Perry Granof is an insurance services consultant and managing director of Granof International L.L.C. He also is of counsel with the Williams Kastner Law Firm in Seattle, and has traveled twice to China, where he spoke with Chinese lawyers, underwriters and brokers about insurance issues. Following is an overview of Chinese nonlife insurance from the perspective of the country's regulators, as well as insights on the market, niche insurance products such as directors and officers insurance, and the Chinese economy in general and how it impacts the industry.

The principal regulator for Chinese insurers is the China Insurance Regulatory Commission. The CIRC also operates at a provincial level, where it seeks to enforce regulations, which have a regional impact throughout the Chinese provinces. All rules and regulations for domestic and foreign insurers are identical, but in their implementation, foreign insurers are perceived to be subject to more scrutiny and thus tend to be more careful in complying with local regulators' dictates. Before insurers can offer new insurance products in China, they must be pre-approved by the CIRC. The CIRC also evaluates insurers' applications to open new branches.

According to Ali Chaudhry, managing director-Asia for Jardine Lloyd Thompson Group P.L.C., Chinese property/casualty insurers can be broken down between domestic, and nondomestic companies. The “big three” major Chinese insurers are People's Insurance Co. of China Ltd., Ping An Insurance Group Co., and China Pacific Insurance Co., with a combined 65% market share. Other large Chinese insurers include China Union Holdings Ltd., predominately an auto insurer, China Life P&C Co. and Huatai Insurance Co. of China Ltd., which has a strategic partnership with ACE Ltd., a leading global property/casualty company.

The “top three” non-Chinese insurance carriers are Chartis Inc., Liberty Mutual Group Inc. and Tokio Marine Holdings Inc. However, as of 2011, their combined market share was reported to be 0.4%, part of the nondomestic carriers' 1.34% overall market share. Mitsui Sumitomo Insurance Co. Ltd. (Japanese) and Samsung Fire & Marine Insurance Co. Ltd. (South Korean) are also among the largest non-Chinese insurers. Their respective market shares primarily service their considerable Japanese and Korean investments in China.

The small nondomestic insurance presence is mainly due to the fact that 70% of the country's insurance premiums are derived from selling auto liability coverage, which is estimated to be $50 billion annually. PICC is China's largest car insurer, with about one-third of the market. Up until now, Liberty and Allianz S.E. were part of a small group of non-Chinese companies licensed to underwrite auto insurance, and they were restricted to writing voluntary as opposed to mandatory coverage. However, China is opening up this market to nondomestic carriers, which will certainly expand their share.

%%BREAK%%

For niche products such as directors and officers liability insurance, underwriting premiums constitute a relatively small market share. According to Patrick Zeng, Zurich Insurance Co. Ltd.'s national underwriting manager for financial lines, D&O still is considered to be highly technical coverage. There are few experienced Chinese D&O underwriters. Due to the large proportion of U.S. securities class actions filed against Chinese companies, loss ratios for D&O coverage is high, and Chinese insurance companies are hesitant to write such coverage. To the extent that domestic insurers are looking for a share of the D&O market, they have primarily sought to write excess coverage. Where an insurance tower for a particular insured is small, local markets can and will provide limited capacity. Should larger limits be necessary, offshore support from the United States, the United Kingdom or Europe is required.

Aside from Western-venued shareholder proceedings—and U.S. securities class actions in particular—there are limited Chinese domestic exposures. There are defense-cost exposures for individual criminal proceedings before final judgment. In addition, Article 152 of the 2006 Chinese Company Law provides a statutory basis to assert derivative claims. However, according to Arthur (Xiao) Dong, a senior partner in the law firm of Lantai Partners, derivative litigation is still new in China, and plaintiffs have difficulty accessing company records and data, hampering shareholders' efforts to establish evidence of wrongdoing.

Damages awarded in Chinese derivative cases, have varied from 1 million yuan ($158,100) to 5 million yuan ($790,500). More than 50% of the cases brought are dismissed, often due to the plaintiff's inability to establish causation between the defendant's behavior and the damages suffered by the company. Messrs. Dong and Zeng said liability is more easily established where Chinese regulators or law enforcement agencies penalize a company for financial misrepresentation, tax dodging or other forms of “misconduct.” In these instances, damages awarded typically parallel the amount of penalty assessed and have varied from 10,000 yuan ($1,581) to 300,000 yuan ($47,430). Mr. Dong cautioned that this data only refers to cases involving nonpublicly listed companies. The penalties for publicly listed companies likely would be much larger.

Despite China's economic boom, the country is experiencing inflation and other economic turmoil, such as a lack of liquidity. Under current economic conditions, banks have limited lending money to private businesses, in contrast to state-owned companies, which can effectively guarantee repayment of loans. This is creating a disparity between state-owned companies and private enterprises. As a result, privately held companies have become cash poor and, according to Mr. Zeng, are having a hard time coming up with the cash necessary to pay their insurance premiums.

%%BREAK%%

Perhaps because of China's inflation and liquidity problems, the United States still holds a special cachet for Chinese companies as an investment-banking center. For example, there is status in being U.S.-listed on either the NASDAQ or the NYSE exchanges. However, according to Changchun Yuan, a founding partner with Beijing-based Broad & Bright Law Firm and licensed in both the U.S. and China, tougher U.S. laws, stricter scrutiny and increased class actions may deter Chinese companies interested in investing in the U.S.

Conversely, China's perceived role as the world's manufacturing behemoth may be changing. Chinese asset management companies are looking to acquire manufacturing operations in the U.S. because, at the current exchange rate and the cost of transportation, it is price-competitive to manufacture products in America where one can enjoy the benefit of advertising that the product was “Made in the USA.”

This could potentially change Chinese businesses' perceived need for such insurance products as D&O and related financial lines, including employment practice liability coverage. The demand for EPL coverage likely will increase, with newly placed Chinese managers in U.S. manufacturing facilities who may not have the required age, gender and racial sensitivity when dealing with a U.S. workforce. It also potentially will impact the product liability insurance market, as Chinese manufacturers will be less able to rely on their geographical distance, language limitations and state jurisdictional protections to avoid paying damages for such product liabilities as tainted milk, defective drywall and unsafe baby cribs, which have arisen in the past. It's uncertain whether such products will be underwritten domestically or abroad.

Nevertheless, foreign investors continue to maintain a keen interest in China's domestic insurance industry. This month, the CIRC approved Insurance Australia Group Ltd.'s proposal to purchase a 20% interest in Bohai Property Insurance Co., for 687.5 million yuan ($108.7 million), making IGA Bohai's largest shareholder. In addition, Chartis, Allianz and other insurers are looking to enter the lucrative Chinese auto insurance market and other niches. The Chinese insurance industry certainly appears to be a dynamic and complex environment subject to dramatic changes.

Perry Granof is managing director of Glencoe, Ill.-based Granof International L.L.C., where he provides insurance consulting services. He can be reached at pgranof@granofinternational.com.