A captive insurance company is an insurance company affiliated with an enterprise group that directly underwrites or reinsures the risks of its parent company and member enterprises. Today, captive insurers have become an important risk management tool for large multinational corporations worldwide. Although the capital strength of Chinese enterprises has gradually grown—mainland companies took more than 70 spots on the 2012 Fortune Global 500 list—China previously had no professional captive insurer. The emergence of the first captive insurer will therefore have a far-reaching impact on the improvement of Chinese enterprises' risk management capabilities, the diversification of insurance market players and the specialization of underwriting.
"Karamay" is the transliteration of the Uyghur word for "black oil." As an oil industry city that grew up on the Gobi desert, oil earned it the title of the western holy land of China's petroleum industry; little known is that oil also created a "Karamay speed" in the financial sector.
—On April 22, 2009, China National Petroleum Corporation announced that it had received formal approval from the State Council, SASAC and the CBRC to take a stake in Karamay City Commercial Bank. In just over three months, Karamay City Commercial Bank completed its capital increase and share expansion, creating the "Karamay speed" of capital expansion among city commercial banks. The bank was officially renamed Bank of Kunlun in 2010, registered in Karamay, with branches in major cities and oil-and-gas producing areas across the country.
Today, another gap in the financial sector is about to be filled in Karamay. On October 10 this year, the CIRC website announced its approval for China National Petroleum Corporation and PetroChina Company Limited to jointly initiate preparations for CNPC Captive Property Insurance Co., Ltd.—China's first captive insurer will be located in Karamay.
The Puzzle of Locating Onshore
News of CNPC's establishment of a captive insurer had been frequently confirmed in various unofficial settings, and an announcement issued by CNPC in January this year confirmed its reliability. The announcement stated in detail that the captive property insurer would be funded RMB 2.55 billion by China National Petroleum Corporation for a 51% stake and RMB 2.45 billion by PetroChina Company Limited for a 49% stake; Zhou Mingchun, chief financial officer of PetroChina Company Limited, would serve as chairman, and Pan Guochao, current chairman of Generali China Insurance, would serve as general manager.
A professional captive insurance company is an insurance company owned or controlled by a non-insurance enterprise that mainly underwrites the group's internal risks. In fact, corporate self-insurance is nothing new internationally and has become an important risk management tool for large companies around the world. Data show that there are now more than 5,000 professional captive insurers globally, with annual premiums exceeding US$50 billion, concentrated in Europe and the United States. Nearly 90% of the U.S. Fortune 500 companies own captive insurers. Chinese enterprises, by contrast, have lagged far behind in establishing captives: in August 2000, China National Offshore Oil Corporation established a captive insurer in Hong Kong—CNOOC Insurance Limited.
Unlike the CNOOC captive, which chose to register in Hong Kong, CNPC located its captive's registered domicile in Karamay, a choice questioned by many in the industry. In principle, a captive insurer can be registered in any country or region in the world, but captives are generally concentrated in jurisdictions with looser regulation and lower tax rates, where the captive business has developed for longer and strategies can be adjusted promptly in response to market changes to maintain advantages. Singapore, for example, stipulates that a captive's offshore insurance business is taxed at only 10%, while onshore insurance business is taxed at 24.5%; ordinary commercial insurers pay 24.5% on both onshore and offshore business. To attract captive registrations, Hong Kong has similar preferential policies.
Given CNPC's strength, outsiders unanimously believed there would be no obstacle to registering its captive overseas, so the choice of Karamay was puzzling: "Judging from financial regulation and tax incentives, it is unlikely that a captive would be set up in Karamay. If it is merely a pilot, the scope of services is too small"; "If the explanation is promoting local economic development, since a captive does not do business with the public, its establishment will not boost local GDP at all." Nevertheless, Karamay—a city bound up with oil—has once again relied on oil to fill the gap of having no captive insurer onshore.
High Risks Urgently Need Diversification
Wherever the registered domicile is chosen, it demonstrates oil companies' strong enthusiasm for professional captives. Why is that? CNPC's announcement elaborated on the reasons for establishing a captive: because the oil industry is high-risk and highly specialized, ordinary commercial insurance currently cannot cover all of the company's business areas. In addition, establishing a captive can meet the risk management needs of high-risk and overseas projects, reasonably transfer operating risks, balance commercial insurance spending, improve risk response capabilities, and ensure the effectiveness of claim payments after losses occur.
It is understood that most large domestic enterprises currently manage risk through a combination of three approaches: risk retention, corporate self-insurance and commercial insurance. Corporate self-insurance mostly takes the form of self-insurance funds, such as Sinopec's work safety guarantee fund and China Post's postal value insurance.
"Compared with a self-insurance fund, a professional captive insurer underwrites various businesses of multiple enterprises within the group, so the scope of risk diversification is wider. At the same time, a captive insurer has a scientific insurance company operating mechanism; it is an independent legal entity whose operating model is not much different from that of an ordinary insurance company," said Tuo Guozhu, professor at the School of Finance of Capital University of Economics and Business.
In fact, for an enterprise—especially a multinational group—the captive insurer plays a very important role in its global risk management. When a multinational corporation with projects in different countries and regions arranges insurance for those projects, it is subject to the insurance regulations and legal provisions of various countries. A captive insurer, by contrast, can legitimately participate in the risk management of its investment projects and understand their risk transfer strategies and project operation information.
Tuo Guozhu also said that, for enterprises, the biggest benefit of a professional captive insurer is keeping the profits in-house. "A principal rule for commercial insurers to make profits is that premium income must exceed all costs. With self-insurance, both premium income and final profits stay within the group."
Profits are reflected not only in premiums remaining within the group but also in relatively lower costs. It is learned that traditional insurance premiums consist of pure premiums and loading premiums, a large part of which covers the insurer's business development and operating expenses. For a captive's parent company, the premiums paid to the captive do not include profit loading, marketing expenses or management fees—in other words, captive premiums are basically calculated at the pure rate, which can greatly save insurance costs.
The Market Remains to Be Tapped
The seemingly perfect model of corporate self-insurance has never taken hold among Chinese enterprises, which shows from the side that, for parent companies, captives are not as perfect as they appear. The RMB 5 billion registered capital of the CNPC captive alone deters many enterprises. Large amounts of capital and high operating costs are only the surface; behind them lies the need for substantial business volume to support the captive, and given the limited scale of Chinese enterprises, not many can meet the requirement. Without business volume to support it, developing a captive insurer would be unprofitable.
From the perspective of risk diversification, a captive insurer is no "superman" able to spread the risks of all kinds of enterprise businesses. Tuo Guozhu believes that a captive insurer's risk-bearing capacity is not necessarily stronger than that of commercial insurers. In addition, the current market environment is not conducive to captive development: there are no laws or regulations on captive insurers, tax policies are unclear, and regulatory responsibilities are ill-defined—all factors that will affect the development of captive insurers.
Compared with the development of captive insurers themselves, their impact on the entire insurance market has also drawn considerable attention. Many speculate that once it becomes a trend for large companies to set up captives, insurers' premium income will inevitably be affected. Shao Yunzhou, deputy general manager of the liability insurance department of PICC P&C, is not worried about captives impacting the existing market. He believes that, judging by the current depth and density of China's insurance market, the market still has huge potential. "In the future there will certainly be more and more players in this market. The emergence of captive insurers enriches the forms of insurance and adapts to various insurance needs—this is a sign that the whole market is becoming more professional and mature."
In addition, according to Shao Yunzhou, a captive insurer does not underwrite all of its parent company's insurance business; only products with captive characteristics—such as those with stable loss patterns and loss frequencies—fall within the scope of captive business.
Earlier, CNPC's announcement showed that its captive would mainly engage in property loss insurance, liability insurance, credit insurance, surety insurance, short-term health insurance and accident insurance for the CNPC group. How China's first onshore captive insurer will actually insure itself will soon be revealed.
Source: Financial Times November 14, 2012