Interpretations on C-ROSS II

I. Background to the China Risk Oriented Solvency System (C-ROSS) Phase II

The China Banking and Insurance Regulatory Commission (formerly the CIRC) launched the newly designed C-ROSS in March 2012 and formally implemented the system in January 2016 with remarkable results, using the "Three-Pillar" regulatory framework that was well adopted internationally, and with the basic principle of "risk orientation". However, as the internal and external business environment, business model, and risk profile of China's financial and insurance markets continue to evolve, the insurance market and solvency supervision faces new risks and challenges, and C-ROSS needs further adjustment and improvement. Accordingly, CBIRC launched the fine-tuning of C-ROSS in September 2017. Taking into account new requirements and conditions of insurance supervision, the CBIRC comprehensively optimized and upgraded the existing C-ROSS rules, while widely soliciting and incorporating opinions from various parties, and issued the C-ROSS II in December 2021 which will be fully implemented from the first quarter of 2022. C-ROSS II aims to enhance the scientific, effective and comprehensive nature of the solvency supervision system, promote the high-quality development of the insurance industry, drive insurance companies to focus on the main business of protection provided to the community, enhance the ability to serve the real economy, effectively guard against industry risks, and protect the interests of insurance consumers.

II. Changes in C-ROSS II

C-ROSS II matches the three-pillar framework of solvency supervision, and the three pillars are working together to form a comprehensive solvency risk supervisory framework for the insurance industry. Compared with the C-ROSS issued in 2015, C-ROSS II adds new rules on look-through measurement with regards to market risk and credit risk's, capital planning and Lloyd's (China), an increase of number of regulations from 17 to 20.

Figure 1: Three-pillar framework system of solvency supervision

Main changes to C-ROSS II are as follows:

1. Guide the insurance industry in returning to its initial purpose of protection and focusing on its main business

1.1 Strengthen asset-liability matching (ALM) and focus on the main business of insurance

Compared with the current rules, the interest rate risk assessment under C-ROSS II will adopt a 60-day moving average treasury yield curve, which is more sensitive to market changes, and more realistic and quicker to reflect the ALM level. It encourages insurers to further strengthen interest rate risk management by adopting effective ALM, while focusing on the main business of insurance and remaining vigilant of risks on the  asset side.

1.2 Focus on deterioration risks in critical illnesses and return to the origin purpose of protection

In order to monitor financial risks and promote life insurance risk management, C-ROSS II now factors in risk and deterioration trends related to critical illnesses  in order to reasonably reflect the trend of change in critical illness risk.

1.3 Set up regulatory feature factors to support national livelihood insurance products

In order to reflect the regulatory guidance and policy orientation, C-ROSS II adds regulatory feature factors to support the business operations of insurers by giving certain capital discounts to selected insurance products and institutions.

2. More stringent capital recognition standards to prevent and mitigate risks in the insurance industry

2.1 Optimize the methods of including expected future surplus into capital

In order to improve the quality of capital, C-ROSS II optimizes the expected future surplus of long-term life insurance policies to be spilt into core or supplementary capital respectively, according to the remaining terms of the policies, while strengthening the correlation between core solvency adequacy ratios and the real net assets of companies. The difference between core solvency adequacy ratios and comprehensive solvency adequacy ratios of insurers will increase under C-ROSS II, as a result of more emphasis on the loss absorption capacity of core capital.

2.2 Implement the principle of "Complete look-through and look-through to the bottom" and discourage the use of complex structured instruments

Minimum capital measurement standards were improved in order to emphasize the identification of capital investment orientation, highlight the risk of capital use, prevent disorderly expansion of capital, and emphasize adherence to risk orientation. Risk factors were also calibrated according to the data of the past 10 years. When insurers cannot accurately measure assets via a look-through approach, the capital charge will be determined to be the highest factor, resulting in a significant increase in capital use. This is to guide insurers in actively monitoring the risks of underlying assets, for a better risk management practice.

3. Promote the insurance industry to  serve the real economy more efficiently and effectively

3.1 Improve the measurement standards for long-term equity and require insurers' prudence to carry out such investments

C-ROSS II improves the measurement standards for the available capital and minimum capital of long-term equity investments, and significantly increases the risk factors. Long-term equity investments with control, with certain exceptions, will have 100% capital charges to prevent disorderly capital expansion. For long-term equity investments, adequate provision for asset impairment is also required.

3.2 Revise eligibility standards to encourage certain products to reflect national strategies

In order to align with national strategies towards carbon peaking and net-zero, a 10% discount is given to the credit risk factor for green bonds invested by insurers. At the same time, in order to support the innovative and active small and medium-sized insurers and technology insurers, C-ROSS II provides a 10% discount to the insurance risk factor for auto insurance businesses when their last year's premium income is less than RMB 2 billion, and a 10% discount to the insurance risk factor for professional technology insurers. A 10% discount is given to the longevity risk factor to reflect supervisory encouragement to pension insurance products. 

3.3 Increase the capital charges by the real estate industry and focus on the main business of insurance

C-ROSS II tightens the recognition criteria for investment properties to prevent the solvency ratios from being overestimated. Insurers are required to change the admitted assets calculation basis of investments in real estate properties from either cost or fair value basis options to cost basis only. This is in order to urge insurers to focus on their main business of insurance and to stay away from speculations in real estate. Moreover, a transition arrangement is reasonably articulated to assist relevant insurers in realizing a smoother transition on such changes to related minimum capital calculations.

4. Strengthen the insurers' capabilities in risk control

4.1 Clarify the standards for capital planning and enhance capital management

C-ROSS II clarifies the regulatory standards for capital planning and requires insurers to conduct capital planning for the next three years on an annual rolling basis, taking into account the internal and external environment, and to incorporate capital planning into strategic planning, risk management, performance appraisal and profit allocation to improve capital management and efficiency of capital use.

4.2 SARMRA: Deepen risk management and add new control focuses

The Solvency Aligned Risk Management Requirements and Assessment (SARMRA) under C-ROSS II mainly focuses on the regulatory requirements for Class I companies and relaxes the requirements for Class II companies (Class I and II are different groups of insurers based on multiple criteria under C-ROSS II). It adds new control points, raises the requirements on shareholding structure, corporate governance, risk concentration, business risks in entrusted investments and risk data quality management, clearly puts forward the requirements for the construction of related polices and mechanisms on market risk, credit risk, operational risk, and reputation risk, and stresses the basis for strategic objectives and planning. It also changes the scoring methods by introducing industry relative scores to more accurately reflect the distribution of insurer solvency risk management scores within the industry, as well as introduces a variable control risk factor to calculate the minimum capital for control risk (the lower the SARMRA score, the higher the capital requirement for control risk).

4.3 IRR: Focus on the management of legal entities and subdividing rating levels

The Integrated Risk Rating (IRR) under C-ROSS II clearly focuses on the classified supervision of legal entity insurers, and abolishes classified supervision on branches. It also adopts a hierarchical supervision model to assign insurers respectively to CBIRC headquarters as the direct supervisors, and CBIRC's local offices as the local supervisors. At the same time, the assessment is more focused to promote insurers to concentrate on their own strategic risks. C-ROSS II subdivides the supervisory categories of insurers into eight categories, and the IRR ratings of insurers will be more differentiated so that more specific regulatory control measures can be taken. In addition, CBIRC is committed to promoting the use of regulatory technology (RegTech) by gradually incorporating relevant reporting, measurement and scoring into information systems.

4.4 Liquidity risk: Enhance the framework, and clarify management requirements for the industry

According to C-ROSS II, insurers are expected to manage the liquidity risk in a refined, dynamic and timely manner. The enhanced liquidity management framework provides more clarity and transparency with regard to the supervision components. With an increase in types of monitoring indicators, insurers are asked to separately monitor the liquidity risks of property & casualty insurance, life insurance, and re-insurance, with an aim of identifying and responding to potential liquidity risks earlier. 

To implement a national policy of further opening up in the insurance sector, C-ROSS II offers favourable treatment to foreign insurance institutions whose home jurisdiction is with an equivalent solvency system, and additionally improves the measurement of counterparty default risk in reinsurance transactions by reducing the risk factors of counterparty default in certain overseas reinsurance areas. Furthermore, it expands the scope of solvency disclosure by adding items on board and management's statements, risk management capacity, key issues, analysis and discussion of management, external opinions, etc. to provide more transparency on insurers' solvency status and improve market discipline. 

III. What the new rules mean for insurers in practice

Insurers should thoroughly understand these regulatory trends, make dynamic adjustment to the portfolios of products and assets based on their own specific circumstances, and try to turn regulatory constraint into benefit while complying with the regulatory requirements. Insurers are suggested to interpret C-ROSS II in combination with other recently published regulatory rules to bring the business to the next level.

Operation:

1. Interest-rate risk is one sub-risk under the market risk, and it is one of the most prominent risks for life insurers. As a result of the improvements in the measurement method, an insurer can be more acutely aware of the ALM status. Bearing the long maturity and interest sensitivity of liabilities in mind, insurers should adjust the asset portfolios to further improve ALM, and effectively manage interest-rate risks.
2. Insurers should make full use of the supportive measures for health insurance products (particularly pension products) under C-ROSS II, and take advantage of the strong market demand to scientifically and rationally plan for health insurance offerings.
3. Under C-ROSS II, a look-through approach is expected to be used for calculating the minimal capital for all non-underlying assets, with the capital measurement for minimum concentration risk being introduced. Insurers should set up the look-through management mechanism of non-underlying assets in strict compliance with the requirements, improve the quality of capital, avert from investments in complicated structures, and enhance the monitoring of asset concentration for investments, aiming at increasing the capital utilization efficiency and proactively prevent the credit risk. 
4. C-ROSS II puts more emphases on asset risks, and insurers should strengthen the management of significant equity investments, while prudently making long-term equity and real estate investments. 

Management:

1. Insurers should keep strengthening the management of equity structure and corporate governance in accordance with SARMRA under C-ROSS II, make continuous efforts to build up robust systems and mechanisms for risk management, improve the systematic risk management, and strengthen data quality controls. Insurers should closely monitor the company's relative ranking of SARMRA performance within the industry, and act and adapt in time.  
2. Insurers should upgrade the liquidity management framework pursuant to corresponding requirements under C-ROSS II; create supervisory indicators and monitoring indicators as required, according to the business characteristics with well-defined calculation standards to improve the capability of identifying and managing liquidity risks.

In summary, insurers should determine their strategic goals and make strategic plans in line with the requirements of C-ROSS II based on a thorough consideration of factors such as market environment, their own risk appetite, capital position, and capabilities. They should also adjust accordingly against the economic and financial trends and financial policy changes to ensure the sustainable growth of their companies. 

As the first article of a series of interpretations on C-ROSS II, we explore the key points of C-ROSS II and suggest how insurers should respond. In subsequent articles that we are going to release, we shall provide more interpretations and in-depth analysis. We welcome your continued interest.