Risk and Capital Management of Life Insurance Companies in China

Chinese Version

Editor’s note: This article is based on the 2024 Society of Actuaries (SOA) and China Association of Actuaries (CAA) professional development online training course, “Risk Management Experiences of Life Insurance Companies in the Current Environment.”

The global economy is currently experiencing many challenges and uncertainties, including continued post-pandemic economic recovery and volatility due to complex international situations.

These factors are intertwined with the capital market, leading to increased volatility in asset prices and pressure on investment returns. Against the persistently declining interest rates and increased volatility in the equity market in China, how to effectively manage assets and liabilities to maintain companies’ financial stability and sustainable growth has become a topic of discussion within the industry.

Impact of Economic Environment on Life Insurance Companies in China

Interest rates have been trending downward in recent years in China. Meanwhile, the equity market’s performance has become more volatile. The continued declining interest rate may result in lower actual investment returns than the expected returns embedded in product pricing, potentially leading to investment losses. In addition, the valuation rate used for reserving is based on the yield curve of government bonds. The declining interest rate may strengthen liabilities, therefore negatively affecting a company’s relevant financial metrics and solvency ratios.

The volatility of the equity market also has profound implications on investment strategies and, consequently, investment returns, which imposes stricter requirements on asset management for life insurance companies in China.

Pre-sale Product Approval and Risk Control

Grappling with these economic challenges, life insurance companies in China need to take measures to actively control risks in both the pre-sales and post-sales stages. First, in the pre-sale product development and approval process, the company can assess product risks in both qualitative and quantitative aspects.

For example, in the case of Manulife-Sinochem (as shared in the discussion), during the initial risk assessment, a product feasibility analysis is conducted, and a formal analysis report is prepared to assess the product risk profile from a qualitative perspective. After the feasibility analysis, various financial metrics of the proposed product are further reviewed.

In addition to the analysis required by the regulator, there is also a focus on the following additional return metrics for the proposed products:

• Return on capital (ROC)
• Break-even interest (BEI)
• Lifetime return on capital (LROC)

For example, ROC is the ratio of the product’s profit to required capital for each year, which needs to be higher than the company’s internal minimum requirements, and the BEI is the required break-even rate of return on investment based on the best-estimated cash flow of the proposed product, which needs to be lower than the company’s thresholds. In the overall context of the external environment, these metrics can help the company identify the potential risk and provide quantifiable indicators for making the decision to launch this new product.

If the suggested financial indicator breaches the company’s expected level, it generally requires special approval processes or actions, such as termination of product development, setting sales limits, setting profit loss limits and other measures. Throughout the new product development cycle, it is not only necessary to track the development progress on a regular basis, but also to consider any potential changes from internal, external economic and regulatory perspectives in a timely manner; revise the product development process accordingly; and reinitiate the product review process when necessary.

Post-sale In-force Management

Upon the insurance policy sold, the focus shifts to in-force management. In-force business management is focusing on business quality while keeping healthy and sustainable growth. Due to the long-term nature of life insurance contracts, especially under International Financial Reporting Standard 17 (IFRS 17), there is a critical need to track and manage the in-force policies. In-force management involves a wide range of tasks, such as policy persistency management, claims management, policy crediting interest rate management for universal life (UL) insurance products, par fund management, reinsurance optimization, capital management, etc.

In the example of Manulife-Sinochem’s practice, there are five things to consider when managing in-force business:

1. Establish an automated process to generate timely reports that assess the risk profile of the in-force business through experience study and trending analysis, including mortality, morbidity, lapse and other policyholder behavior. Identify deviations from actual experience vs. best estimate assumptions, associated with the corresponding financial impacts observed.
2. Identify root causes of deviations and issues, including internal and external factors.
3. Propose feasible action plans to solve issues, perform pros-and-cons analysis and quantify financial impact.
4. Prioritize the work plan with clear roles, responsibilities and key performance indicator (KPI) measures.
5. Hold regular meetings to assess the outcomes and, at the same time, provide feedback to the different parties. If the outcome is not going as expected, then the action plan could be revised to shift to a new plan and start the work all over again.

Solvency and Capital Management

Another essential consideration for life insurance companies in China is maintaining a healthy solvency ratio and ensuring capital adequacy. Maintaining a comfortable solvency ratio is like building a water dam. If the height of the dam is too low, it could easily lead to flooding, and if the dam is built too high, it would waste public resources. Therefore, it is important for insurers to maintain an appropriate level of solvency and set a series of reasonable capital targets.

In setting the target ranges, it is imperative that the regulatory minimum floor is the hard red line that the company must stay above. On top of this, the company could set three targets for the solvency ratio:

1. Lower internal target
2. Upper internal target
3. Aspirational target

These capital targets not only take into account the regulatory requirements but also combine the company’s current solvency position and risk tolerance, providing more comprehensive guidance to the company’s solvency and capital management.

These capital targets are based on the magnitude of changes in a company’s solvency under different adverse scenarios, such as 1-in-10-year and 1-in-2-year risk events (going back to the example of a dam, the height of a dam’s design needs to take into account whether it can withstand a 1-in-x-year flood level on top of the minimum level), to ensure that a company can maintain an adequate level of capital when facing market volatilities and uncertainties.

Those risk buffers can guide the company to maintain a sound solvency position in adverse market conditions. For example, when the company’s actual solvency ratio falls below the internal target, the company would conduct timely monitoring and take immediate actions to bring the company’s solvency level back to within the reasonable range to safeguard the company’s financial position.

On the other hand, if the actual solvency ratio is higher than the aspirational target, the company would also consider whether to reinvest the free surplus or pay dividends to shareholders to optimize resource allocation. In short, by setting solvency targets in advance, the company can have objective, quantitative indicators and a sound mechanism for maintaining a healthy solvency ratio.

Conclusion

Faced with the complex challenges of a volatile external environment and the transformation of the life insurance industry in China, I believe it’s important to be proactive responding to challenges and finding new opportunities in the midst of changing so as to achieve the long-term and sustainable growth.

Statements of fact and opinions expressed herein are those of the individual authors and are not necessarily those of the Society of Actuaries or the respective authors’ employers.

Copyright © 2024 by the Society of Actuaries, Chicago, Illinois.