Regulatory Foundations for Bancassurance in China

In China, some regulatory obstacles to bancassurance have recently been removed. Under the amended Insurance Law (保险法)(effective January 1 2003), corporate agents are no longer prohibited from selling life insurance policies for more than one insurer. For distribution of non-life insurance policies, there was no such restriction even before 2003. The People's Bank of China (PBOC)² has also created a clear framework for banks' intermediary (including insurance agency) businesses through regulations promulgated in July 2001. However, other practical and regulatory difficulties remain.

What are the opportunities for transplanting bancassurance business arrangements to China and what are the challenges given the current Chinese regulatory environment?

Distribution and Alliance Arrangements

Distribution agreements between banks and insurers are frequent in China, but they have not yet led to the kind of close cooperation and synergies that have underpinned the success of bancassurance as a business model. Existing arrangements have usually been short-term, ad hoc and non-exclusive.

A major difficulty in fostering distribution alliances in China is the high degree of autonomy enjoyed by bank branches. Prior to the enactment of the PRC Commercial Banking Law(中华人民共和国商业银行法) in 1995, regional and local branches of China's four main state-owned commercial banks (the Bank of China, the Industrial and Commercial Bank of China, the China Construction Bank and the Agricultural Bank of China) determined lending principles and limits themselves. As a result, they were largely independent from their head offices, and loans were granted on the basis of the interests of local governments. Since 1997, the PBOC has required that unified management structures and lending principles be installed in these state-owned commercial banks. However, the centralization of bank management does not yet extend to all areas. Local governments retain a measure of influence on the appointment of branch executives. Also, branch managers have a vested interest in maximizing the profits of the branch rather than those of the bank as a whole.

A typical bancassurance arrangement in China involves a master agreement between the insurer and the bank at the national level. This agreement remains relatively vague and envisages cooperation in various areas (for example, distribution, investment, credit card insurance, and collection and payment services) without stipulating binding commitments. Specific agency agreements are then negotiated piecemeal at the branch level. The head office is not necessarily in a position to compel the branches to sign such agency agreements.

This practice is likely to change as Chinese insurers wake up to the benefits of deeper, better executed distribution alliances and foreign investors attempt to transfer their relevant experience to China. To build successful long-term relationships with Chinese banks, insurers will have to create incentives for both the bank's head office and its branches. This may require creativity in defining the areas of cooperation. Agency commissions can be used to incentivize the distribution partner only to a certain extent, since these commissions are deductible from taxable income only up to 8% of premium paid.

Foreign-invested insurance companies face an additional problem in developing an exclusive distribution relationship. Under China's commitments to other members of the WTO, foreign-invested insurers and branches of foreign insurance companies will be allowed to operate in only five cities until December 11 2003 and 15 cities until December 11 2004, when all of China will be opened. In addition, existing companies that want to create additional branches in the permitted cities face formal and informal obstacles to their expansion: for each additional branch, the insurance company's registered capital must be increased by Rmb50 million (up to a maximum of Rmb1.5 billion for holders of national licences or Rmb500 million for holders of regional licences). In practice, foreign-invested insurance companies have been very slow in obtaining approval for, and actually establishing, additional branches.

Foreign-invested banks and branches of foreign banks are subject to similar restrictions when considering a marketing alliance with a Chinese insurance company. Until geographical restrictions on renminbi business are phased out by December 11 2006, foreign banks' expansion will be slowed with respect to bancassurance as well as other products.

Cross-ownership

In developed insurance markets, cross-ownership arrangements between banks and insurance companies strengthen the bancassurance relationship between the two institutions and expand its scope beyond mere distribution.

PRC law, however, categorically prohibits such cross-ownership arrangements. Under the Insurance Law, insurance companies are not allowed to hold equity interests in any company other than an insurance company. Likewise, the Commercial Banking Law prohibits commercial banks from investing in entities other than financial institutions (insurance companies are not deemed to be financial institutions for this purpose).³

However, two types of institutions may invest in both banks and insurance companies: foreign entities and PRC financial holding companies.

Cross-border Investments

Because they are not governed by the Insurance Law or the Commercial Banking Law, foreign banks are allowed to invest in PRC insurance companies, and foreign insurers are allowed to invest in PRC banks. The non-PRC affiliates of Chinese banks and insurers, such as the Hong Kong-listed BOC Hong Kong (Holdings) Limited, The Industrial and Commercial Bank of China (Asia) Limited, and China Insurance International Holdings Limited (CIIH) enjoy the same freedom. They are not deemed to be domestic entities subject to those limitations. Thus, a bank or insurance company incorporated or operating in China could invite one of these "red chips" (i.e., foreign incorporated entities controlled by PRC parent companies) to invest in them to create or reinforce a bancassurance relationship with the Chinese parent of the red chip.

In addition, several large banks and insurance companies are preparing overseas initial public offerings for the next few years. Through the IPOs, foreign banks could acquire shares in these Chinese insurers and foreign insurers could acquire shares in Chinese banks. On the other hand, it is not clear whether the newly listed companies themselves will be allowed to invest in PRC banks. This will depend on the structure of the IPO; if the issuers are PRC-incorporated banks or insurance companies, they could be subject to the cross-ownership prohibitions under the Commercial Banking Law or the Insurance Law. If, however, the listed companies were red chips, the restrictions would not apply. Even in the case of PRC issuers, with the endorsement of the State Council, the CBRC, the CIRC and the China Securities Regulatory Commission (the CSRC) might grant exemptions from such cross-ownership restrictions.

Foreign investments of this type raise several issues, which must be addressed when contemplating such a transaction.

Impact of Foreign Ownership Restrictions

Foreign equity interests in life insurance companies, commercial banks and other financial institutions in China are limited to a certain percentage of registered capital. This limitation is subject to China's commitments upon its WTO accession. An equity investment by a red chip company in a foreign-invested enterprise (FIE) might be considered "foreign" for the purpose of calculating the foreign ownership ratio and thus reduce the maximum percentage ownership available to "real" foreign investors. However, there are no written rules as to whether red chips are considered foreign shareholders, and in practice the regulatory authorities (the PBOC and the CIRC) have shown some flexibility. For example, the CIRC allowed CIIH to hold a majority interest in Tai Ping Life, without treating CIIH's investment as foreign investment. The impact of the foreign ownership limitation must be assessed case by case.

Ceiling on Foreign Minority Investments

The PBOC and the CIRC allow foreign investors to hold equity interests of less than 25% in domestic banks and insurance companies, without subjecting them to the geographical and business scope restrictions that apply to FIEs operating in these two industries. However, as a minority shareholder, the foreign investor will have to negotiate satisfactory minority protection rights. Also, a bank or an insurance company will be impacted in its overseas listing plans if existing foreign minority investments, together with shares issued to the public, raise aggregate foreign ownership above 25% of share capital. Ping An may have to obtain an exemption from the restrictions governing FIEs to solve this problem in its planned Hong Kong IPO.

Group Structure of Chinese Banks and Insurance Companies

In case of a cross-ownership arrangement involving an overseas affiliate of a PRC bank or insurer, the affiliate's position within the group structure must be considered. Red chips are typically subsidiaries of a state-owned holding company in the PRC. Critical decisions (including an exclusive bancassurance relationship) are made at the parent company level, and not by the affiliate in which the foreign investor holds shares and may have a board seat. Also, the red chip possibly does not own all of the operational entities (branches or subsidiaries) in the PRC.

Investments in Financial Holding Companies

A company that is neither a bank nor an insurance company is not subject to the investment restrictions in the Commercial Banking Law(商业银行法) and the Insurance Law(保险法). There is no rule prohibiting such a company from holding equity interests in both insurance companies and banks. There are several examples of such investments, including China International Trust and Investment Corporation (CITIC), which holds interests in CITIC Industrial Bank, and CITIC Prudential Life Insurance Company Ltd.

There are no specific regulations governing financial holding companies, and none of the current PRC regulatory authorities in the financial services industries seems to have jurisdiction over them. However, certain restrictions do apply. The PRC Company Law ((中华人民共和国公司法) )prohibits equity investments exceeding 50% in the aggregate of the investing company's net assets. Also, the approval requirement for substantial shareholdings in financial institutions and insurance companies allows regulators to block investments they consider undesirable.

Some of the existing conglomerates are interested in attracting foreign investment in their respective bank and insurance subsidiaries. So far, however, there is no precedent for the same foreign and domestic investors holding equity interests in both a bank and an insurance company.

Towards Integrated Financial Services?

The logical conclusion of the convergence between banking and insurance services would be the formation of integrated financial services groups. Internationally, major corporations like CitiGroup and Allianz have embraced this strategy.

In China, many of the factors that favour the integration of banking, insurance and securities services in other markets are not yet at work. Bank and insurance products are seen as distinct, so that banks and insurers do not directly compete for the management of retail customers' assets. Insurance companies are only beginning to replace an agency-based push strategy with more sophisticated financial planning services.

The regulatory situation also hinders further convergence. The CBRC, the CIRC and the CSRC supervise discreet industries and institutions, with little coordination. There is an acute need for more flexible supervision and greater regulatory coordination with respect to the development of new business products and other matters.

Regulatory restrictions are not likely to change in the short term. In the meantime, foreign investors can explore cross-ownership opportunities that arise through overseas IPOs of Chinese companies and the evolving role of domestic financial holding companies. Such potential investments have issues for the foreign minority shareholder, who will at best have negative control. A corporate governance structure acceptable to all shareholders also has to be negotiated and implemented. In addition, and equally importantly, the economic interests of the shareholders need to be aligned in the long term. This is best achieved if, in addition to equity investments, all shareholders may derive benefits from the jointly provided consumer services, which might include distribution of insurance products, credit card services, and other services.

Endnotes

1 Sigma no. 7/2002, "Bancassurance developments in Asia - shifting into a higher gear."

2 In March 2003, the National People's Congress approved the transfer of the PBOC's supervisory function to a newly created China Banking Regulatory Commission (CBRC).

3 One historical exception is Bank of Communications' shareholding in China Pacific Insurance. The latter was originally a division of Bank of Communications and was spun off in 1991, before the Commercial Banking Law was adopted. Also, Ping An acquired a trust and investment company before the Insurance Law became effective and was allowed to retain ownership during Ping An's restructuring in 2002.