In 1992, US-based American International Group (AIG), one of the world’s largest insurance companies, was given the first licence issued to any foreign company to operate in China’s insurance market. Although other foreign companies started to receive licences in 1995, by 2001 AIG still held 8 out of the 12 licences granted to non-Chinese firms in the Chinese insurance industry. Moreover, the other foreign insurers had to set up joint ventures with local Chinese firms and were limited to either life or general insurance. In contrast, AIG was permitted to run wholly owned subsidiaries selling both life and general policies in Shanghai and Guangzhou.[i]
How did AIG gain this unique position? Why did AIG decide to enter China when the market was still small and highly regulated? How did AIG fill the institutional voids? And how should AIG address the new challenges of the increasingly competitive Chinese market?
AIG: Its origin and expansion strategies
AIG was founded in 1919 by a Californian World War I veteran named Cornelius Vander Starr. Partly because of his former experience with an insurance agency in San Francisco before joining the army, Starr founded property/casualty insurer American Asiatic Underwriters (AAU) in Shanghai, underwriting businesses for other insurers. In 1921, Starr began selling life insurance policies to the Chinese, at a time when other foreign insurers were unwilling to do so. Starr reasoned that many Chinese already lived long lives and that life expectancy would probably continue to rise due to improving living standards. Over the next ten years, his businesses expanded in the Far East. In 1926, Starr set up a New York office called American International Underwriters, specializing in foreign risks incurred by American companies.
The Japanese invasion during World War II, and later the Communist Party takeover, interrupted AAU’s operation and finally forced AAU to cease its operations in China in 1950 and shift its focus to the US. Starr’s businesses in other regions continued to grow, and AIG was established in 1960 as a holding company for Starr’s insurance companies around the world. In 1962, Starr handed over the management of the company to Maurice Greenberg, who changed the business focus from personal insurance to high-margin corporate coverage. Moreover, Greenberg switched the distribution channel from using agents to working with independent brokers, so as to avoid paying agents’ basic salaries when business was down. AIG went public in 1969.[ii] In Asia, with the exception of mainland China, AIG also expanded with growing market shares. By 1975, AIG had become the largest foreign insurer in Asia.
During its long history, AIG developed the strategy of entering markets in their early stages of market development. According to then-CEO Greenberg, “AIG companies were the first foreign insurance companies to enter Japan, South Korea, and many Southeast Asian countries. Our joint ventures in Central and Eastern Europe were the first of their kind in those markets.”[iii] In Japan, AIG started to operate “almost the day after MacArthur landed there following World War II”.[iv]
Early entry brought AIG three major first-mover advantages. First, AIG could develop favourable government relations. When the markets were protected, AIG could nonetheless win approvals and new businesses by utilizing its government connections through unusual (often informal) channels.
Second, competition in these markets was less fierce than in the US or Europe, so AIG could dominate niche markets. Even if competitors did enter later, AIG had by then already established its brand and it could also apply so-called grandfathering provisions to protect its existing rights. For example, other foreign insurance companies were required by the Chinese government to set up joint ventures with local Chinese firms, but AIG was given permission to set up two new wholly owned branches.[v]
Third, AIG was able to reach a minimum efficient size quickly and then compete with latecomers from that low-cost position. With low overhead costs in these markets and low operating costs through a centralized command system, AIG was able to reach its minimum efficient size quickly. Because it then had lower costs than latecomers, it earned a high profit margin.
The Chinese insurance industry in the late 1970s and 1980s
After the communist takeover in 1949, the Chinese government created the People’s Insurance Company of China (PICC), which became the only insurance company operating in China. Between 1959 and 1979, even PICC ceased most of its operations, with its activities largely confined to international business, such as aviation and marine cargo insurance. In these years, China basically had no domestic general insurance business or life insurance business. As recalled by Greenberg, “When I first met with PICC in 1975, it was tiny. There were probably about 200 people in the whole insurance industry in China. There was no need to insure anything because everything was government owned.”[vi]
Since the economic reforms initiated by Deng Xiaoping in 1978, both the macro-economic environment and the insurance industry gradually improved. First, the Chinese economy grew significantly. Economic growth typically leads to a strong expansion of life insurance premiums, after the GDP per capita passes the threshold of US $1,000–1,300. In the late 1980s and early 1990s, a few cities and several provinces in China had passed that threshold.
Second, the Chinese government started to introduce new laws to govern domestic economic activities, including insurance activities. Important milestones included the Economic Contract Law (1981) and the Provisional Ordinance of Insurance Enterprise (1985). However, in the 1980s such regulations were still rudimentary, and enforcement was patchy. Thus, ‘good relationships’ (guan’xi) with local and central governments remained crucial for doing business successfully in China.
Third, the Chinese government, lacking experienced personnel in the insurance industry, decided to open the insurance market gradually to both foreign and domestic companies. For example, China Pacific Insurance Company and Ping An Insurance Company entered the insurance market in the 1980s, resulting in some domestic competition.
Despite these slight improvements, the Chinese insurance industry in the late 1970s and 1980s did not look like a promising place to invest. According to Greenberg, “No other foreign insurance company was even paying attention to China at that time, and no one thought there was a chance to get a license in China.”[vii] However, Greenberg still decided to work on China, mainly because he believed that “one day China would join the world of open markets because 1.3 billion people cannot exist in isolation for long, and you cannot have a truly global trading system if China is not part of it”.[viii]
Opening the market in China, step one: Building relationships
Greenberg decided to put the company “at the leading edge of opening markets”.[ix] To get into markets early, he followed five rules: know what you want to do, develop a long-term view, understand the local culture, be persistent and “have the CEO out front”.[x]
Greenberg made his first visit to China in 1975, only three years after Nixon’s visit. Between then and the time that AIG’s first licence was granted in 1992, Greenberg made between 40 and 50 trips to China. Greenberg’s initial visits led AIG to establish a representative office in 1980 and a joint venture called the China-American Insurance Company between AIG and PICC in 1979. Focusing on insurance related to Sino–America trade and worldwide reinsurance, the China-American Insurance Company had only a niche market with modest commercial success. However, it transferred know-how from AIG to PICC and, for AIG, the joint venture helped develop relationships with State Council members and deputy prime ministers.
In the mid 1980s, AIG opened an infrastructure fund and soon started its first project in Shanghai, with an investment of US $195 million in the Shanghai Centre Office-Residential Complex. This large investment was viewed as a firm commitment and won AIG the support of Zhu Rongji, then mayor of Shanghai and later premier of China. Several years later, Zhu asked Greenberg to help create the International Business Advisory Council for Shanghai. The Council became so influential that almost every ministry in Beijing sent officials to attend the council’s meetings. In the late 1980s and early 1990s, Greenberg’s network expanded to the top echelons, including Jiang Zemin, General Secretary of the Chinese Communist Party Central Committee, and Rong Yiren, Vice Chairman of the National People’s Congress Standing Committee.
Nonetheless, an application for a licence to sell insurance in Shanghai through Zhu Rongji was blocked by PICC. Zhu, then Deputy Prime Minister, suggested that Greenberg should personally try to convince every member of the State Council, especially Li Peng, then Premier. Greenberg recalled how hard it was to convince Li Peng, as it was difficult to see him and he did not want to discuss the issue at all. When Greenberg, at that time travelling in Europe, was finally offered a 10minute meeting with Li Peng in New York, Greenberg flew back and the meeting actually lasted almost an hour and a half.
What Greenberg did to win licences went beyond the insurance industry. For example, AIG bought the bronze windows that had been stolen from the Summer Palace by foreign forces in 1900. These windows had been hidden until 1992, when they reappeared at a Paris gallery. AIG had the windows authenticated and sent back to China as a donation. This was viewed as a nice gesture by both Chinese officials and the public at large, as Chinese people have always desired to bring missing relics back home.[xi]
Opening the market in China, step two: From relationships to business
In 1992, AIG was finally granted a licence. Greenberg said, “It had taken some seventeen years since my first visit to China to get our first insurance license … it was worth the wait.”[xii] By 2001, AIG was granted licences to sell life insurance in Shanghai, Guangzhou, Fushan and Shenzhen, and property and casualty insurance in Guangzhou. AIG had 12 wholly owned subsidiaries in these cities, even though, as noted above, all other foreign companies had to form joint ventures to enter China. In 2001, AIG was granted four new licenses, namely in Beijing, Suzhou, Dongguan and Jiangmen. The firm’s insurance products were divided into two sections; life insurance versus property and casualty insurance, which are often referred to as general insurance. AIG’s life insurance is sold under the subsidiary The American International Assurance Company Limited (AIA), while its general insurance is sold under the subsidiary Chartis Inc.
Gaining access to the market was only the first step towards profits. AIG still had to tailor its products and distribution channels to the Chinese market in three major ways.
First, because China had so few agents with expertise in insurance, AIG made substantial investments in training its agents. By the year 2000, according to Greenberg, “over 6,000 agents currently employed by the domestic insurance industry were trained by AIG”.[xiii]
Second, AIG introduced the agency distribution system to China. AIG only paid commission to its agents – not a basic salary. In this way, AIG realized huge savings. At present, the agency distribution system is widely adopted by most insurance companies in China.
Third, as many Chinese customers view life insurance as bringing bad luck, AIG designed endowment policies for Chinese customers and marketed these policies as savings instruments rather than insurance products.
AIG’s China’s life insurance operations have been successful. In Shanghai and Guangzhou, AIG had a market share of respectively 13 per cent and 7 per cent in 2000, behind only the domestic firms China Life and Ping An. In 2003, AIG bought a 10 per cent stake in PICC, China’s largest nonlife insurer. In 2004, AIG sold policies worth US $580 million, accounting for 1.49 per cent of the life insurance market and positioning itself as the largest foreign life insurer in China.[xiv]
Prior to 2007, general insurance was sold in branches under AIU Insurance, a subsidiary of Chartis. In September 2007, AIG General Insurance Company China Limited (AIG General) was incorporated and became AIG’s first wholly owned foreign enterprise in China.[xv] In July 2009, it began operating under the name Chartis Insurance Company China Limited. Chartis has been able to expand the geographic coverage of its operations, establishing a branch in Beijing in 2008 and in Jiangsu in 2012.
AIG bailout
AIG put itself into a dangerous position when its subsidiary, AIG Financial Products, became heavily involved in the mortgage-backed securities markets in the United States. When the housing bubble burst in 2007, AIG faced an inevitable crisis. In August 2008, AIG reported losses of US $5.36 billion and in September of that year the company had US $14.5 billion in capital requirements from derivative contracts.[xvi] The US Treasury was faced with a vital decision on whether AIG should be bailed out or left to fail. On 16 September 2008, the US treasury offered an US $85 billion emergency loan to AIG.[xvii] This loan was later renegotiated with the government as an extended five-year loan valued at US $60 billion with the government taking an 80 per cent share in the company.[xviii] The US Treasury and the Federal Reserve expressed the importance of backing AIG due to the potentially devastating consequences of losing a firm with a swap portfolio valued at over US $441 billion.[xix] Over the next several years the government intervened and renegotiated the terms of the loan several times. By April 2012, US taxpayers had put approximately US $182 billion into the AIG bailout.[xx]
However, by 2012 AIG had realized a substantial turnaround from its bailout just four years earlier. The company reported net income of US $3.1 billion for the first quarter of 2012. President and CEO, Robert H. Benmosche, also announced that AIG “achieved the milestone of reducing total outstanding or authorized U.S. government assistance by 75 percent”.[xxi] Analysts were projecting that by April 2013, the US government would no longer own any part of the company.[xxii] The company’s turnaround has been controversial as the government allowed AIG to claim prior losses against current income, which will provide years of tax breaks for the firm.[xxiii]
Impact on AIG in China
The bailout of AIG created some uneasiness in the company’s operations in Asia. AIG’s subsidiaries aimed to reassure their clients that their financial situation was healthy and policy claims could be met.[xxiv] The American International Assurance (AIA), the Asian life insurance arm of AIG, stated that “although AIG faces short-term liquidity pressures, we have strong, wellpositioned businesses in diverse markets around the world and a deep asset base”.[xxv] The China Insurance Regulatory Commission also closely monitored the situation after the bailout.
Given AIG’s shaky financial situation, the company realized that selling off parts of its business was necessary to pay back the bailout loan. AIG looked to sell part of its stake in AIA to Prudential, a UK insurance company. The deal eventually fell through so AIG issued shares of AIA to the public in 2010, raising US $20.5 billion.[xxvi] AIG announced in March 2012 that it was again issuing shares in AIA for loan repayment purposes. By the end of this second round of financing, AIG would control only 19 per cent of AIA.[xxvii]
Challenges and opportunities
Although AIG has successfully penetrated the Chinese market, both its market share and profits are modest. Its position as the largest foreign insurer in China was lost to Italy’s Assicurazioni Generali in 2005.[xxviii] In recent years, it has faced several major challenges.
Most importantly, on the domestic front, allegations by US regulators that AIG inflated its revenues forced Greenberg to step down as CEO, thereby leaving a void in AIG’s political networks in China.[xxix] Although Greenberg was still warmly welcomed in China,[xxx] AIG had to find ways to replace Greenberg’s networks and to convince Chinese officials that the new AIG was still committed to China. A number of analysts noted that both Edmund Tse, AIG’s senior vice-Chairman of life insurance, and Donald Kanak, COO focusing on Asia, had good relationships with Chinese politicians,[xxxi] while others commented that political connections were not as important as they had been five years before, as the insurance market in China had matured.
The second challenge was to design the right products. Although AIG had the opportunity to sell products through the 4,300 branches and 128,000 agents of PICC, it had to find the right balance between invading the turf of PICC and finding a sizeable niche market worthy of investment.
A third challenge is the changing role of banks in the Chinese insurance industry. Previously, banks were used only as a distribution channel for insurance; however they now design and market insurance products themselves. Large partnerships are beginning to form between local banks and large international insurance firms, which is drastically changing the insurance environment. In a study completed by PwC in 2011, it was found that the three key drivers in the Chinese insurance industry were regulatory changes, bank entry into the industry and competition among domestic insurers.[xxxii]
Finally, foreign insurance companies continue to struggle in China, whereby only 11 of the 47 foreign companies posted profits in 2010.[xxxiii] Foreign market share continued to be low with non-Chinese companies holding 5 per cent of the life insurance market and a mere 1 per cent in general insurance.[xxxiv] Furthermore, investment opportunities available to insurance companies were still limited due to government regulations.
The market still holds opportunities for foreign insurers with foreign life insurance companies expecting 20–40 per cent growth in 2011. General insurance was expected to grow by 30–50 per cent between 2011 and 2014.[xxxv]
Furthermore, an opportunity arose for AIG from the Chinese government’s plan to lift its restrictions on foreign insurance companies covering mandatory third party liability automobile insurance. Prior to the announcement in 2011, foreign companies were restricted to providing only optional coverage, making insurance contracts unattractive to locals who desired full, comprehensive coverage.[xxxvi] Removing the regulatory restrictions was expected to allow foreign insurance companies to gain access to the lucrative 50 billion dollar market. Kevin Goulding, the head of Chartis China, sees large potential for business stating, “It’s an extremely large market and will also allow us to offer other products to consumers.”[xxxvii]
Given the above challenges, AIG’s profits in China did not grow much during the past decade; however with government restrictions slowly being loosened and the market growing, the longterm future for AIG does not look too bad.
QUESTIONS
- What, if any, were the relevant institutional voids in China?
- Based on the framework developed by Khanna et al., what types of strategies should foreign insurance companies pursue? What did AIG do to cope with the institutional voids?
- What were AIG’s FSAs developed in China? What non-location-bound FSAs had been transferred to China? What first-mover advantages did AIG reap in China?
- How did AIG combine the use of its location-bound FSAs and nonlocation-bound FSAs in China?
NOTES
[i] Jean-Philippe Bonardi and Tony S. Frost, ‘AIG and China’s accession to the WTO’, IVEY case number 9B02M021 (2002).
[ii] Andrew Bolger, ‘Putting down new roots on familiar soil’, Financial Times (15 March 2000), 30.
[iii] Maurice R. Greenberg, ‘Opening markets in a turbulent world’, Georgetown Journal of International Affairs (Summer/Fall 2003), 149.
[iv] Ibid., 153.
[v] James Kynge, ‘Beijing secures compromise on treatment of AIG’, Financial Times (7 December 2001), 12.
[vi] Greenberg, ‘Opening markets in a turbulent world’, 150.
[vii] Ibid., 151.
[viii] Ibid., 150.
[ix] Ibid.
[x] Ibid.
[xi] Xinhua News Agency, (2 December 1993).
[xii] Greenberg, ‘Opening markets in a turbulent world’, 152.
[xiii] AIA refers to American International Assurance, AIG’s subsidiary for life insurance in China. Maurice Greenberg, ‘Statement submitted to the US House of Representatives’ (16 February 2000).
[xiv] Geoff Dyer and Andrea Felsted, ‘AIG loses its edge in China’, Financial Times (24 May 2005), 27.
[xv] ‘American International Group, Inc; AIG General Insurance Company China Limited receives approval to establish branch in Beijing’, Business & Finance Week (21 July 2008), 57.
[xvi] Nanette Byrnes, ‘Where AIG went wrong’, Bloomberg BusinessWeek (18 September 2008).
[xvii] Nanette Byrnes, ‘AIG’s uphill battle’, Bloomberg BusinessWeek (26 February 2009).
[xviii] Ibid.
[xix] Phil Mintz, ‘Another handout for AIG’, Bloomberg BusinessWeek (2 March 2009).
[xx] Roben Farzad, ‘AIG may not be as healthy as it looks’, Bloomberg BusinessWeek (26 April, 2012).
[xxi] ‘AIG reports first quarter 2012 net income of $3.2 Billion’, AIG press release. http://ir. aigcorporate.com/phoenix.zhtml?c=76115&p=irol-newsArticle&ID=1691406&highlight= (3 May 2012).
[xxii] Roben Farzad, ‘AIG may not be as healthy as it looks’, Bloomberg BusinessWeek (26 April, 2012).
[xxiii] Ibid.
[xxiv] Bruce Stanley, Jackie Cheung, James T. Areddy, Shai Oster, ‘The financial crisis: AIG at risk AIG’s Asian units seek to allay customers’ fears; companies stress their independence, solid capital status’ Wall Street Journal (Eastern Edition) (17 September 2008), A.10.
[xxv] Ibid.
[xxvi] Denny Thomas and Clare Baldwin, ‘AIG to sell $6 billion in AIA stock to repay bailout’, Reuters (5 March 2012).
[xxvii] Ibid.
[xxviii] Geoff Dyer and Andrea Felsted, ‘AIG loses its edge in China’, Financial Times (24 May 2005), 27.
[xxix] Francesco Guerrera, ‘Departure will leave a void in Asian strategy’, Financial Times (15 March 2005), 26.
[xxx] Richard McGregor, ‘Ousted AIG chief welcomed by Chinese’, Financial Times (18 March 2006), 9.
[xxxi] Dyer and Felsted, ‘AIG loses its edge in China’, 27.
[xxxii] PwC, ‘Foreign insurance companies in China’ (2011), 18.
[xxxiii] ‘Growing pains’, The Economist (3 December 2011).
[xxxiv] PwC, ‘Foreign insurance companies in China’ (2011), 4.
[xxxv] PwC, ‘Foreign insurance companies in China’ (2011), 5.
[xxxvi] Noah Buhayar, ‘AIG targets China drivers in $50 billion insurance market’, Bloomberg (3 April, 2012).
[xxxvii] Ibid.