Stock Market Access Paves the Way for New Utilization of Insurance Funds

Main Contents of the Tentative Procedures

There are a total of 61 articles in the Tentative Procedures, which are divided into eight chapters. The regulations mainly focus on the qualification requirements imposed on insurance institutional investors, the scope and proportion of investment, trusteeship of stock assets, prohibited conduct of insurance institutional investors, risk control and supervision, and administration.

Qualifications

Insurance asset management companies may invest in stocks without administrative approval as long as they meet certain requirements (Article 5). Insurance companies, on the other hand, must first submit application materials to the CIRC to obtain approval before they can make any stock investments, regardless of whether they are planning direct investments or entrustment of stock investments through qualified insurance asset management companies (Articles 6 to 10).

Scope and Proportion of Investments

As mentioned above, insurance institutional investors may directly purchase most renminbi common stock (except for eight specific types, detailed in Article 14) in the primary market or trade it in the secondary market, and can also purchase convertible corporate bonds and other investment product types stipulated by the CIRC (Articles 11 and 12). Stocks in a listed company held by an insurance institutional investor shall not attain 30% of the said listed company's renminbi common stock (Article 13). The Tentative Procedures also authorize the CIRC to enact other stipulations governing the exact proportion of an insurance institutional investor's stock investments (Article 13). According to senior officials of the CIRC, for the time being the proportion shall be 5% of an insurance institutional investor's total assets (calculated according to the cost price) at the end of the previous year. Accounting methods for convertible corporate bonds and investment proportions for certain insurance products such as investment-linked products and universal products are also specified in the Tentative Procedures (Articles 15 and 16).

Trusteeship of Assets

An insurance institutional investor that engages in stock investments shall establish independent trusteeship mechanisms (Article 3). The Tentative Procedures provide detailed stipulations regarding the obligations and prohibited conduct of a trustee of stock assets (Articles 18 to 20) and the contents of the trusteeship agreements (Article 21).

Prohibited Conduct of Insurance Institutional Investors

Various conduct and activities are strictly prohibited for insurance institutional investors (Articles 23 to 29), in order to protect the normal order of the stock market and the lawful interests of other stock investors, particularly individual investors, and to avoid risks.

Risk Control

Safety and security are of vital importance to insurance funds. More than one-third of the Tentative Procedures are devoted to stipulations regarding risk control of stock investments by insurance institutional investors (Articles 30 to 52). These stipulations cover different aspects of risk control, such as investment tenets (Article 30), risk control systems (Articles 31 to 34), transaction rules and requirements on facilities (Articles 35 to 47), and requirements on personnel (Articles 48 to 52).

Supervision and Administration

The CIRC and the CSRC shall be responsible for supervision and administration over insurance institutional investors' stock investment business, according to their respective jurisdictions (Articles 53 and 58). Generally speaking, the CIRC shall carry out qualification examinations and/or approvals of insurance institutional investors (Articles 5 to 7) and shall be responsible for the supervision and administration of insurance institutional investors' internal risk control systems (Article 31), the scope and proportion of investment (Articles 11 to 16, and 23 among others), reports and data submission (Article 54), and information disclosure (Article 55). The CSRC shall be responsible for the supervision and administration of the market transaction practices of insurance institutional investors (see for example Articles 56, 58 and 59).

The Tentative Procedures and the Insurance Industry

Problems with the Utilization of Insurance Funds

As mentioned above, China's insurance industry has been developing at an annual average rate of increase of 30% for more than 20 years. In sharp contrast with the fast development of the insurance industry and its total assets, however, the utilization of insurance funds has developed slowly and is, to date, unsatisfactory.

Unbalanced Utilization Structure of Insurance Funds

For many years, the utilization of insurance funds has been limited to bank deposits, the trading of government bonds and financial bonds, and other means of funds' utilization specified by the State Council. In recent years, the authorities have gradually allowed insurance funds to be used for corporate bonds, inter-bank loans, securities funds, banks' fixed-term debts, banks' fixed-term bonds, and convertible corporate bonds. However, most of these newly added products for insurance funds' utilization are interest-earning products with low returns, which are almost the same in nature as bank deposits with somewhat higher risks. Therefore, the proportion of insurance funds used in investments other than bank deposits has only increased slowly.

This has resulted in an unbalanced utilization structure for insurance funds: too many eggs have been put into the one basket of bank deposits. According to Wu Dingfu, the Chairman of the CIRC, by the end of June 2004 total insurance funds' utilization reached Rmb973.2 billion, among which Rmb519.4 billion, i.e., 53.37% of the total amount, went into bank deposits; Rmb180.5 billion (18.55% of the total amount) was for government bonds; Rmb69.2 billion (7.11% of the total amount) was for securities investment funds; Rmb47.3 billion (4.86% of the total amount) was for corporate bonds; and about Rmb85.0 billion (about 9% of the total amount) was probably for financial bonds.² The remaining roughly 7% of the total amount went into other investments. From these figures we can see that only about 40% of the insurance funds that could be utilized were used in securities assets (including government bonds, financial bonds, corporate bonds and securities investment funds). This figure stands in sharp contrast to countries with developed insurance industries, such as the member countries of the Organisation for Economic Cooperation and Development (OECD countries). In the OECD countries, about 80% of insurance funds is invested in various securities, and roughly 20% of the total amount is invested in stocks.

Continual Decrease in the Income Ratio of Insurance Funds' Utilization

Although insurance funds have been accumulating rapidly in recent years, the income ratios for their utilization have decreased for three years consecutively owing to an unbalanced utilization structure. In 2001, 2002 and 2003, the comprehensive income ratio of China's insurance funds' utilization was 4.3%, 3.14% and 2.68%, respectively. In the past several years, the People's Bank of China has reduced the interest rates of bank deposits and loans eight times consecutively. With so many eggs being placed, as it were, in bank deposits and other fixed-income (income on interest) products such as government bonds, financial bonds and corporate bonds (while only limited investment is made in equity investments such as securities funds and others), it is easy to understand why the income ratio for insurance funds' utilization has continued to decrease. Although the People's Bank of China increased the interest rate for bank deposits and loans recently (in October 2004), this will not help redress the overall imbalance in insurance funds' utilization very much. Insurance funds are looking for new investment options. The promulgation of the Tentative Procedures has opened a new and important method for insurance funds' utilization.

Significance of the Tentative Procedures for the Insurance Industry

The promulgation of the Tentative Procedures is really good news for the insurance industry. It can help insurance institutions to establish reasonable utilization structures for insurance funds, optimize insurance assets allocation, decentralize investment risks, and improve the profitability of insurance institutions.

Income on investments is very important to insurance companies' profitability. According to relevant data of foreign insurance industries, insurance companies in many countries suffer losses from their insurance businesses. However, income on insurance funds investments can make up for such losses and help insurance companies meet their profit targets. For example, from 1994 to 1999, losses suffered by the US property insurance industry from the insurance business were US$22.2 billion, $17.7 billion, $16.7 billion, $5.8 billion, $16.8 billion and $23.4 billion, respectively; their income on investments, however, in the same years reached US$33.7 billion, $36.8 billion, $38.0 billion, $41.5 billion, $39.9 billion and $38.6 billion, respectively. After making up for losses from the insurance business, they enjoyed profits of US$11.5 billion, $19.1 billion, $21.3 billion, $35.7 billion, $23.1 billion and $15.2 billion, respectively.

In addition, according to relevant data taken from statistics on the performance of the insurance industries in other countries, investments in stocks enjoyed the highest average annual income ratio across all investment products. For example, in the OECD countries, the true average annual income ratio (after making allowance for inflation) during the period from 1970 to 2000 for investments in stocks reached 8.0%, while the income ratio of investments in loans was half of that of stock investments, and the income ratio of investments in government bonds was only one-fifth. In the US, the average annual income ratio over the past 20 years for investments in currency markets, bonds and stocks was 3.7%, 5% and 10.3%, respectively. And in Germany, the average annual income ratio over the past 30 years for investments in currency markets, bonds and stocks was 3.5%, 7.9% and 14.4%, respectively. In new market economy countries, the stock investment income ratio was even higher than that in developed countries.

All of this shows that direct stock investments will greatly improve the profitability of China's insurance industry. As the State Council has enacted favourable policies for the stock market, this is an excellent time for insurance funds to invest in the stock market. Moreover, with the development of business and reform of the administrative system for the utilization of insurance funds, all insurance companies have separated their funds' utilization business from their insurance business and some of them have even established specialized asset management companies; and with years of investments in bonds and securities investment funds, they have accumulated a wealth of experience in macroeconomic analyses and securities investments, and have built a body of specialized investment personnel. In short, insurance companies have never been as well prepared for stock investments as they are now.

The Tentative Procedures and China's Capital Markets

The promulgation of the Tentative Procedures is also good news for the capital markets. Firstly, it is an important step on the road towards fulfilment of the favourable policies for the capital markets, and especially the stock markets, which have been enacted by the State Council. The Tentative Procedures will help to build market confidence and improve market expectations, which are of great importance to stock markets that are hopefully moving towards a more bullish sentiment. Secondly, they will provide a stable and large quantity of funds that is urgently needed for the continuous and healthy development of the stock markets. At present, 5% of an insurance institutional investor's total assets at the end of the previous year can be invested in the stock markets. With total insurance assets of more than Rmb1.1 trillion at the end of July 2004, this means that about Rmb55 billion could soon be invested in the stock markets. If the insurance industry continues to develop as rapidly as it has over the past 20 years, there shall be even more funds available for investment in the stock markets. Thirdly, insurance institutional investors' direct access to the stock markets will improve the structure of the markets. Also, as significant institutional investors that are required to possess a long-term investment and value investment tenet (Article 30), insurance institutional investors can help foster a rational investment tenet among other investors, especially individual investors, and urge listed companies to carry out more standardized operations. In this way, the insurance market and the capital markets can enjoy coordinated development that will be mutually beneficial.

Conclusion

It is an internationally accepted practice for insurance companies to invest in stock markets as institutional investors. The Tentative Procedures, which are in line with such international practices, were promulgated in time to meet the demands of both the insurance industry and the capital markets. They will surely not only greatly promote the development of the insurance industry but will also be of immense benefit to the capital markets, which will in turn benefit insurance consumers and the mass of individual investors in the stock markets. However, Rome was not built in a day. We cannot expect an immediate change to the insurance industry and the stock markets, as has been demonstrated by the continued poor performance of China's stock markets after the promulgation of the Tentative Procedures. Joint efforts still need to be made for better coordination between the insurance industry and stock markets for their mutual benefit.

Endnotes

1 Lü Guoming, Juris Master, is also a lecturer of law at Jining Medical College.

2 Wu did not mention the specific amount of insurance funds used for government bonds. However, according to statistical data available at the end of 2003, Rmb82.87 billion, i.e., 9.48% of the total insurance funds that could be utilized at that time, was used for financial bonds. Generally speaking, the amount used for financial bonds as of the end of June 2004 should be a little higher than that at the end of 2003.