Fitch Ratings believes the relaxation of rules on mergers and acquisition (M&A) by the Chinese insurance regulator will be a credit positive for China's insurance market. The change is likely to improve the overall market efficiency, especially in the area of capital and cost management, in the long term. The changes will likely offer more benefits to regional non-life insurers and foreign insurers.
The China Insurance Regulatory Commission on 4 April 2014 said it would allow insurers, including foreign insurers, to acquire peers that operate in the same business segment. The new M&A regulation also allowed M&A transactions to be funded through loans, though any loans associated with M&A deals must not exceed 50% of the acquisition price.
When the changes come in effect on 1 June 2014, insurers with solid capital strength will have the option to expand their coverage through M&A activities rather than through organic growth. Currently, insurers are banned from purchasing stakes in more than one peer that competes in the same business field. The ability to acquire peers will provide a faster route for well-capitalized regional insurers to expand their geographical presence.
Ongoing business growth and equity volatility have consistently moderated many Chinese insurers' capitalisation. Many non-life insurers with small operating scale had wider underwriting deficits in 2013 primarily due to keen market competition in the motor insurance business. The average combined ratio of the top three non-life insurers in China rose to 97.8% from 95.4% a year earlier. Fitch expects thinly capitalized insurers with poor financial flexibility to mitigate their solvency strain by merging with larger insurance groups.
While foreign participation in the Chinese insurance market remains small, the new rule will give foreign insurers an alternative to expedite their penetration via M&A transactions. They could acquire some business lines in which they don't have competitive advantage or gain access to some Chinese provinces in which they have limited market profile.
Greater economies-of-scale and wider risk spreading are the key incentives for foreign insurers to take part in M&A deals. That said, Fitch believes expansion through M&A might make better sense for foreign insurers in the non-life sector because foreign companies are currently restricted from owning more than 50% of a domestic life insurer. Foreign insurers only captured about 1.3% of the non-life and 5.6% of the life markets in China in 2013.
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