Insurance sub-debt rules may weaken capital base

The capitalization of Chinese insurance groups could weaken following the relaxation of subordinated debt issuance rules for holding companies, as insurers are more likely to fund growth by issuing sub-debt instead of through new equity injections, Fitch Ratings said in a report on Monday.

The lifting of the restrictions on holding company sub-debt could encourage insurance groups to utilize capacity at the holding company level to issue sub-debt, the report said.

"We believe the issuance of sub-debt is not a sustainable solution to improve capital strength because the effective tenure of such debt is typically short — five years or less. Issuers tend to redeem the debt before the actual due date to head off higher interest costs from step-up provisions," said Joyce Huang, director of financial institutions at Fitch.

Furthermore, proceeds from holding companies' sub-debt issuance may flow down to subsidiaries in order to support the operating companies' solvency margins. This is likely to increase double leveraging and expose holding company debt to deeper legal subordination than debt carried at the operating company level, according to the report.

Solvency is under pressure as premium growth, although slowing, continues to outpace internal capital generation.

Allowing insurance holding companies in China to issue sub-debt, subject to a cap of 50 percent of net assets, increases the flexibility in capital management for insurance groups.

The new rule applies to 10 Chinese insurance groups that may benefit from the ability to manage their leverage on a consolidated basis.

China's insurance regulator, the China Insurance Regulatory Commission, issued a new directive easing subordinated debt issuance rules last month as it moves to manage insurance groups' leveraging on a consolidated basis. The regulator had banned such issuances and only allowed operating companies to issue sub-debt as recently as 2011.