Chapter 5

The Competitive Environment of Hong Kong Insurance Industry

5.1 Michael Porter's Model of Competitive Force

A successful competitive strategy cannot be formulated if a firm's

environment has not been referred. A firm's environment may be defined as an

industry or industries in which the firm competes. Industry structure has a

strong influence to a firm while in deciding which competitive strategy should

be used. The intensity and nature of competition is different from one industry

to another.

In order to analysis the state of competition in an industry, Michael

Porter developed a five forces model of competition that identifying the key

structural features of industries that determine the strength of the competitive

forces and hence industry profitability.

The goal of competitive strategy for a business unit in an industry is

to find position in the industry where the company can best defend itself

against these forces or can influence them in its favor.

A n understanding of the five competitive forces - threat of new

entrants, bargaining power of buyers, bargaining power of suppliers, threat of

substitution and rivalry among existing competitors highlights the critical

strengths and weaknesses of the companyanimates the positioning of the

company in its industry, clarifies the areas where strategic changes may yield

the greatest payoffand highlights the places where industry trends promise to

hold the greatest significance as either opportunities or threats.

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 A l l five competitive forces jointly determine the intensity of

industry competition and profitability and the strongest force or forces are

governing and become crucial from the point of view of strategy formulation.

Porter's five forces model of competition

Existing Rivals
(Competing on
price & service)

Pressure from Threat of Pressure from

Supplier New Entrants Buyers
(Reinsurers) (Direct Insurance) (better service)

Pressure from
substitution
(Captive Ins.)

In order to identifying the competitive environment of Hong Kong

insurance industry, Michael Porter's five forces model of competition is used

for this structural analysis.

52 Threat of New Entrants

New comers to an industry bring new capacity, the desire to gain

market shareand often-substantial resources. Prices can be bid down or costs

inflated as a result, reducing profitability.

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 The threat of entry into insurance industry is high, as the barriers of

entry are low.

Capital Requirements

Any person wishing to carry on insurance business in Hong Kong

needs to comply with certain minimum requirements as prescribed in Section

8 of the Insurance Companies Ordinance. One of the requirements that will

affect an investor's consideration in the amount of capital investment is

Solvency Margin. Solvency requirement requests an insurer maintaining an

excess of assets over liabilities of not less than a specified solvency margin.

The minimum amount of solvency margin is HK$10 million and HK$20

milliondepending on whether a general insurer carries on compulsory

insurance or not. Life insurers are required to maintain a minimum solvency

margin of HK$2 million.

In addition to the statutory requirement on capital investment, set up

cost is depending on the size of the company to be established. Life insurers

may need to invest heavily in advertising and recruiting full time agents so as

to build up its image and penetrate into the market.

In recent yearsnew comers to the industry are international firms or

those with very strong financial background; they have sufficient financial

resources to enter into the Hong Kong insurance marketthe extent to which

capital requirements create entry barriers to new entrants is therefore

insignificant.

Access to distribution channels

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 In Hong Kong, insurance intermediary is the major channel for an

insurer to sell its products. Under the Insurance Companies (Amendment

No.3) Ordinancea person who wants to act as an insurance agent must be

appointed by an insurer and registered. The number of insurers to be

represented by an insurance agent at anyone time is limited to four. Most of

the agents in the market place have completed their registration with

maximum number of representation. Existing insurers strengthen the

relationships with the existing channels by providing attractive commission

terms and high quality service. Insurers like Bank of China Group Insurance

and Asia Insurance have built up their exclusive distribution channels through

parent company's banking networks.

New entrants may find it difficult to market its products by using the

existing channels. In order to secure distribution for its productsnew entrants

need to establish its sales force that may involve substantial investment, in

particular for life insurers. Thereforeto certain extent access to distribution

channel can create barrier to entry.

Product Differentiation

No matter general insurance or life insurance product

differentiation has little effects on creating entry barriers. Traditional general

insurance products like fire insurance, motor insurance and travel insurance,

life insurance products like whole life and endowmentthe insurance cover

protection and benefits are similar. Even some insurers try to design new

productsit can easily be copied by competitors in very short time.

Cost disadvantages independent of scale

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 New entrants with the experience of its own countries may not be

applicable to the Hong Kong market. Existing insurers possess of abundant

experience in underwriting and claims handling can accurately assess the risks

to be accepted and predict the trend of claims payment. Insurers writing motor

insurance and employees compensation insurance in Hong Kong, past

experience is of significant importance. New entrants do not have such

experience in the market may have to pay the premiumsometimes it is

painfulthat leads them to a cost disadvantage position.

Government Policy

Government policy has always been the major source of entry

barriers. Government can limit or even foreclose entry into industries with

such controls as licensing requirements and limits on access to raw materials.

The Chief Executive pledged in his 1997 Policy Address that under

the "One CountryTwo Systems" principle, the Government of Hong Kong

Special Administrative Region would endeavor to further develop Hong Kong

as a major international financial center with a world class supervisory regime

and a business-friendly environment.

The Insurance Company Ordinance provides the regulatory

framework for insurers operating in Hong Kong. Any person wishing to carry

on insurance business in or from Hong Kong is required to comply with

certain regulations. They include Authorization, Solvency Requirement

Fitness and Propemess of Management, Maintenance of Assets in Hong Kong,

Statutory Valuation Basis for Assets and Liabilities, Submission of Financial

Information and Intervention. The objective is to inspire public confidence in

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the insurance industry and to maintain Hong Kong as an international financial

center. Government policy in the sense of creating entry barriers for new

entrants is not prominent.

53 Intensity of Rivalry among Existing Insurers

The competition among insurers in Hong Kong is severe. The

reasons are:

Firstlybeing one the most important insurance centers in the world,

there have long been more than two hundred insurers from all over the world

competing in the market place (Appendix 1).

Year General Life Insurer Composite Total

Insurer Insurer
1993 170 40 19 229
1994 169 41 19 229
1995 161 42 20 223
1996 158 46 15 223
1997 151 45 19 215

Leading insurers in the world already set up its offices here, not

only because they have interest in Hong Kong marketbut also they have

perceived the huge potential of China market. NaturallyHong Kong is the

most important base for them to well prepare for entering the China market.

Out of the two hundred insurers, more than one hundred and fifty

are general insurers. Though general insurers are numerous, only fifty percent

of them are active in the market. The top twenty insurers dominate the market

with more than sixty percent market share. As they all have strong financial

support and large capacitythey are able to sustain price competition for a long

period of time.

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 Secondly, following the open door policy of China, manufacturers

moving their factories to the north so as to benefit from comparative

advantages. Hong Kong economy has been changed from manufacturing

industry to servicing industry. From insurance point of view, manufacturing

industry is more hazardous than servicing industry and therefore higher

premium will be charged. As a result of the transition of Hong Kong economy

the gross premium derived from manufacturing industry had shrunk in recent

years. The booming of general insurance market of the 1980s is past. As

general insurance market matures its growth rate declines (Appendix 2).

General insurance business experienced a decline in premium in 1996 for the

first time in the past five years. Total gross premium dropped by 7% to $18.7

billion as a result of keen competition among insurers.

Unlike general insurance business, though market competition is

fiercelife insurance business is still attractive. In terms of office premiums

and number of policies, life insurance business recorded two-digit growth

continuously in the past four years (Appendix 3). In 1996the number of

individual life contracts exceeded three million for the first timewhich

represented 49% of the Hong Kong population. In consideration of more than

50% of Hong Kong people do not have life insurance protection and the MPF

market to be operated in 2000there are still more rooms for life insurers to

improve their performances.

Thirdly, it is not easy for an insurer to differentiate itself from

competitors by providing unique insurance product. Types of insurance and

covers provided by insurers are similar to each other. The way insurers are

frequently used is to add value to the insurance policy. An outstanding

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example is motor insurance. In addition to the standard cover of motor policy

motor insurers also provide fringe benefits to add value to the policy. Such as

personal accident insurance cover to the driver; No Claim Discount protection

cover; new for old cover for private car within the first year of registration in

the transport department etc, all are free. Other insurers even provide free

service such as 24-hour road - side towage.

Though some insurers have tried very hard to design new products,

it can be copied easily by its competitors.

As insurance products are lack of differentiationinsured's choice of

insurer is largely based on price. In order to maintain market position or even

outperform its competitorinsurers competing in price war. The case is

particularly serious in general insurance business.

Fourthly, as a result of excess reinsurance capacity around the

worldinsurers are easily to obtain reinsurance supports. Reinsurers are

willing to accept reinsurance from insurers at low premium rate. Reinsurer's

attitude on accepting business can be seen as an enabler of driving down the

market premium.

Fifthlythe exit barrier is high. An insurer who ceases business

venture in the insurance market does not mean that its liability ceases

simultaneously. He has to honor all outstanding claims that reported to him

previously. For those insurers writing liability insurance for example motor

insurance and employees compensation insurance, they have to maintain an

office for run-off operation. The run-off period could be as longer as ten years.

For life insurersunless they can find a buyer to purchase its whole portfolio

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the run-off time may even longer than that of general insurance as all life

polices are arranged on long term basis.

5.4 Pressure from substitute products

Substitutes are products that offer the buyer a choice. For

example, many consumers see grapefruit as a substitute for oranges and hot

dog as a substitute for hamburger. The greater the number of close substitutes

availablethe greater will be the elasticity of demand.

To understand the threat of substitute productsthe first thing we

need to do is to identify substitutes. Identifying substitute products is a matter

of searching for other products that can perform the same function as the

product of the industry. Substitutes limit the potential of an industry by placing

a ceiling on the prices firms can charge.

Substitution is the most difficult competitive force to anticipate

and when it happens, it is usually the most devastating of the five forces

because it fundamentally changes the rules of the game. For many

international airlines the major contribution to their profitability comes from

the business class passengers who pay significantly more than economy class

passengers. Video conferencing would be a good example of competition by

substitution.

As far as insurance industry is concernedcaptive insurance is a

form of substitution as is the use of the capital markets as a vehicle for risk

management.

In the Insurance Companies (Amendment) Bill 1997Captive

Insurer" is defined as a company which carries on general insurance business

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only (which does not include compulsory insurance business) and such

business is restricted to the insurance and reinsurance of risks of the

companies within the same grouping of companies to which the captive

insurer belongs.

In view of its limited activities in the Hong Kong insurance market

captive insurers do not constitute a threat to the existing insurers. But the

present situation is expected to be changed in the coming years due to the

Government's intention to promote Hong Kong as a niche market for captive

insurers.

In his 1996-97 Budget Speechthe Financial Secretary highlighted

the importance of maintaining and enhancing the status of Hong Kong as

world-class financial center. To this end, one of the initiatives taken by the

Government as published in Action Agenda" of the Budget Addendum was

to encourage the development of reinsurance and captive insurance business in

Hong Kong.

To this enda Working Group on Reinsurance and Captive

Insurance (Working Group)chaired by the Secretary for Financial Services

and comprised experienced insurance and financial practitioners and the

Insurance Authority, was set up in May 1996 to advise the Government on the

ways and means to promote these two types of insurance business in Hong

Kong.

As regards captive insurance business, there are currently about

3,400 captive insurers in the world and only a small portion of them have

established their presence in Asia. The number of captive insurers is forecast

to grow to 4,000 by the year 2000. As Hong Kong meets most of the criteria
for an ideal captive location, it is believed that Hong Kong has the potential

for developing this line of insurance business.

During 1997the Insurance Authority implemented a series of

promotional measures recommended by the Working Group. The most

important one is regulatory concessions for captive insurers.

The concessions offered to the captive insurers in the Insurance

Companies Ordinance include the following:

The minimum capital requirement is HK$2000000 as opposed

to HK$ 10?0007000 for general insurers;

The Insurance Companies (General Business) (Valuation)

Regulation, which sets out prudent valuation and admissibility

criteria for different categories of assetsdoes not apply to

Captive Insurers;

The minimum solvency margin is HK$2000000 as opposed to

HK$10000000 for general insurers; and

The requirement for maintaining assets in Hong Kong under

Section 25A of the Insurance Companies Ordinance does not

apply to Captive Insurers.

In addition, a captive insurer is further exempted from the

requirements set out in the Authorization Guidelines to demonstrate to the

Insurance Authority before authorization that:

It has undertaken a feasibility study in respect of its proposed

operation in or from Hong Kong;

It would not engage in a 'fronting" operation; and

It would be managed and operated independently of its group.

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 Apart from the regulatory concessions for captive insurers, the

Working Group recommended that enhancement of tertiary insurance

education, co-ordination of overseas promotional activitiesand provision of

tax incentives are effective measures for the promotion of captive insurance

business in Hong Kong.

Though the Hong Kong economy as a whole will benefit from the

promotion of captive insurance by bringing in capital funds and creating job

opportunitiesthe development of captive insurance business will also enhance

the intensity of market competition that existing insurers should not overlook.

5*5 Suppliers in the Insurance Industry

On the suppliers' sideapart from the most important factors of

production land, labor and capital, reinsurers and IT companies are also the

influential suppliers.

The power of reinsurer is depended on the market environment. In

early 90sas a result of catastrophe accidents occurred frequently around the

worldwide insurance marketsreinsurers suffered substantial losses. In order to

recover their lossesapart from tightening the reinsurance capacity provided in

the insurance marketthey also raised the premium substantially and imposed

restrictive terms and conditions to the reinsurance contracts. Reinsurers'

measures for improving underwriting results directly affected insurers

business as it increased the operating costs and reduced the flexibility of

insurers. Reinsurers' bargaining power was powerful at that tough period.

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 Since 1994because of excess reinsurance capacities in the world

the reinsurance market was becoming soft. Reinsurers bargaining power is

gradually reducing.

IT companies including manufacturers, systems integrator, or niche

software providers are important to an insurance company who heavily relies

on information technologies to create competitive edges.

Instead of examining whether a supplier can exerts power over a

customer, we should treat the customer-supplier relationship on a peer to peer

basis and not master-slave. Managing the supplier relationship well would

provide the insurance company with access to scare resources and knowledge

and thus be a basis of competitive advantage; managing the relationship in a

traditional manner or not managing it at all constitutes a threat to the business

and is the basis of competitive of disadvantage.

5.6 Buyers in the Insurance Industry

Buyers in the insurance market consist of ultimate consumers the

policyholders and intermediaries insurance brokers and insurance agents.

They are increasingly demanding and sophisticated. The bargaining power of

the buyers is strong for many reasons:

There are numerous insurers in the market competing for

business. Most of them are eligible to provide full lines of

insurance products and services to the potential insureds.

Insureds have more choice to arrange their insurance matters.

As mentioned earlier in this chapter, insurance products in the

market are similar and less differentiatedan insured will have

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less chance to incur switching cost from transferring his

insurance cover from one insurer to another. Due to the keen

competition among insurersmost often, the insured can have

savings and more coverage by switching to an aggressive

insurer.

Insureds are well informed of the market situation. By way of

appointing insurance brokers on their behalfcorporate insureds

can get the up-to-date market information. As a result of the

advertising campaigns launched by direct insurers in recent

years, such as direct motor insurance schemes initiated by AIU

and Carlingford Insurance (now known as Hong Kong Bank

Insurance), an individual insured can easily obtain motor

quotations through the hot line service provided by the direct

motor insurers. Not necessary an insured's intention to switch

insurer, but he can compare the price and exert pressure on the

existing insurer to reduce price.

Powerful large conglomerates and agents engage in the practice

of backward integration pose a credible threat to the existing

insurers. The formation of Bank of China Group Insurance

Company was a good example. In view of the huge premium

size and profitable business that were usually introduced to its

business partner China Insurance Group as an agent, in 1993

Bank of China Group formed a subsidiary company namely

Bank of China Group Insurance Company to provide general

insurance services to its clients directly. In 1997Bank of China

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 Group expanded its insurance business to life insurance market

by establishing Bank of China Group Life Insurance Company.

As a result, China Insurance Group's performance in terms of

underwriting profit had seriously been affected. Other large

firms like China Resource Group set up its insurance broker to

consolidate the group's insurance matters. Apart from reducing

the overall insurance coststhe broker may generate profit to the

group from participating in the insurance brokerage business.

Insurance agent and insurance brokers with large premium

portfolio and quality business e.g. fire insurance, marine cargo

insurance are most powerful. They have influential power to

insurers in demanding favorable commission terms and more

services.

In the fast changing environmentcustomer priorities change

quickly. To gain competitive edge over the othersan insurer must keep up

with the changing patterns of customer demand. To be genuinely customer

focused requires a significant investment in customer care behavior and

information systems and technology that support it.

To concludewith the numerous insurers in the marketthe low

entry barrier, the cut-throat rivalry among existing insurers, the declining of

industry growththe increasing threat of substitute products, high pressure

from managing the suppliers relationshipand strong bargaining power of

insureds and intermediaries, the competition in the Hong Kong insurance

market is fierce.

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