OREANDA-NEWS. Fitch Ratings says China's implementation of a second-generation solvency regime - the China Risk-Oriented Solvency System (C-ROSS) - will prompt Chinese insurers' to overhaul their investment strategies, underwriting policies, reinsurance arrangements, and capital management.

The new regime, which will apply granular risk charges based on a more comprehensive assessment of insurers' market, credit and insurance risks, will enhance Chinese insurers' risk awareness. This will prompt them to focus more on risk-adjusted returns when forming their investment strategies and improve their product mixes so that they sell more insurance policies with good profit margins after considering the required capital.

Fitch expects the new regime to drive Chinese life insurers to expand their long-term regular-premium policies. Insurers with long-duration insurance liabilities could benefit from a release of insurance reserves, adding to available capital. This is because the discount rates used to determine the insurance reserves under C-ROSS are linked to market interest rates, which will likely be higher than the rates used under the current regime, which are benchmarked to initial guaranteed returns of the policies (mostly capped at 2.5%).

Chinese non-life insurers with thin capital resources will likely retreat from business lines with weak underwriting results, limited operating scales, and higher capital charges. In contrast to the existing solvency regime, the computation for required capital under the new regime will depend on the lines of business underwritten and the level of catastrophe exposure they face. The C-ROSS applies different capital-risk charges to different insurance lines. Property insurers will face higher capital requirements than motor insurers for the same amount of premiums they underwrite. The operating scale and underwriting profitability of each business line will also be considered in the determination of insurers' capital risk charges.

Fitch expects Chinese insurers to manage their capital positions more dynamically following the changes. This includes issuing more types of capital instruments to strengthen their capital bases, and using non-traditional reinsurance to reduce required capital. This follows the introduction of the concept of "core" and "supplementary" capital in the C-ROSS, and the regulator's release of proposed new regulations in November 2014 that list rules for issuing various capital instruments, such as preferred shares, subordinated and convertible bonds, securitisation of insurance liabilities, and non-traditional reinsurance. Chinese insurers currently rely primarily on subordinated debt and common equity as eligible capital, while some life insurers have engaged in non-traditional reinsurance contracts to improve their capitalisation.

The China Insurance Regulatory Commission promulgated the overall framework of the C-ROSS in May 2013 with the aim of enhancing solvency supervision. The regulator announced on 17 February 2015 the final rules of the new regime. Chinese insurers are now required to calculate their solvency margins under the C-ROSS during the transition period, but still subject to supervision based on existing capital rules until the formal implementation of the C-ROSS.

The new capital regime contains three key facets: capital, risk management and disclosure. Insurers will be required to evaluate their risk management sophistication in terms of operational risk, strategic risk and reputation risk under the C-ROSS framework, in addition to quantitative capital adequacy assessment. Furthermore, insurers will also need to enhance their transparency through greater information disclosure.