Taiwan's Insurance Industry
Nearly 10 million policyholders have been left stranded in Taiwan as foreign insurance companies sell what they can and hit the high road. How can Taiwan patch the fissures in its damaged insurance edifice?
Left StrandedBy Yi-Shan Chen, Hsiang-Yi Chang
From CommonWealth Magazine (vol. 417 )
At 3 p.m. of Friday, Feb. 27, U.K. insurer Prudential plc announced it had entered into an agreement to transfer the assets and liabilities of its agency distribution business and its agency force in Taiwan, PCA Life Assurance (PCA), to China Life Insurance for the nominal sum of NT$1.
"One NT dollar is just one-one million five hundred thousandth of my coverage!" Hontai Life Insurance Co. public relations director Chen Shu-ching, herself a PCA policyholder, shrieked in alarm on first hearing the news of the deal. "So while I'm still paying NT$5,000 every month, they sell me and everyone else out."
Distressed, Baffled, Betrayed
"I only bought from PCA because I initially viewed them as a rock-solid, centuries-old British institution," one 50-something senior executive laments. "I never thought I'd be sold out."
The headquarters of the company that once handled payment of claims in the wake of the sinking of the Titanic sits in the heart of London's old financial district, a stately edifice sitting atop a foundation of ancient castle stones in the midst of the modern age.
Unlike when banks are sold off and dissatisfied clients can simply take their money elsewhere, required at most to wait until time deposits mature, insurance policies are for life. Clients are basically hostages to the insurance companies through old age and even death.
Policies left behind when sales agents have quit or simply disappeared were once known as "orphan policies" in local Taiwanese industry parlance. Companies would take great pains to mollify these clients and "the company" was there to dispatch new service personnel, resulting in no disruption to the client. But now it is the insurance companies themselves that are disappearing.
Nearly 10 Million Policy Orphans
Taiwan is now looking at the greatest wave of newly orphaned policies in its history.
The sale of ING Antai last November impacted about 2.5 million policyholders.
Another roughly 900,000 were affected with PCA's February asset/liability transfer.
Already in the approval stages, AEGON's plans to sell off its Taiwan operations would affect another more than 500,000 policyholders. Furthermore, Nan Shan Life Insurance is looking to sell off a 49-percent stake in its operations, with more than four million policyholders.
If the AEGON and Nan Shan deals reach fruition, nearly 10 million Taiwanese policyholders will be affected in total.
"It's like these foreign companies came to Taiwan to gamble, soaked up a whole lot of Taiwanese premiums, lost, and are just selling us off," one junior executive says candidly. "Insurance begins with people. These foreign companies have not fulfilled their social responsibilities."
But China Life senior vice president Tsai Sung-ching, who was a principal in the PCA transaction, strenuously defends Prudential.
"Time and again, they've increased capital. Prudential has invested enough in Taiwan," Tsai said. "With this once-in-a-century financial meltdown, they really can't bear the load."
At the very least, with a net asset value of NT$5 billion on its books, in selling now for NT$1, Prudential assumes a charge of NT$4,999,999,999.
Only Taiwan for Sale in Asia?
Just as foreign insurers are rationalizing their withdrawal by falling back on the global financial meltdown, international accounting standards, low interest rates and other external factors, looking at the broader international perspective one finds an even more surprising fact – they are pulling out of Taiwan faster than anywhere else in Asia. A purview of media reports since the collapse of Lehman Brothers last September reveals at least seven reports concerning foreign insurers withdrawing from Asia, two of which involved consummated transactions, and both of those were in Taiwan. (See Table)
There is an even more serious problem than the retreat of the foreign insurers.
"After several consecutive years in the red, lower-tier, smaller companies are in even greater peril," says Dr. Jennifer Wang, professor and chairman of National Chengchi University's Department of Risk Management and Insurance. Taiwan's insurance industry is undergoing a process of reverse elimination, with foreign insurers selling off what subsidiaries they can and withdrawing, invariably leaving the lower-tier small players waiting too long to get out.
Taiwan has become the ATM of European insurance companies, a reflection of the decrepit state of Taiwan's insurance market. The patchwork supervisory logic and spotty adherence to international norms created room for insurance companies to play with the regulations, making it easy for them to sell out and leave clients holding the bag. The cumulative effect of 20 years of virulent competition and precipitously declining interest rates has made Taiwan's negative spread issue the worst in Asia.
According to figures from McKinsey & Company, Taiwan, with a population of just 23 million, is Asia's fifth-largest insurance market. Between 2002 and 2007, growth in insurance premiums paid an average of 18 percent annually, comparable to China and second only to India.
Actuary No Longer 'Actual'
With public awareness and willingness to buy insurance so high, Taiwan's insurance market appears to be a goldmine, but it is Asia's least profitable.
"Taiwan's negative spread is the worst in Asia," notes Joe Ngai, a partner with McKinsey & Co. who has conducted extensive research on the insurance industry.
So-called "negative spread" refers to the gap between the rate an insurance company uses to calculate interest on paid-in premiums (i.e. assumed interest rates on policies) and the actual rate of return on investments. Where a policy's assumed interest rate is high, the premiums are low. If the rate of return on investment falls below the assumed rate on policies, the implication is that insurance companies will not earn the money to pay clients, so the government then steps in to demand the insurer increase its capitalization to protect the interests of clients.
A 40-year veteran of the insurance industry, Shin Kong Life president Pan Po-tseng says the seeds of the negative spread issue were actually planted some 20-odd years ago when foreign insurers such as Aetna (now ING Antai) began offering policies with an assumed interest rate of eight percent in an effort to garb market share and Nan Shan went as far as offering 10 percent. It was the first salvo ushering in an era of virulent competition.
Reputable foreign firms became the purveyors of the virulent competition. Highly regarded actuaries colluded in the market madness of Taiwan, signing off on and legitimizing the increasingly higher assumed interest rates.
Taiwanese actuaries did as they were told and altered the policies. As the broader industry got wind of it, the government finally enacted the "Regulations Governing Appointed Actuaries in the Insurance Industry," nearly 60 years after enactment of similar regulations governing accountants, physicians and attorneys.
What's more, prior to 2001, regulatory supervision was loose, with capitalization of only NT$2 billion required, and major shareholders were eager to divvy up profits with no regard for the future.
When it rains, it pours. Taiwanese interest rates began to drive off the cliff in 2000, and the gap between key rates and the assumed interest rate on many policies grew increasingly wide.
"Those companies that did not already have their asset-liability management in order were left with no means to rectify matters," one investment manager with an American insurer says bluntly.
Taiwanese Insurers' Overseas Investments Battered
For the past nine years, Taiwan's central bank has applied a loose monetary policy of low exchange rates and low interest rates, resulting in a flood of capital into Taiwan. But yield on 10-year government bonds quickly fell from six percent to two percent and has yet to recover.
To address the issue of excessively low domestic interest rates, Taiwanese insurers began to invest overseas. McKinsey & Co. research shows that overseas investments account for 34 percent of total investments of Taiwan's top three insurers, twice the figure for the top 10 Japanese insurers and three times that of South Korea's top four insurers.
"Taiwan has a heap of exchange-rate risk and credit risk that other countries do not," Ngai says, which makes Taiwan one of the most deeply wounded nations resulting from the global financial meltdown.
Aggregate hedging costs spent on Taiwan's overseas investments is US$60 billion, greater than the total net worth of Taiwan's entire insurance industry.
Who Would Sell Such Policies?
"Actually, what should be taken more seriously is why the negative spread is so bad, and still there are some companies in Taiwan willing to assume [the liabilities of foreign insurers]," the Taiwan manager of an American investment bank says, taking a different tack.
So is acquiring a company with clear negative spread issues to obtain an infusion of capital in the end good or bad for Taiwan? Are local insurers swallowing a poison pill or an invigorating tonic?
"The pace of transactions in Taiwan is due to claims to compliance with the International Financial Reporting Standards (IFRS) on the part of Singapore, Hong Kong, South Korea and even China, while Taiwan has been slower in that regard," says Chung Tan-tan, an accountant with KPMG Taiwan.
Of greatest impact on the insurance industry is IFRS 4 (International Financial Reporting Standards No. 4), a guidance issued by the International Accounting Standards Board (IASB) to improve public disclosures of insurance contracts. The European Union is formulating even stricter standards to take effect two years hence. While Taiwan's Financial Supervisory Commission initially planned to complete implementation of IFRS 4 in two years, it is now considering further delays. Such regulatory gaps have emboldened local insurers to gamble on the European policies, aiming to grab more market share or even an infusion of capital.
NCCU's Jennifer Wang believes China Life and Fubon Financial are basically in good shape as regards to two pending acquisitions but the Financial Supervisory Commission will be watching closely to ensure lesser companies do not in the future try to acquire a foreign insurer as a means on increasing capital.
This jalopy-style regulation mandating insurers increase capital over the long-term has increased the attractiveness of swallowing the poison pill.
Hontai Life chairman Chou Kao-dun, formerly with the Center for Insurance Industry Development, says while the RBC (risk-based capital) requirements of Taiwanese regulators are American-oriented, several of the latest accounting-related public announcements have been European-oriented, resulting in a conflict of differing systems of logic and creating the volatile fluctuations seen in the net worth of Taiwan's life insurance industry since 2006.
One minute, net worth is up NT$230 billion on the year. Last year, NT$400 billion went up in smoke while the industry as a whole increased capital by NT$150 billion. Farglory Life, Global Life, Sinon Life, Kuo Hua Life and Singfor Life all ended last year with negative net worth.
"With such massive fluctuations in net worth, the layman is unable to discern the good insurers from the bad," says Hontai's Chou. He strongly recommends disconnecting the European-oriented public announcements from the American-oriented RBC requirements. Chou also urges the Financial Supervisory Commission to clarify its regulatory logic in consideration of the state of Taiwan's market and clearly delineate a timetable for bringing Taiwan onto the international track.
Because Taiwan's insurance industry lacks funds, there has been a recent influx of capital into Taiwan's insurance industry backed by mainland Chinese real estate speculators, says one former president of a foreign insurer in Taiwan.
"They're looking to use clients' money to speculate in real estate," he says. "If Taiwan's insurance industry doesn't get its house in order soon, it'll be chaos on top of chaos."
In Search of an Exit Mechanism
But NCCU's Wang believes that with Taiwan's toxic competition, the reduction in the number of competitors through M&A activity is a good thing for the industry. Furthermore, the main impetus for the withdrawal of foreign insurers lies not in Taiwan.
Taiwan should learn a lesson from this incident. When Aetna first entered the market 20-odd years ago, they opted to sell high-risk, high-interest-rate policies to raise their profile, Wang says. Taiwan has expended great effort to attract foreign business, but has been negligent in its regulation. One should not assume well-known foreign concerns will do the right thing.
She strongly urges that the scope of the Insurance Stabilization Fund be expanded so that those insurers on the verge of collapse will have a means to withdraw from the market.
When you buy life insurance, you buy it for life. But the insurers have now fled, leaving nearly 10 million policy orphans. It will be difficult to calculate the social cost of being abandoned like this.
Translated from the Chinese by Brian Kennedy