Update: China Risk Oriented Solvency System (C-ROSS)

Introduction

The Chinese regulator, CIRC, is expecting to finalise the technical standards of China’s second generation solvency regime, C-ROSS, by the end of 2014. It is likely that there will be a transitional period in 2015 before full implementation in 2016.

C-ROSS introduces risk based solvency regulation to the Chinese regulatory framework and has implications both for Lloyd’s Insurance Company China Ltd (Lloyd’s China) and for the Lloyd’s market.

C-ROSS has three pillars (quantitative capital requirements, qualitative regulatory requirements and market discipline) and places emphasis on risk and capital management.  

The move to a more risk sensitive method of calculation is expected to result in the capital requirements of large domestic insurers reducing under C-ROSS as they benefit from solvency releases in respect of motor business. Conversely, medium-sized and smaller domestic insurers are likely to face additional capital requirements as risk factors for non-motor business increase. 

In the third draft of the relevant C-ROSS technical standards applicable to P&C companies released on 18 September 2014, risk factors related to the reinsurance counterparty risk still see unsecured “offshore” reinsurance or retrocession arrangements requiring significant additional capital, over and above similar arrangements with the Chinese domestic reinsurance market. This would affect both Lloyd’s China and the Lloyd’s market.

Lloyd’s China

In response to the C-ROSS requirements, Lloyd’s China is increasing its paid in capital from RMB 220 million to RMB 1 billion [around GBP 100 million] to maintain a solvency ratio in excess of 200%. Onshore reinsurers need to maintain a solvency ratio of at least 200% or local ceding companies will face an additional solvency charge when arranging reinsurance with such reinsurers.

This will also support growth over the next few years. With capital at RMB 1 billion, Lloyd’s China will be able to lead treaties and participate in a proposed new agriculture pool. High offshore unsecured counterparty credit risks also mean that Lloyd’s China is likely to become a more attractive reinsurer for local ceding companies. 

As a wholly owned subsidiary of Lloyd’s, the capital has been provided from Lloyd’s central assets. However, capital requirements above RMB 1 billion will need to be matched by back-to-back funding from participating Lloyd’s syndicates. The mechanism for providing such funding will be agreed with syndicates during 2015.

Lloyd’s China requires capital to support the counterparty credit risk from the reinsurance and retrocession to Lloyd’s syndicates which are treated as related parties for this purpose. Beyond 2015, reinsurance balances will need to be secured to be able to use the lower credit risk of 7.83% set out in the latest draft regulations (representing  a 10% reduction on the 8.7% credit risk factor for international reinsurance where it is to an approved related party). Syndicates are likely to need to provide a letter of credit or another form of guarantee from 2016. Unsecured balances would attract a credit risk of 52.92% (58.8% credit risk for international reinsurance, with a 10% reduction for approved related party arrangements).

Lloyd’s China will also need to enhance its risk management framework, including the participating syndicates’ China SBF.

Lloyd’s market

In 2013 reinsurance premiums placed directly to Lloyd’s syndicates in London and Singapore were in excess of $300 million. Whilst the latest draft regulations reflect a second change to the original factors proposed, the risk factors relating to the counterparty credit risk resulting from the cession of reinsurance to international reinsurers would still significantly increase the capital cost to domestic cedants unless reinsurance balances are secured, with credit risk factors of 8.7% (secured) and 58.8% (unsecured).

Syndicates writing reinsurance business on a cross border basis may therefore be required to provide collateral of some sort from 2016.

Summary

Significant uncertainty remains over the final form of the C-ROSS framework. Further details will be shared as soon as they are available.

The latest changes may be in response to feedback from local market players as well as international concerns and Lloyd’s continues to monitor developments and engage with the CIRC and the wider industry. Further updates will be provided as new information becomes available.