The China Insurance Regulatory Commission (CIRC) is instituting sweeping changes through its three-tiered China Risk Oriented Solvency System (C-ROSS) framework that will dramatically impact how (re)insurers conduct business. It will strengthen capital requirements, risk management and transparency disclosures - bringing China in line with, and in some cases overtaking, global standards. The C-ROSS framework is similar to Solvency II: three tiers focusing on quantitative, qualitative and disclosure requirements.
The C-ROSS framework was developed rapidly and implementation timing is aggressive. Before C-ROSS, capital requirements were based only on premium levels and recent loss experience. The CIRC researched various solvency standards and in May 2013 published a paper explaining the conceptual framework for C-ROSS.
Industry testing started in 2014 with the aim to evaluate the reasonableness and practicability of the C-ROSS formula. The most updated version of C-ROSS was published on February 13, 2015, and the transition period of the solvency system with respect to meeting the capital requirements commenced. In the transition period, (re)insurers will run Solvency I and C-ROSS in parallel and report the results under the two solvency systems to the CIRC. Full implementation of C-ROSS is anticipated in January of 2016. Less than three years from concept to full implementation: celerity of which European Insurance and Occupational Pension Authority officials can only dream, but time will tell if C-ROSS is ready for the market, and vice versa.
Pillar 1 will include various risk factors applied to premium, reserve and catastrophe risk based on lines of business. A table comparing the premium and reserve risk factors for C-ROSS and Solvency II is below.
Credit risk charges are also included in the analysis, which will significantly impact reinsurance cessions and how international reinsurers conduct business in China. For example, cedents who use offshore reinsurers are penalized with credit risk factors ranging from 8.7 percent to 86.7 percent depending on reinsurer approval in domiciled countries and collateral positions. By contrast, cessions to onshore reinsurers are 0.5 percent to 4.7 percent when reinsurers meet a greater than 100 percent solvency ratio threshold. Collateral is recognized to offset some of the risk charge applied to cessions to foreign reinsurers. Retrocession business to offshore reinsurers is less punitive, with risk factors on recoverables from reinsurers rated AAA to BBB- ranging from 0.5 percent to 11.5 percent, respectively.
The large risk charge discrepancy is anticipated to increase cessions to onshore reinsurers at a cost to foreign carriers. Recent discussions have indicated various approaches by international reinsurers, including establishing a domestic capitalized branch, writing through the local Lloyd’s operation or writing retrocession to access China-based exposures. It is anticipated that the CIRC will recognize funds withheld and letters of credit as collateral for reinsurance purposes.
The CIRC has also announced a system for tracking and approving reinsurance companies writing business in China. The Reinsurance Registration System (RRS) is anticipated to launch in January 2016 to coincide with C-ROSS. Domestic and international reinsurers and brokers will be required to register in the RRS.
Cedents must select companies that are approved on the RRS or potentially face penalties from the CIRC. Brokers and reinsurers that are not compliant from a truthfulness or timeliness standpoint will be barred from the RRS for a number of years.
RRS applicants must be recommended by a China-based affiliate, cedent or broker as well as meet various solvency and rating requirements. The registration is valid for three years, after which the reinsurer must renew its application.
C-ROSS anticipated areas of impact:
- Larger, multiline insurers may experience better outcomes based on receiving a diversification benefit.
- Small, monoline or thinly capitalized companies may need to raise capital or consider strategic alternatives.
- All companies will likely feel pressure to upgrade enterprise risk management capabilities.
- Increased consolidation is likely.
- Potential created for new, low-cost providers due to lower capital charges on certain lines.
- C-ROSS creates a protected market for domestic reinsurers, including Lloyd’s and global reinsurance groups that have domestic operations. This may contribute to increased volatility in reinsurance and retrocession pricing.