Moody’s probes solvency regime transparency in China and Japan

Analysis of the solvency regimes in China and Japan suggests that both countries will benefit from developments that make them more transparent, a report from Moody’s has said.

In the report, which compared the two Asian countries solvency practices to the European Solvency II regime, researchers examined key differences and how the systems could evolve.

Currently, China's Risk Oriented Solvency System (C-ROSS) has structural similarities to Solvency II but has different disclosure standards and capital charges.

While Japan’s economic solvency ratio (ESR) references Solvency II and Insurance Capital Standard (ICS), implementing them remains voluntary, so insurers decide which ESR metrics they will disclose. This results in variability between insurers.

Frank Yuen, Moody's vice president and senior analyst, said that while C-ROSS has similarities with Solvency II, it was designed “to better fit the development stage of the country's insurance industry and the still developing state of its financial markets”.

But he added: “The upcoming C-ROSS Phase II, however, will introduce more stringent capital requirements and improve transparency on asset risks.”

The report said that the C-ROSS upgrade will “improve asset transparency but some bottlenecks will remain”.

Analysts said that the China Banking and Insurance Regulatory Commission (CBIRC) has indicated it would expand ‘look-through’ analysis to most asset classes and tighten treatment on investments in affiliates in C-ROSS phase II, which will be finalised in 2020. This could address concerns around lower capital requirements for equity and credit risks and “narrow the gaps between C-ROSS and Solvency II”.

“The industry’s capital quality would benefit from better asset transparency as a result,” the report said. “Nevertheless, some differences between C-ROSS and Solvency II will persist because C-ROSS reflects more the fundamental needs and characteristics of China’s insurance markets, including its less-developed financial markets and the relatively short track record of risk-management capabilities in the industry.”

In comparison, “Japan's ESR practices are driven largely by the enterprise risk management,” explained Soichiro Makimoto, a vice president and senior analyst at Moody’s. “They are broadly similar to Solvency II practices in terms of quantitative approach in that both practices are in line with global trends in economic capital modeling.

“Japanese ESR practices make frequent references to Solvency II and the risk-based global ICS.”

The reported said the growing introduction and disclosure of capital management with the ESR by major insurers over the past decade has “improved the industry’s risk profile transparency”.

“More importantly, it also correlates with the industry’s major efforts to address its vulnerabilities,” the report said.

However, as ESR practices are driven by insurers on a voluntary basis, there is wide variability among insurers regarding their disclosure of economic metrics. The report said insurers could raise credibility by improving the transparency and explanation of the process.

Efforts have focused on interest rate risks, equity risks and natural catastrophe risks, which have been evident in the past decade. However, the report said, one consequence of the ESR is that it is “very sensitive to interest-rate movements”. This is particularly the case for the life insurance business, “as reflected in the sharp declines in reported ESRs at the end of March 2016 just after the implementation of the NIRP (negative interest rates policy) in February 2016”.

The report said that this raises the risk that the resulting short-term volatility in ESR metrics could “distract insurers’ long-term strategies and business activities” if pressure comes from external parties such as debt and equity investors, bank lenders and policyholders. External stakeholders may “have difficulty” understanding the economic metric in conjunction with voluntary ESR practices.

“Therefore, improving stakeholder management by enhancing voluntary ESR disclosures is a key to ensuring sound capital management,” the report said.

“Insurers will continue to compute ESR figures at their discretion, at least until the potential new capital regime is determined. However, these insurers could gain credibility by improving transparency and explanation of the process. Such a move will also facilitate appropriate oversight by the external stakeholders and strengthen market discipline.”

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