Dominic Barton
March 27, 2006

After 20 years of breathtaking growth and massive industrialisation, China is now facing economic and social challenges to its sustained development. On the one hand, it must find 12 trillion yuan over the next five years to finance the construction of infrastructure - if it is to keep its growth on track and extend economic development to smaller cities and rural areas.

On the other, it must address increasingly pressing issues of social harmony and stability, in part by tackling shortfalls in its pension and social-welfare systems. Both these efforts will be crucial for narrowing the potentially explosive gap between the wealthier coastal and urban regions, and the poorer countryside.

Either undertaking - let alone both - will almost certainly cost more than the government can afford. So Beijing must mobilise a market-oriented source of finance to expand its investment capacity without compromising fiscal discipline. It could do so, at least in part, by further reforming its life insurance market.

A vibrant life insurance industry is uniquely suited to address infrastructure and social needs. By redirecting China's enormous household savings - now held largely in short-term bank accounts - into life insurance products, insurers could help to raise the long-term financing that the state needs for big infrastructure projects. This is because insurers provide demand for government bonds. In mature economies, insurers often hold 40 per cent or more of sovereign debt: in China, the figure is only 8.7 per cent.

On the social-welfare side, life insurance protects ordinary people, giving them peace of mind and securing long-term savings for their retirement. Pension and annuity products can provide income well after people retire.

Moreover, it helps to reduce the burden on the government by supplementing the pension and social-welfare systems. Thus, a thriving life insurance industry, once further reforms are implemented, would allow China to address its infrastructure and social issues simultaneously.

Even by Asian standards, however, life insurance - at 2.2 per cent of the gross domestic product, as measured by the volume of premiums - has barely penetrated the mainland. A recent survey found that only 6 per cent of the population had even a modest knowledge of its benefits.

The government should consider launching a programme to drive the industry's development. Beijing should consider several initiatives. To begin with, China's citizens should be educated about the value of life insurance. But that alone wouldn't be enough: experience from more developed markets shows that a strong and wise regulator is vital to ensure a healthy environment.

The primary task of the China Insurance Regulatory Commission will still be to monitor the financial health and risk-management systems of life insurers. But it should take on other tasks, too: stricter regulation of the design of insurance products; and outlawing unsustainable pricing, impossible promises of future returns and contracts that are incomprehensible or disadvantageous to consumers.

An attractive and thriving life insurance industry will also require more flexible investment options so that insurers can achieve stronger returns. That, in turn, will let them offer higher returns to policy holders and thus help to close the gaps in government social-welfare programmes.

Such benefits mean life insurance plays a special role in boosting economic growth and social stability. Many countries therefore use preferential taxation policies to encourage greater participation. China should do the same.

Even if all these measures were implemented, both the government and industry might have to devise creative initiatives to assure broad coverage in rural and remote areas, where a direct sales force is costly to field.

Time and again, experience has shown the many benefits of life insurance in the developed world. China's life insurance industry could play a key role in tackling the country's economic and social challenges if the government helps the industry to realise its vast potential.

Dominic Barton is a director in McKinsey & Company's Shanghai office and leads McKinsey's offices in Asia.

This article was originally published in the South China Morning Post.