Academic journal article Risk Management and Insurance Review

The Investment Portfolio of the Life Insurance Industry in China: Peculiar Constraints and the Specialist Problem

Academic journal article Risk Management and Insurance Review

The Investment Portfolio of the Life Insurance Industry in China: Peculiar Constraints and the Specialist Problem

Article excerpt

ABSTRACT

This article describes the particular investment and legal constraints on the life insurance investment portfolio in China (the "Portfolio") and investigates the specialist problem. The "specialist problem" is here defined as an agency problem as in information economics. In September 2004, the China Insurance Regulatory Commission ("CIRC") announced that three of the four largest life insurance companies in China could not meet the mandatory capital adequacy requirement. The author found that although it is harder to manage the Portfolio because of the peculiar constraints, the main characteristic of the poor performance of the Portfolio-failing to meet the capital requirement-is due to the specialist problem, which is mainly due to the controlled economic system. In conclusion, the author suggests specialists and risk management strategies that can be implemented in China with immediate effect, taking into consideration data deficiency and the difficulty of contract enforcement in China.

INTRODUCTION

The insurance industry in China has been growing rapidly (see Table 1). Given the estimated population of 1.3 billion and the nascent stage of the industry, it is reasonable to expect that the industry will sustain a high growth rate over the coming decade. This, however, is only viewed from the insurance fee income perspective. Could the assets earn a sufficiently high return to match the corresponding long-term actuarial liability?

In September 2004, the China Insurance Regulatory Commission ("CIRC") announced that three of the four largest life insurance companies could not meet the mandatory capital adequacy requirement. They are the China Life Insurance Group, the China Pacific Insurance (Group) Co. Ltd., and the New China Life Insurance Co. Ltd.1

In China, the types of investment instruments permitted by the CIRC for life insurance companies are very limited (for details, see section 2). Furthermore, the term of fixed income instruments is far shorter than the term of the corresponding actuarial liabilities. Most bonds that life insurance companies are authorized to buy are of less than ten years' duration (see Table 2). The prevailing term of negotiated term deposits with banks in the last few years is only five years. Such terms that are shorter than the corresponding actuarial liability imply a reinvestment risk.

A further issue is the specialist problem. Are the staff in investment departments in China qualified and sufficiently experienced to manage billions of RMB of liquid assets in the capricious market? How are investment staff evaluated? Last but not least are the problems related to the controlled economic system. For instance, a public statement by the government that they were going to sell their state-owned noncirculation shares on June 22, 2001 crashed the market, although some might argue that this was simply a major correction of the bubble.2 The truth is that the PRC government does indeed try to manage the capital market with bona fide intention.

This article will describe the specific constraints on the life insurance investment portfolio (the "Portfolio") in China and examine the specialist problem. Finally, the author will make a number of suggestions to mitigate these problems.

The remainder of the article is organized as follows. The second section describes permitted investment instruments in the Portfolio, while the third section describes the legal constraints on the Portfolio. This is followed by an investigation of the legal risk for negotiated term deposits, followed by an investigation of the reinvestment risk with negotiated term deposits. The next section investigates bank credit risk followed by an analysis of the specialist problem. The eighth section offers suggestions to mitigate these problems, and the final section makes a number of concluding remarks.

PERMITTED INVESTMENT INSTRUMENTS

The capital market in China is in its nascent stage and, on January 11, 2003, the market capitalization of the two stock exchanges in China was RMB 4 trillion (US$ 461 at RMB 8. …

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