Is the Tight Solvency of Insurers a Cause for Concern? (AI Translation)

【周刊提前读】险企偿付能力吃紧 滥用财务再保险是饮鸩止渴吗？

The life insurance industry is currently experiencing pressures and challenges related to "financial reinsurance," a method that allows insurance companies to temporarily borrow capital from reinsurance companies to improve their solvency margins. This practice has become increasingly critical as many insurance companies are now facing solvency crises due to regulatory changes like the implementation of the "China Risk-Oriented Solvency System" (C-ROSS) Phase II rules [para. 1][para. 3].

Financial reinsurance has always been controversial due to its potential to artificially inflate the solvency of insurance companies and obscure financial risks. This was highlighted when the National Audit Office issued an opinion on China Reinsurance (China Re), indicating that financial reinsurance could misrepresent an insurer's solvency capability. This opinion has sparked concerns within the life insurance sector, which is already struggling with capital replenishment challenges [para. 4][para. 5].

Industry experts liken financial reinsurance to medical anesthesia - helpful in the short term but potentially harmful if overused. Abuse stems from insurers' overspending tendencies and reinsurers' profit drives, combined with inconsistent regulation over the years [para. 6][para. 7][para. 8].

Moreover, the impact of past financial scandals has added to the skepticism surrounding financial reinsurance. Notably, companies like HIH Insurance, AXA, and AIG have faced severe consequences due to the misuse of financial reinsurance. This has led to regulatory tightening in various countries, including China, where financial reinsurance has seen a fluctuation in acceptance and regulation [para. 9][para. 10][para. 11][para. 12].

The life insurance industry, burdened by financial pressures, relies heavily on financial reinsurance, especially small and medium-sized companies struggling to secure shareholder capital or issue bonds [para. 13]. However, the National Audit Office’s findings may lead to tighter regulations.

The Beijing Bureau of the State Administration of Financial Supervision has already taken steps to regulate financial reinsurance by requiring thorough documentation from companies that use it to improve solvency. Similar measures are anticipated in other regions like Shanghai [para. 14][para. 15][para. 16].

While some predict a substantive tightening of financial reinsurance, others believe that regulatory efforts will focus on eliminating fake financial reinsurance while allowing legitimate transactions [para. 17]. The industry's consensus is that reinsurance contracts need to maintain a significant risk transfer to qualify as legitimate reinsurance [para. 18][para. 19].

Solvency standards under C-ROSS Phase II encourage genuine risk transfer through reinsurance, emphasizing transparency and detailed reporting. However, many insurers still misuse financial reinsurance to embellish their financial statements, presenting a challenge for auditors and regulators [para. 20][para. 21][para. 22].

Notable cases of insurers like Huaxia Life and Junko Life illustrate how financial reinsurance can manipulate solvency perceptions and delay genuine capital replenishment efforts. Thus, experts emphasize the regulated and responsible use of financial reinsurance, rather than an outright ban [para. 23][para. 24][para. 25][para. 26][para. 27].

Li Yunze, the party secretary and director of the State Financial Regulatory Administration, stressed the need for reforms and improvements within the insurance industry to address capital insufficiencies. Potential reforms include diversifying capital sources, issuing perpetual bonds, revising shareholder qualifications, and modernizing regulatory practices [para. 28][para. 29][para. 30]. Theoretically, permitting shareholders like commercial banks to own more than a third of an insurer's equity could stabilize companies by alleviating solvency pressures [para. 31][para. 32].

In summary, while financial reinsurance remains a critical tool for short-term solvency support, the industry and regulators must focus on sustainable, long-term capital solutions. Continued reforms and broader capital channels are essential for the stability and development of the life insurance industry.