Insurance as a transforming force for China real estate
December 08, 2009 | BY
clpstaff &clp articles &China's amended insurance law provides new opportunities for insurance companies to influence the development of the real estate industry. As long as implementation is correct, the benefits could be huge
On February 28 2009, the Standing Committee of the 11th National People's Congress of China adopted a substantially amended and revised PRC Insurance Law (中华人民共和国保险法 (修订)). The amended Insurance Law, which became effective on October 1 2009, introduces international best practices to the China insurance industry and attempts to create a regulatory framework to accommodate and guide an industry undergoing rapid transformation. The amended law and related implementing regulations have been closely watched by participants inside and outside the insurance industry. The real estate industry, in particular, has been captivated by the opportunities and challenges created by China's evolving insurance laws and regulations. Under the amended Insurance Law, insurance companies are now expressly allowed to invest in real estate for the first time, thereby creating a potentially new, large and influential institutional player in the Chinese real estate landscape. There are important amendments relevant to the real estate industry as well as key areas where future implementing policies of regulatory authorities will shape the future scope and impact of insurance companies on the real estate market in China.
Evolution of the Insurance Law
The Insurance Law is still remarkably new. It was first promulgated only in 1995 and was first amended in 2002, partly in response to issues created by China's accession to the World Trade Organization in 2001. Over time, the Insurance Law came to be viewed as increasingly inadequate to address the needs of a rapidly growing and evolving market. China's domestic insurance industry was undergoing a process of unprecedented growth and transformation. Assets under management by insurance companies expanded exponentially. New participants and new innovative products were introduced, which in many cases were simply not adequately addressed by the existing legislative framework.
The China Insurance Regulatory Commission (CIRC), China's primary insurance industry regulator, responded to some of the inadequacies of the Insurance Law by adopting a series of regulations designed to strengthen its supervision over insurance company corporate governance and risk management practices. The existing Insurance Law, however, did not give clear authority to the CIRC to regulate and supervise many critical areas relating to the insurance industry which the CIRC attempted to or desired to supervise. Consequently, many of the CIRC regulations took the form of provisional or trial measures rather than final detailed regulations.
Before the most recent amendments to the Insurance Law, insurance companies could not be a significant force in the real estate industry. Insurance companies were strictly limited by law in the use of their funds. Proceeds from insurance premiums and other funds on hand for the most part could only be deposited into banks or invested in certain types of bonds, such as government bonds. Although the CIRC did issue provisional rules to allow some direct investment in domestic stock markets and in offshore financial markets through the qualified domestic institutional investor (QDII) scheme, the law and provisional regulations never expressly listed real estate as a permitted investment asset for insurance companies. Regulators did permit insurance companies to purchase some real estate provided it was for the company's own occupation or self-use. While this exception did permit a certain level of real estate investment by insurance companies that creatively interpreted the meaning of “self-use,” the right to purchase real estate-related assets as an investment was never actually recognised by law or regulation. This feature of the law, however, was bound to change in the most recent amendments, as insurance companies pushed to have access to the lucrative real estate investment market.
After an extended period of review and debate, the Insurance Law was finally amended, for the second time in its history by the National People's Congress on February 28 2009. The amended Insurance Law, which became effective on October 1 2009, among other things:
(i) grants the CIRC greater supervisory powers over the insurance industry;
(ii) gives the insurance companies more latitude in the types of products and services it may offer to customers;
(iii) expands the types of investments the insurance companies may make; and
(iv) provides enhanced protections to insurees by mandating certain changes to insurance contracts.
Most notably to the participants in the real estate industry, under the amended Insurance Law, immovable property (i.e. real estate) is expressly recognised as a permitted investment for insurance companies in China for the first time.
By expressly opening up real estate investment to insurance companies, the amended Insurance Law has created an opportunity for insurance companies to emerge as new and potentially influential players in the real estate market. Chinese insurance companies are estimated by some industry watchers to mange approximately US$540 billion-worth of assets. If insurance companies are permitted to invest 5% to 10% of their assets under management in real estate, this will give insurance companies between approximately US$27 billion and US$54 billion to invest in real estate over the next several years.
Real estate as a new investment class
Article 106 and the pending real estate investment regulations
The timing and scope of China insurance company investment in real estate along with the exact nature of opportunities created by the potential involvement of insurance companies in the real estate industry cannot be determined from the amended Insurance Law itself. In reality, the only change in the amended Insurance Law which references real estate is the addition of the words “immovable property” (不动产) to the list of items in which an insurance company can invest its funds (as described in Article 106). The amended Insurance Law provides no guidance as to the amount or types of real estate investments an insurance company may make, nor does it specify any standards, procedures or requirements for the selection, management or disposition of real estate investments. Article 106 of the Insurance Law, however, makes clear that it will be up to the CIRC to introduce the specific implementing regulations describing the standards and practices governing the investment of insurance company funds into real estate.
The insurance and the real estate industries have now turned their attention to the CIRC and the long-awaited CIRC implementing regulations or measures governing insurance company investment in real estate (Real Estate Investment Regulations). Unfortunately, the final Real Estate Investment Regulations have not yet been promulgated. They have been the subject of continuing and heated debate and discussion among insurance companies, the CIRC and real estate industry participants. Much of the debate over the content of the Real Estate Investment Regulations focuses on three primary issues:
(i) the investment percentage;
(ii) the types of permitted real estate investments; and
(iii) the risk management guidelines.
The resolution of these key issues will shape the future scope and nature of insurance company investment in the real estate.
Investment percentage
The investment percentage refers to the proportion of the insurance company's assets that may be invested in real estate-related assets. As a matter or risk mitigation and management, the CIRC is likely to dictate that the amount of the insurance company's funds invested in real estate-related assets cannot exceed some pre-determined maximum percentage. The regulators do not want insurance companies to overweight their investment portfolios in certain asset classes, hence the need to impose investment percentage caps. The amount of the investment percentage will be critical in determining the amount of funds that will actually be made available for investment in real estate by insurance companies. Global insurance industry standards for percentage of assets invested in real estate range from about 3% to 10%. The CIRC may consider international standards and practices in formulating the investment percentage for China.
Types of permitted real estate investment
Once it has been determined that an insurance company can invest in real estate, the next step is to determine the actual form the real estate investment may take. Real estate investment is not limited to simply making a direct investment by acquiring title and directly owning a property. Real estate investment can also take the form of making equity investments in joint ventures, acquiring the shares of a listed or unlisted real estate company, investing in a real estate private equity fund, or investing in trust products, including a real estate investment trust. Real estate investment can also take the form of debt, whereby the insurance company extends loans to real estate investors or developers or acquires interests in real estate debt-related securities or instruments. Presently, Article 106 of the Insurance Law only says that insurance companies can invest in real estate. The exact forms of the permitted real estate investment still need to be determined.
Global insurance industry practices favour long term stabilised income producing real estate investment assets rather than short term and riskier speculative investments. Traditionally, in China most of the profits in the real estate industry have come from the development sector. Consequently, a number of insurance companies are keen to be able to invest in this segment of the market. It is uncertain whether the CIRC will permit direct investment in development projects or whether it may permit investment under certain circumstances with CIRC prior approval.
Risk management guidelines
The issue of types of permitted real estate investment is directly linked to risk mitigation requirements. Whether or not a particular type of investment may be permitted may depend on the risk profile associated with the investment. One of the core themes of the amended Insurance Law is the improvement of the risk management of insurance companies. To this end the amended law requires insurance companies to establish comprehensive internal compliance controls, to implement operational and risk management systems and to provide the CIRC with solvency reports, financial reports and actuarial reports on a regular basis. Real estate investing and asset management requires specialised skills, knowledge and expertise. The CIRC will very likely require insurance companies which desire to invest in real estate assets to put in place and adhere to certain asset management standards and practices. This may, among other things, involve insurance companies establishing an independent asset management company or department to assist with regards to real estate investment activities. The company or department would need to include employees with the requisite real estate asset management experience and expertise.
Evolution
In the coming months and years the insurance industry regulatory framework in China will continue to evolve as insurance companies continue to expand the breadth and scope of their operations and as the CIRC promulgates further implementing regulations and unofficial policies. A changing insurance company landscape will have direct implications beyond the insurance industry. The real estate industry is one such industry that may be significantly altered by changes in insurance company standards and practices facilitated by evolving laws and regulations which permit insurance companies to become active participants in the real estate investment and asset management.
In developed markets around the globe, insurance companies are an important source of debt and equity capital for real estate investment and are also an important force in real estate asset and risk management standards and practices. The amended Insurance Law and the forthcoming CIRC regulations, if properly drafted and implemented, may enable the insurance industry to play a similar role in China's real estate industry.
Joel H Rothstein, partner, Paul Hastings Janofsky & Walker
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