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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