discipline through disclosure requirements and external oversight.

Rob Chaplin (15:00):
Thank you, Feargal. Under the C-ROSS framework, the NFRA reviews insurance companies every quarter and gives each a solvency risk rating: A, B, C or D, with A being of satisfactory risk and D indicating the highest level of risk. These ratings are determined by considering factors like the company’s core and comprehensive solvency ratios along with a range of other indicators. The NFRA will take regulatory measures against insurance companies with core solvency ratios lower than 50%, comprehensive solvency ratios lower than 100%, or a solvency risk rating lower than B. These measures include requiring capital increases, restricting business activities and limiting profit distributions.

(15:56):
Persistent or severe deficiencies can lead to regulatory takeover, restructuring or even bankruptcy proceedings. For context, in 2024, insurance companies in China recorded an average core solvency ratio of 139% and an average comprehensive solvency ratio of 199%. For reinsurance companies, which generally seem to see higher solvency ratios, reinsurance companies average core solvency ratio and comprehensive solvency ratio reached 221% and 254%, respectively, while the transition period for C-ROSS-II comes to an end.

(16:43):
By the end of this year, the new regime is expected to strengthen insurers’ capital bases and to cater for the changing macroeconomic environment in China and the world. Some highlights include the introduction of the following: the look-through approach for complex structured products where a detailed investigation of the underlying assets will be conducted to ascertain the suitable risk charges. If assets can’t be looked through, punitive capital requirements are applied and a morbidity trend risk factor that addresses the risk of deteriorating health conditions, particularly within critical illness insurance products. Feargal, why don’t you give us an overview of the regulatory requirements with respect to reinsurance?

Feargal Ryan (17:32):
Thanks, Rob. Chinese law generally allows the parties considerable freedom to agree on the terms of reinsurance contracts. However, there are certain mandatory restrictions, particularly around proportion of risk that a reinsurer can assume in specific types of reinsurance arrangements. Each insurer is obliged to retain risk within parameters that are commensurate with its financial strength and business volume. These regulatory limits are designed to ensure prudent risk distribution and maintain the overall stability of the insurance sector. The NFRA places significant emphasis on the qualifications of participating reinsurers. Importantly, any reinsurance company, whether domestic or foreign that wishes to transact with a Chinese cedent must first register in a dedicated system managed by the NFRA. As part of this process, reinsurers must submit detailed information on their solvency, credit rating, financial strength and other relevant matters. Based on this assessment, each reinsurer is classified by the NFRA. Rob, can you tell us more about the collateral requirements under Chinese law?

Rob Chaplin (19:06):
Yes. Interestingly, Chinese law does not require a reinsurer to post collateral in a reinsurance transaction. However, under the C-ROSS solvency regime, there are important implications for Chinese insurers ceding business to overseas reinsurers that are not licensed in China. In these cases, unless the overseas reinsurer provides collateral, the Chinese cedent will receive reduced solvency credit for the reinsurance arrangement compared to what it would receive if the business was ceded to a locally licensed reinsurer.

(19:43):
To address this, overseas reinsurers can provide collateral, typically in the form of a bank deposit or a standby letter of credit to support the reinsurance recoverables. For bank deposit collateral, the funds must be placed with an eligible Chinese commercial bank and remain fully accessible to the ceding insurer. These funds can’t be returned to the reinsurer’s account within one quarter of the deposit date unless the underlying reinsurance contract has already been settled. As for standby letters of credit, they must be issued or confirmed by a bank that meets NFRA’s criteria, ensuring that the collateral is reliable and can be drawn upon if needed. This framework is designed to protect the financial position of Chinese insurers and ensure that reinsurance recoverables are secure, particularly when dealing with offshore counterparties. Feargal, before we wrap up this episode, can you tell us about recent developments in the reinsurance space in China?

Feargal Ryan (20:49):
Of course, Rob. In recent years, the Chinese government has continued to make an effort to support the development of the reinsurance industry. In 2024, the total assets of reinsurance companies in China reached 827.9 billion Chinese yuan, equivalent to approximately $116 billion US dollars, demonstrating more than a 10% year-on-year increase. Last year, the NFRA and the Shanghai Municipal People’s Government jointly issued a set of guidelines to accelerate the city’s pace in becoming an international reinsurance hub, outlining support for the establishment of specialized reinsurance businesses, brokers, and their branches or subsidiaries in Linggang special area.

(21:50):
Last October, the Shanghai International Reinsurance Registration and Trading Center was established in the number one financial hub in China, with an aim to enhance its competitiveness and influence as an international reinsurance hub. The Trading Center allows both domestic and foreign reinsurance company branches to establish reinsurance operational centers in Shanghai, offering incentives and support policies for institutions in areas such as establishment and capital increase.

(22:29):
Last October, the NFRA also approved the establishment of a new property and casualty insurance company, jointly founded by a partnership of Chinese and European multinational corporations. On the same day, it granted approval for a large U.S. financial services company to set up an insurance asset management company in Beijing, marking another step forward in China’s ongoing efforts to further open up its insurance market. As China’s reinsurance market continues to expand and attract greater investment, we can expect the reinsurance sector to sustain its strong growth momentum going forward.

Rob Chaplin (23:13):
Thanks, Feargal. That seems like an excellent note on which to end today’s podcast. We look forward to the promising development of the insurance and reinsurance sectors in China. With ongoing enhancements to the legal and regulatory framework and strong market oversight, the insurance industry is set to play an increasingly important role. We hope you found this episode informative. Please stay tuned for our next episode in our series on global prudential solvency requirements, in which we’ll cover India, a jurisdiction that shares some common themes to today’s episode. As ever, if you have any questions, comments or suggestions, we’d love to hear from you. Thanks for listening today. Until next time.

Voiceover (23:57):
Thank you for joining us on the Standard Formula. If you enjoyed this conversation, be sure to subscribe in your favorite podcast app so you don’t miss any future episodes. Additional information about Skadden can be found at skadden.com. The Standard Formula is a podcast by Skadden Arps, Slate Mar & Flom, LLP, and affiliates. Skadden is recognized for its deep experience in representing insurance and reinsurance companies and their advisors on a wide variety of transactional and regulatory matters. This podcast is provided for educational and informational purposes only, and is not intended and should not be construed as legal advice. This podcast is considered advertising under applicable state laws.