The mainland's fragmented insurance industry is undergoing a shake-up as smaller and financially vulnerable players continue to battle to meet tightened regulatory solvency requirements during the economic downturn. About 14 insurers were likely to fail the solvency tests in the first half of this year, sources said, up from 10 which fell short of requirements last year. The result would be an acceleration in the trend towards consolidation in the industry, they added. Solvency ratios measure the extent to which liabilities are covered by assets. When liabilities balloon as a result of increasing new insurance coverage and assets slump as investments lose value, solvency rates suffer. Under the 'tiered regulatory monitoring system' of the China Insurance Regulatory Commission (CIRC), insurers have to report operational and financial data on a quarterly basis. Insurers classified in the lower solvency tiers face on-site examinations, restrictions on writing new business, management reshuffles and ultimately may be placed in receivership. The nation has 47 non-life insurers and 56 life insurers. In a concentrated market, the top five biggest property and casualty companies account for a combined 75.5 per cent market share, while the top five life insurers hold a 78.5 per cent share. Solvency problems beset smaller players that wrote new business when the economy was booming at low margins in a bid to increase their market share. Although industry fundamentals were now improving, a number of smaller and new players continued to suffer from relatively weak business and financial profiles, said Standard & Poor's analyst Connie Wong. 'The polarisation between strong and weak players may become even more prominent, highlighting the challenging environment for less-competitive players,' she said. Year-on-year life insurance premium growth for the sector hit a high of 80 per cent last July but then turned negative in November before staging a selective recovery that saw smaller players lose a combined 2.7 per cent market share in the first four months of the year to three big insurers - People's Insurance (Group) of China, Pacific Property and Casualty and Ping An Property and Casualty, according to an ABN Amro report. In their battle to present a solvent picture, some insurers have resorted to irregularities and in the first five months of the year the CIRC issued 17 penalty notices, double the amount of a year earlier, for various offences ranging from booking insufficient allowance to conducting illegal related party transaction. The solvency problem was highlighted when AXA, Europe's second-largest insurer, reportedly dropped plans to acquire China United Insurance in May. China United Insurance is the nation's fourth largest non-life insurer. It made a 6.4 billion yuan (HK$7.26 billion) earnings loss in 2007 with a negative shareholders' equity of 5.35 billion yuan. Recent media reports speculated the Xinjiang-based insurance firm may introduce AXA as a foreign strategic investor to shore up its capital. But the French insurer eventually pulled out of negotiations on concerns over solvency issues of the mainland insurer. AXA declined to comment. 'The global financial crisis has put foreign insurers at a disadvantage and the joint-venture structure makes it difficult for foreign insurers to grow,' said Chee Cheong, regional chief executive of Greater China for ING Insurance Asia-Pacific. While foreign peers showed a limited appetite for acquiring ailing local insurers, interest in such acquisitions was growing among big domestic insurers, said analysts. A source with a privately owned health insurer said the insurer was close to being taken over at a 'bargain price. The management is reluctant but there seems no choice for them given the current climate of consolidation in the industry, encouraged by, if not at the behest of, the authorities.' In fact, the campaign to open up the insurance sector to private investors that started in 2003 was apparently now drawing to an end, the source said. 'The regulator issued licences, mostly in niche markets like health policies and life policies, to around a dozen private insurers between 2003 and 2006. But now the few state-controlled national champions have been flexing their muscles in various acquisition deals targeting fledgling smaller private rivals. 'We smaller insurers have been viewed as vulnerable to fraud among other irregularities, which is simply not the case,' said the source. 'We are neither better nor worse than the state-owned big guys.' Lifeline The China Insurance Regulatory Commission tiered monitoring system is being seen as the antidote for insolvency problems among smaller mainland insurers Four-tier classification Tier A Sound solvency, corporate governance, investment performance, market conduct Tier B Sound solvency, but modest risks on corporate governance, investment and market conduct Tier C Below-standard solvency, or sizable risks on corporate governance, investments, market conduct Tier D Solvency severely below standard, or significant risk on one of corporate governance, investments, market conduct Monitoring measures Tier A No special measures Tier B Regulatory discussion, risk notification, on-site examination, insurers to explain how to prevent insolvency Tier C Restrictions on dividends, new businesses, new branches, investments, asset disposal, management reshuffle, and must raise capital Tier D Receivership and other measures deemed appropriate Source: China Insurance Regulatory Commission