Fitch Ratings-Sydney/Hong Kong-06 August 2013: The removal of the interest rate cap on some guaranteed life products is likely to increase product diversity in the Chinese life insurance market, Fitch Ratings says. If insurers can offer new products that are more attractive than the dominant "with-profit" policies, this could help to boost the penetration of risk protection, retirement and healthcare products amid an aging population.

We expect insurers to include more risk-protection elements in their non-participating products, now that they are no longer subject to a 2.5% cap on guaranteed rates. Protection features and better guaranteed rates could make the products more attractive to customers.

This could help ease market competition, which has been concentrated on very similar products, as most policies are savings-oriented with relatively low protection coverage. More variety could help insurers differentiate their products from bank deposits and other wealth-management offerings, and limit direct competition with banks.

Chinese life insurers will need to develop a more professional and productive agency network to sell the more complicated policies, as the popular bancassurance channel is unlikely to be suitable for policies with risk-protection features. We believe that large life insurers have an advantage over small companies in promoting these products, in light of their relatively strong agency base.

Product innovation should contribute to the shift in product mix already underway. Chinese life insurers are increasingly placing more emphasis on margin improvement than on market share. Efforts to boost more profitable regular-premium policies have contributed to the growth in the value of in-force business. This should continue, especially if greater flexibility with pricing can generate regular-premium non-participating products that gain traction with customers.

However, participating products dominate the Chinese life insurance market because customers can often obtain higher returns from sharing profit on the investment performance. This preference may not change significantly even though non-participating products can now offer guaranteed rates above 2.5% while with-profits policies are still subject to the cap.

To prevent excessive competition, the China Insurance Regulatory Commission introduced a 3.5% cap for the discount rate used for determining statutory insurance reserves - the amount of assets that firms must hold for future insurance claims. An insurer that sets a guaranteed rate above the discount rate cap could be more vulnerable to a reserve deficiency, so it is unlikely that many insurers will offer rates substantially higher. The guaranteed rate on non-participating policies could still be less attractive compared with with-profits products.