Although establishing a captive insurer can expand coverage, increase underwriting flexibility, save premium expenses and reduce insurance costs, strengthen risk control, centralize insurance management, improve corporate cash flow and enhance capital utilization—and has become the common choice of 80% of Fortune Global 500 companies—the captive insurance market in China is still in its infancy. Domestically there are only two institutions, CNPC Captive Property Insurance Co., Ltd. and China Railway Captive Insurance, while offshore there are only a handful of captive insurers established in Hong Kong, such as the CNOOC captive, the Sinopec captive and the CGN captive.
In 2013, the CIRC issued the Notice on Issues Concerning the Regulation of Captive Insurance Companies, setting out more relaxed regulatory policies than those applied to ordinary commercial insurance companies. It made clear that captive insurers may conduct insurance business nationwide for their parent companies and the parents' controlled subsidiaries without establishing branch offices; allowed them to establish wholly-owned insurance subsidiaries and insurance asset management companies overseas related to the captive's business; exempted them from depositing capital guarantee funds and paying into the insurance security fund; relaxed the requirements on the number of directors and supervisors and the setup of certain management positions; and simplified reporting conditions and procedures.
However, the particularity of captive insurers' service targets and business scope objectively determines that they differ from traditional insurance companies in business operations and operating models, and China's current regulatory approach, which differentiates little, has to some extent constrained the development of the captive market.
First, the threshold for establishing a captive insurer is high. Under the establishment conditions stipulated in the Notice on Issues Concerning the Regulation of Captive Insurance Companies, an enterprise must possess a certain scale and capital to ensure that the captive insurer has sufficient capacity to bear risk-related losses. Although China has a number of large enterprise groups such as CNPC, not many enterprises meet the requirements. By contrast, the minimum registered capital requirement for an offshore captive insurance company in the United States is only US$200,000, and in Singapore only S$400,000.
Second, there is a lack of supporting policies and a favorable external development environment. Apart from the above notice, the definition of insurance market participants in all of China's insurance laws and regulations does not include the category of "captive insurance companies," and none of the current insurance laws, regulations and systems contains clear regulatory provisions on captive business. There are no matching laws, regulations or supporting policies, and captives enjoy no preferential tax treatment.
Third, regulatory policies have not achieved meaningful differentiation. Developed countries generally have dedicated laws, or dedicated provisions in their insurance laws, to supervise the operations of captive insurers, whereas China's regulation applies the same policies as for commercial insurance. Among these, China's Provisions on the Administration of Reinsurance Business state that "the sum insured or limit of liability ceded under any single facultative reinsurance contract to an affiliated enterprise of the policyholder may not exceed 20% of the sum insured or limit of liability of the direct insurance business," which limits the business scale and development of captive insurers. The commercial property insurance market has weak underwriting appetite and limited capacity for large, high-risk subjects, forcing many transactions to breach underwriting capacity limits, which conflicts with the Insurance Law requirement that business "may not exceed 10% of the insurer's actual capital plus capital reserve, with the excess to be reinsured"—this in turn constrains captive insurers in conducting reinsurance and cession business. The Insurance Law also provides that "an insurance company shall have a sound organizational structure and management system," requiring captive insurers to establish internal departments for underwriting, reinsurance, claims and so on, which increases operating costs.
Besides the fact that regulatory policies and approaches to some extent restrict the establishment of captive insurers, the underwriting capacity of China's reinsurance market is another problem facing China's captive insurers.
After all, although captive insurers have many advantages, their disadvantages are also obvious—a small business scale means risks cannot be effectively spread through the law of large numbers, and enterprises lack in-house risk management talent, making effective risk assessment difficult. These inherent weaknesses determine that the survival and development of captive insurers must rely on cooperation with, and supplementation by, the reinsurance market. A large number of captive insurers worldwide choose to register in places with strong reinsurance underwriting capacity.
Specifically, establishing and operating a captive insurer is a complex process involving many insurance-related areas such as actuarial science, accounting, taxation and regulatory rules, with which the enterprises establishing captives are often unfamiliar and in which they lack talent. When underwriting business, a captive insurer should assess and select risks, transferring risks that are small in volume and lack loss records directly to commercial insurers; for risks with potentially severe losses, it may cede the portion exceeding its own solvency to commercial insurers or reinsurers, so as to effectively control risk and expand underwriting capacity.
However, although China's reinsurance market has developed considerably in recent years, its underwriting capacity still cannot meet the needs of the primary insurance market, and a large volume of ceded premiums flows overseas. Therefore, raising the underwriting capacity of the domestic reinsurance market is one of the keys to the common development of the reinsurance and captive markets, and the key to raising reinsurance capacity lies in cultivating reinsurance market entities and optimizing the structure of the reinsurance market.
It should be noted that the development experience of foreign captive insurers shows that the establishment of captives will, in the long run, gradually impact commercial insurance companies.
In primary insurance business, because the business retained by captive insurers tends to be high-quality risks with few claims, while the business ceded out tends to be the more uncertain risks, commercial insurers lose quality business; and as captive insurers grow stronger, they will gradually accept higher risks and expand the scope of insured subjects, creating a greater impact. In reinsurance business, because captive insurers can participate in the reinsurance market and spread risks exceeding their own capacity through it, commercial insurers' influence on the reinsurance market is reduced and their reinsurance business is affected. In terms of the insurance cycle, during the depressed stage the supply capacity of commercial insurance is severely insufficient, so captive insurers tend to emerge in large numbers; while increasing insurance market supply, they also reduce demand for commercial insurance, thereby lengthening the depressed stage of the cycle and negatively affecting the operation of commercial insurers.
Responding to the impact through cooperation and seeking new market opportunities in the process is the basic strategy for commercial property insurers facing the rise of captives. According to foreign experience, in the early stage of captive development, tax benefits are the main objective of captive insurers; at that stage, although commercial insurers lose premium income, cooperation with captives leaves their business quality largely unchanged, and they participate in captive business through intermediary cooperation and primary insurance cooperation based on reciprocal exchange. As captive insurers continue to develop and return to the essence of insurance, commercial insurers' business begins to be materially affected, leading to the development of two cooperation models—reinsurance cooperation and insurance pool cooperation—to cope with the impact.
In light of the current development of China's commercial property insurers, cooperation can be carried out at both the business and management levels: business cooperation mainly covers database building, reinsurance business and innovative policy-issuance models, while management cooperation mainly involves participating in the operation and management of captive insurers through the establishment of captive management companies.