By staff reporter Chen Huiyin

After being required to pay a fixed 2.5 percent interest rate on life insurance premiums for nearly a decade, China’s insurers are preparing for regulatory reforms that allow adjustable rates and could lead to more market-oriented flexibility.

The first step toward reforming the state-controlled industry came when the Chinese Insurance Regulatory Commission (CIRC) recently launched a pilot project that lets insurers in Tianjin independently set interest rates for customers with life policies.

CIRC issued guidelines June 20 for the pilot project in the city's Binghai District, an area used for innovative financial projects. The guidelines said rates for complementary life insurance products could be set according to "prudential consideration," and that insurers would no longer be bound by a 1999 rule requiring a 2.5 percent annual interest rate for life premiums.

Also introduced were tax advantages aimed at enhancing the competitiveness of insurance products. For corporate customers, up to 8 percent of insurance spending can be tax-free, and private policy holders can set aside up to 30 percent of their salaries for insurance.

An insurance sector analyst said privatizing insurance rates and tax policies are integral parts of the Tianjin project.

The pilot harks back to the industry's pre-1999 era when insurance companies were allowed to price products as they saw fit, and before regulators began closely monitoring life policies.

Industry leaders China Life, Ping An, and Pacific Insurance sold large numbers of insurance policies that paid high interest rates through the 1990s. After the central bank lowered interest rates, however, insurers posted huge losses because investment returns could not match policy costs. To help companies balance the books, regulators fixed the rate at 2.5 percent.

Over time, the biggest companies reduced financial pressure by selling assets, issuing stock and introducing strategic investments. Annual returns on investments hovered around 3 percent from 2000 to ’04, coinciding with more relaxed macroeconomic controls, and the 2.5 percent rate seemed right.

But when central bank interest rates started climbing in 2004, insurance investment returns increased measurably, and the 2.5 percent rate became too low to attract life insurance customers, hindering the industry.

Since then, whenever the central bank increased interest rates, calls for liberalizing the life insurance industry grew louder.

Zhou Guang, an analyst with China Investment Corp., recently recommended raising insurance rates "for the development of the sector and protecting consumers. But meanwhile, any increase is likely to raise operational risks and detriment competition. In the end, it may come back to haunt consumers. Insurance rate pricing is a complicated matter and should be a compromise between regulators, and large and small insurers."

Now, with liberalization on the horizon, competition is heating up. Several insurers are seeking CIRC approval for new life products.

Shang Jingguo, a CIRC life insurance supervision officer, told Caijing that the changes involve "more than liberating the insurance rate. It is also required that life insurance companies systematically transform their business operations."

Eventually, industry regulation could be reformed to let insurance companies determine all price, risk control, services and management decisions, said Shang.

Looming competition from other financial institutions is encouraging the changes. Soon, insurance companies will face competition from other financial products as well as industry rivals.

"Allowing regulators to price products does not help them cultivate a sense of the market," Shang said. Thus, the long term goal of privatization would not change.

With 11 million residents and a per capita GDP topping US＄ 6,000, Tianjin is a challenging field for an insurance business trial. It represents 2 percent of the nation’s insurance market. One actuary told Caijing, Considering the relatively small scope of the (Tianjin) market, the earlier a product is launched, the better its chance to attract clients.

Meanwhile, CIRC this year asked all insurance companies to regularly evaluate their ability to pay client policies now and over the next three years. The move is part of the regulatory shift that includes the Tianjin project.

"Our supervision focus in the past was on insurance rate supervision," Shang said. "But now weíve switched our focus to ensuring payment ability."

1 yuan = 14 U.S. cents