2014 china auto finance report emerging auto financial services

Deloitte Automotive ServiceJanuary 2014

2014 China Auto Finance ReportEmerging Auto Financial Services

Introduction

This report, built on the China Auto Finance Report released in December 2012, examines new yet popular approaches to innovation initiatives and efficient financial services in the auto industry, and gives an overview of the industry’s most recent developments over the past year. Auto finance, in its broadest sense, refers to financing activities in the manufacturing, distribution, purchase, and consumption of automobiles. Its narrow definition comes down to financing or other financial services offered to consumers or dealerships, involving making loans to dealerships for the construction and equipment input of a showroom and inventory financing, as well as consumer loans, financial leasing, and insurance. According to empirical research, automobile manufacturing processes generate a mere 30% of the total profits created, while distribution and aftersales service departments contribute the other 70%. Financial services rest on the most valuable and energetic part of the auto industry’s value chain, and demonstrate the hugest potential in China. They have proved to be a huge engine driving the auto industry and its consumption activities.

Auto finance was invented in the 1920s in the United States as instalment arrangements offered by automakers to buyers. In China, however, the practice was lagging behind, and wasn’t initiated until the People's Bank of China published the Administrative Rules Governing the Auto Financing Company in October, 1998. Despite the auto finance companies established earlier, the core of auto finance – wholesale finance and consumer finance – has been existing for no more than 30 years in China.

In 2013, 22,116,800 automobiles were manufactured and 21,984,100 sold, among which passenger vehicles respectively accounted for 18,085,200 and 17,928,900, up by 16.5% and 15.7% compared to 2012. For all the huge potential, adverse factors like the growing industry capacity and sales, along with gradually satisfied inelastic demand, are expected to slow down the industry’s growth rate. Deloitte expects, for years to come, China’s passenger vehicle market to grow at a yearly 7% or more, and its used vehicle market at more than 15%. Auto financial services will prosper through market challenges in the future. Given auto purchase financing and leasing combined making up 50-80% in well-established markets, the fact that the proportion remains below 20% in China has reserved much room for the country’s auto finance.

A constant watcher over China’s auto industry, Deloitte extends its predecessor’s focus on wholesale and retail lending, both essential parts of auto finance, and in this report looks further at financial innovation and examines the development of a few new major models in China, including car leasing, used vehicle finance, auto insurance, and the Internet finance. In China, the auto industry has been marching towards an “Internet era”. No longer a buzzword that emerged in recent years, the term maintains its potential. The trend is bound to attract more funds and establish the Internet finance as the backbone of auto finance.

We hope that, by this report, we can help readers look closer at the major participants and business models of China’s auto financial services. By examining the industry’s development, at present and in the future, we wish to facilitate the continuous innovation and healthy development of the auto finance in China.

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Contents

Car leasing 4

Car leasing in China has huge potential 5

Categories of market participants 6

Industrial practice analysis: car leasing business models and prime examples 7

Predicaments & changes 13

Used Vehicle Financing 16

Industry overview 17

Regulations governing the used vehicle industry 18

Competition in used vehicle industry 20

Financing fuels consumption of used vehicle 20

Business models of used vehicle financing of different companies 21

Status quo & visions of used vehicle financing 22

Auto Insurance 23

Industry overview 24

Product analysis 25

Regulations governing auto insurance 27

Analysis of auto insurance sales channels 27

Development of auto insurance extensions 28

Effects of big data on auto insurance 29

Conclusion & expectation 30

Booming auto sales decelerate, and value chain is noticeably shifting to the aftermarket 31

More and more companies are participating in the auto aftermarket 31

The Internet finance will have far-reaching effects on auto finance 32

Contact 34

2014 China Auto Finance Report Emerging Auto Financial Services 3

Car leasing

Abstract:

• China’s car leasing services are currently going through their early stages of development featuring a low penetration rate. However, the next few years are expected to come with high growth and huge potential.

• Leasing companies, auto manufacturers, and dealerships are actively engaged in the market, specializing in short and long term rental as well as financial leasing. They have been exploring applicable business models to seize opportunities of future market growth.

• Rapid growth of the market has also uncovered the rising trends towards centralization and merger. Well-financed companies with sufficient resources have been busy expanding their presence across the country and diversifying their operations to absorb more market shares. On the other hand, concerns remain for small-sized car leasing businesses at a disadvantage for uncompetitive services, management, capital resources, and pricing that result from lack of scale effects.

• Uncertainty is ubiquitous in the car leasing market, involving government regulation, engagement with used vehicles, and residual value evaluation. Companies are expected to face multiple challenges in the future.

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Car leasing in China has huge potential.China’s car leasing industry is currently going through its early stages of development featuring a low penetration rate yet huge potential.Car leasing is categorized according to its nature as financial leasing and operating leasing, the latter subdivided into short-term and long-term. Currently, vehicle leases are mostly short-term, which makes the arrangement the mainstream.

Deloitte’s research into China’s car leasing market finds that, by the end of 2012, there had been hundreds of players, more than half of which are based in first-tier cities like Beijing, Shanghai, and Shenzhen, in contrast to limited presence in second or third-tier cities. In light of market shares, the top ten share 12% of the market, which was more centralized compared to 2011, but rather low compared with mature markets. In terms of the distribution of each group, regionally operating small-sized companies offering long-term leases comprise the majority. Except few big competitors, an average leasing business has a fleet of only about 50 vehicles, which is impossible to benefit from an economy of scale. Financial leasing companies are not great in number, and very few of their vehicles are leased. Although there have been over ten short-term leasing companies of a considerable size, like China Auto Rental, eHi Auto Services, and Yestock Rental Car,

their market shares combined appear to be rather low compared to those in mature markets.

Another defining indicator of early stage is the lower penetration rate (the proportion of leased vehicles to the passenger vehicle parc) compared with that in the United States and Europe. Currently, the leasing market is basically closed to non-corporate players. Even for companies, the ratio remains below 10%, where their clients are mostly foreign-funded. In mature markets like Germany and France, almost 50% of company-owned vehicles are sold in the form of leasing contracts.

In major leasing markets like Shanghai and Beijing, there have been regulations imposing nominally tough limitations on the car leasing business. Shanghai, for example, controls corporate leasing registration and license plates (beginning with Y) with a heavy hand. In practice, however, the enormous demand for car leasing services has allowed a number of unregistered vehicles to compete in the market – the grey area has thus become the mainstream without the government’s crackdown measures. According to the market demand and the government’s attitude, regulations are expected to remain unchanged in the short run, which will eventually loosen up in the long term.

In the future, China’s economy is to continue its steady development, pushing up national incomes. Positive factors, like increasing vehicle parc and sales, supply chain improvement, more asset-light management strategies, rapid development of car leasing companies and their maturing products, and more open-minded leasing regulations, have been providing impetus for the development of China’s car leasing industry.


Source: Deloitte Research

Table 2 Examples of Car Rental Companies

Table 1 Categories of Car Leasing Companies


Category Examples Features

Short-term Rental

• Private companies, like China Auto Rental, eHi Auto Services, and TopOne

• Convenient and efficient services to satisfy short-term rental needs

• Larger fleets, more locations across the country, and more financially secure with venture capital

• Systematic management

Long-term Rental

• State-owned companies like Shouqi Car Rental, and Dazhong Leasing Car

• Foreign companies like Avis-Anji and Arval

• Smaller fleets, regionally operating, and relying on lasting partnerships with clients

Financial Leasing

• Auto financial leasing companies like Herald Leasing

• Financial leasing companies like CDB Leasing

• Financial leasing instruments to facilitate order processing and minimize taxes

• Generation of interest incomes

Bank-affiliated Financial Leasing

• CDB Leasing • Well-financed

• Less-specialized

Manufacturer-affiliated

• ezucoo

• Mercedes-Benz

• Volkswagen New Mobility Services

• Promotion of sales of new and used cars

• Increase of profitability from financial services

Dealerships

• Pangda Leye Financial Leasing

• China Grand Automotive

• eCapital

• China Automobile Trading

• Promotion of car sales

• Increase of profitability of dealership groups from financial services

• Full-swing industry chain

Company Model Price Lease term Driver

China Auto Rental

GL8 2.4L

RMB 7,000/month

Monthly (optional)

N/A

Average long-term rental in Shanghai

RMB 10,000/month

2-3 years Compulsory

Categories of market participantsLeasing companies, dealerships, and manufacturers are actively engaged in the leasing market, which is noticeably being centralized.As the automobile market growth rate returns to normal and profits of new vehicle sales keep slipping, financial leasing effectively lowers the threshold for consumers to buy a vehicle, and pushes forward the sales of new vehicles while invigorating follow-up market services. Consequently, it has become a new source of profits, which explains its popularity among corporate clients. Operating leasing is also an effective approach to wholesale business. Therefore, in addition to leasing companies, auto manufacturers and dealerships are also actively participating in the industry.

Currently, the market is remarkably divided where the top ten share only 12% of the market. A closer look finds that short-term leasing companies makes up the smallest proportion, requiring substantial financing, a large fleet, and a well-established network, while those offering long-term services account for almost 80%. However, the latter are mostly small-sized and operating in certain regions. Financial leasing companies are not great in number, clustered in first and second-tier cities, and offer limited cars for lease.

It’s worth noting that more and more large and medium-sized companies are exploiting their advantages to expand product lines or business presence to seize market shares. Short-term leasing companies own the largest fleets, so they’re trying to provide long-term services to ensure more preferential offers from sellers. Complemented by their well-established financing, marketing, and management measures, they’re about to overtake traditional small-sized long-term service providers with more competitive prices in the future.

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Table 3 Examples of Short-term Operating Leasing Companies

Company Since Fleet Size Location

China Auto Rental Sep. 200750,000 vehicles of all popular models in China

Over 700 locations at 52 airports in 66 cities

eHi Car Service Jan. 2006More than 10,000 vehicles of over 80 models

Almost 400 locations in over 50 cities

Yestock Rental Car Dec. 2005Over 10,000 vehicles

In 153 cities; half of its business from corporate clients

Source: public information; corporate interviews; Deloitte Research

Table 4 Business Model of China Auto Rental

Department Details

FinancingFrom venture capital investment or privately offered funds: RMB 1.2 billion from Lenovo in 2010, and USD 200 million from Warburg Pincus in 2012

ProcurementDirect strategic partnerships with auto manufacturers’ sales companies to get discount offers

MarketingTargeting private customers (over 70%); lease terms varying from days to years; roadside assistance and airport/station pick-up or drop-off

LocationOver 700 in 66 cities; partnerships with 4S dealerships for repair

Used VehiclesVehicles for short-term lease to be sold in 1-2 years to private customers, auto recyclers, and auction houses; establishment of their own secondhand vehicle sales platform

IT SystemSubstantial investment in exclusive nationwide IT system to manage cars, locations, staff, and finance; introduction of a smartphone client in 2013

Manufacturer-affiliated leasing companies are prospering, which highlights the market’s high expectation. In 2011, Volkswagen launched its New Mobility Services and gave it a task of exploring the leasing business. In 2013, Volkswagen took over a long-term leasing service in Beijing, and another in Shanghai. Currently, the company is operating in four Chinese cities.

Companies as subsidiaries of dealerships are availing themselves of the existing networks on their fast track to the booming business, with fleet size and business volume outrunning those of normal-sized leasing services.

It’s foreseeable that, as the leasing market keeps growing, its centralization is sure to be more noticeable.

Industrial practice analysis: Car leasing business models and prime examplesShort-term operating leasing companiesShort-term leasing companies didn’t emerge until around 2006, but are now rapidly developing. Along with changing consumer habits and improving personal credit system, this group of leasing services are booming, with agencies like China Auto Rental, eHi Car Services, and TopOne establishing large fleets for rental.

For them, substantial funds are required to put together different vehicle categories; the same is true of well-functioning online networks and brick and mortar locations. As the number of car owners rises, short-term leasing seems to be a promising business. The ezucoo service, affiliated to the auto manufacturer Nissan, is tied down to its online store and limited range of available car models, compared with non-affiliated companies like China Auto Rental.

As substantial funds are required for the construction of brick and mortar stores, vehicle procurement, and systematic management, these companies usually have financial support of venture capital and banks. In the future, they’ll further expand and enrich their product lines, such as entering the long-term leasing market, offering more models and more flexible plans, establishing online stores, and reaching out to third and fourth tier cities.


Long-term operating leasing companiesLong-term leasing services were established as early as 1980s-’90s. Many of them are state-owned, great in number but little in scale, whose clients are mostly state-owned or foreign-funded.

This category of leasing companies prefer corporate clients (mostly foreign-funded), which explains the popularity of foreign brands. Long-term leasing enjoys advantages of foreseeable and controllable profits and costs, which come with a well-established model that has been put in place for a long time. What’s undesirable, on the other hand, is that it charges more fares, not quite a good deal for companies if they don’t plan to buy their own vehicles. In the future, however, the service may become more acceptable as its costs drop and advantages (e.g. reduction of fleet management expenses) gain more popularity.

A few small-sized players don’t seem to have good prospects for their lack of competitiveness in terms of vehicle procurement costs, fleet management, and product offers. Some of them, registered in Beijing and Shanghai, are facing possible acquisition cases. Well-financed big-sized players, on the other hand, are looking forward to further expansion into third and fourth tier cities.

Table 5 Examples of Big Long-term Leasing Companies

Company Since Fleet Size Location

AVIS–Anji 20026,000 vehicles, mostly GM and Volkswagen models

• In 38 cities

Shouqi Car Rental

Apr. 1992Nearly 10,000 vehicles, mainly Hyundai models

• Headquartered in Beijing with rental locations in around 40 cities

• Engaged in short-term & financial leasing

• Well-connected with state-owned companies

Dazhong Leasing Car

1993Nearly 4,000 vehicles, mostly GM and Volkswagen models

• Headquartered in Shanghai with rental locations in 7 cities

• Targeting corporate clients

Table 6 Business Model of AVIS–Anji

Department Details

Financing Directly by SAIC Motor and AVIS, both listed groups with abundant financial resources

Procurement A number of discounted vehicles from Shanghai Volkswagen and Shanghai GM

Marketing Targeting foreign companies, including a few important Chinese clients

Location Over 100 rental locations in 38 cities; partnerships with 4S dealerships for repair services

Used Vehicles Mostly sold to Avis Car Sales


Source: annual reports; Deloitte Research

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Financial Leasing CompaniesIt’s been a long time since financial leasing companies existed. Despite a well-functioning operational system, high financing costs and insufficient external support have been keeping auto financing products from attracting more attention than auto finance. Therefore, some of them have begun to seek external partners like dealerships and auto manufacturers, hoping to introduce more attractive products and walk out of the predicament.

Financial leasing costs more than long-term leasing because of sophisticated procedures and high interest rates. However, vehicles from financial leasing are eligible to be reported as assets in balance sheets during their lease term, hence quite a deal of attraction to companies.

Table 8 Examples of Leading Auto Financial Leasing Companies

Company Since Yearly Leased Vehicles Location

Anji Leasing1993 (certified by the Ministry of Commerce in 2006)

3,000 In 38 cities

Herald LeasingSeparated from New Century International Leasing in 2006

2,000 In 20 cities, targeting foreign companies

eCapital Leasing

2010 (renamed eCapital in 2012)

1,000, mainly high-end models In over 20 cities

Table 7 A Comparison between Auto Financing Loans and Financial Leasing

Measurement Auto Financing Loans Financial Leasing

Ownership Buyer Leasing company, and then lessee after the lease term

Coverage Vehicle onlyVehicle and any other related expenses including license plate, insurance, and purchase taxes

PreconditionsInitial payment worth at least 20% of the purchase price

No 20% requirement; sometimes deposit worth 5-20% of the total financing amount at the leasing company, which will be returned after the lease term

Interest rates Usually 9-10% without discounts Usually 3-5% higher than auto financing loans




Table 9 Business Model of AVIS–Anji

Department Details

FinancingBy parent company, including selling structured finance products to banks

ProcurementA number of discounted vehicles from Shanghai Volkswagen and Shanghai GM

Procurement Preferably mid-range and high-end brands like Audi

MarketingTargeting foreign and state-owned companies; financial leasing through manufacturer-affiliated 4S dealerships and major clients

Location 17 offices in 12 municipalities and provinces


Bank-affiliated Financial Leasing CompaniesTraditional bank-affiliated financial leasing companies mostly accept capital goods like airplanes, ships, and heavy equipment as subject matters. Currently, some of them have been utilizing their abundant financial sources to march into auto financial leasing business. It’s essential that a fleet as large as hundreds or thousands of vehicles requires a competent management system.

Take CDB Leasing. It was the first in China to enter commercial vehicle leasing business, combining leasing services provided by auto manufacturers and dealerships. Taking into account features of different commercial vehicles and market needs for them, it has developed a systematic business model and, cutting sales costs for manufacturers, realized volume sales, thus offering professional financial leasing services for domestic commercial vehicle manufacturers to engage in a virtuous cycle of R&D, manufacturing, marketing, and development. Currently, CDB Leasing has leased out nearly 3,700 vehicles in almost every part of the country. Good partnerships worth over RMB 8.4 billion have been forged with 11 auto manufacturers including FAW Jiefang Automotive Company, Foton Motor, Shaanxi Automobile Group, Dongfeng Motor Corporation, Beiben Trucks Group, SAIC-IVECO HONGYAN Commercial Vehicle Company, and Hualing Xingma Automobile.

Manufacturer-affiliated Leasing CompaniesLeasing business is important for auto manufacturers to promote sales and earn more profits:

1. Promoting sales of new vehicles

2. Enhancing visibility on roads

3. Increasing used vehicle supply

4. Increasing profits from financial services

Operating leasing and financial leasing are both main sources of used vehicles. A virtuous cycle complemented by leasing business and used vehicle sales will enable auto manufacturers to further explore business along the entire value chain.

At present, a few manufacturers have set foot in the leasing business that includes operating leasing and financial leasing.anufacturer-affiliated

Figure 1 Business Models of Manufacturer-affiliated Leasing and Used Vehicle Sales

After the lease term, the leased vehicle can be returned to its manufacture for testing and then be certified for resale.

Provide vehicles for operating leasing

Provide vehicles for operating/financial leasing

Deliver leasing services


Enrich dealerships’ inventory of used vehicles for resaleManufacturers

Dealerships

Leasingcompanies

Clients

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Manufacturer-affiliated financial leasingTake a rental service affiliated to a luxury vehicle manufacturer for example. Established in June 2012, it’s engaged in financial and operating leasing, acquisition of domestic and foreign leased assets, residual value processing of leased property and its maintenance, and consulting and guarantee services concerning leasing contracts. The rental service, limited to financial leasing at the moment, plans to launch operating leasing in 2014.

However, regulation tightened value added tax bases for financial leasing in August 2013, sale-and-leaseback practices have been negatively affected so much, so that it was almost brought to a halt. According to the new taxing regulation, auto manufacturers are required to pay additional value added taxes, which caused massive losses considering that the singed contracts with clients are based on the old taxation and cannot be altered.

Table 10 Example of Sale-and-leaseback VAT

CategoryBefore

Aug. 2013 (RMB)

After Aug. 2013

(RMB)

Monthly Rent 100,000 100,000

Interests (10%) 10,000 10,000

VAT Base 10,000 110,000

VAT Interest Rates 17% 17%

VAT 1,700 18,700

Source: www.gov.cn.com

Figure 2 Profit Analysis of Dongfeng Nissan ezucoo

operating leasingDongfeng Nissan, for example, launched its ezucoo program in December 2009. It’s seen as a car rental service, built on the networks and expertise of the company’s retailers, providing a full range of services through rental locations, pre-order telephone reservation, and websites. By keeping a fleet of the latest Nissan models, it’s designed to offer the manufacturer’s existing and potential clients comprehensive and customized solutions that apply to all circumstances. It aims to build the company’s services along the entire value chain and highlight its vision of “Enrich people’s life”. As of 2012, ezucoo has leased out over 3,000 vehicles.

Auto manufacturers are well connected with dealerships, and it helps them establish a functioning service network. In case of a lasting inactive inventory of vehicles, dealerships are inevitably challenged by lack of capital shortage; on the other hand, persistent unavailability certainly discourages consumers to enjoy the convenience brought by ezucoo. Introduction of financial services will effectively lift the financial burden from dealerships and thus forge a virtuous cycle.


Dongfeng Nissan Dealerships Consumers•Innovation & brand

elevation•Promotion of sales•Improved client

experience•Utilization of

nationwide presence

•More profits from aftermarket business

•Effective enhancement of client loyalty

•More convenient services

•Exclusive services as Dongfeng Nissan vehicle owners


Pangda’s extensive dealership networks, the service has been engaged in financial leasing in 21 cities, as well as short and long-term leasing in Beijing.

Financial leasing – China Grand AutoBig dealership groups have been venturing into the aftermarket offering financial services centering round used vehicle sales, leasing, and insurance. China Grand Auto, for example, was established in March 2011 and has become a financial service provider with the widest range of products offering one-stop leasing and sale services.

In terms of financial leasing, CGA has come up with a new model that integrates retail purchase and wholesale procurement at discounted prices. Its product line has proved to be even longer than that of an auto finance company. It’s worth noting that CGA is not only relying on its own dealerships, but also working with external partners and used vehicle sellers to establish financial leasing business for used vehicles. However, the new business suffered major setbacks since August 2013 given its similar nature to sale-and-leaseback practices.

1. The buyers and seller agree on prices and ask for CGA financing.

2. CGA entrusts a local agent with the arrangement.

3. The agent tests and evaluates the vehicle concerned, and reports the results to CGA for confirmation of loan amounts.

4. The buyer presents to CGA necessary paperwork.

5. CGA finishes an audit and signs with buyer a leasing contract as well as a legal arrangement taking the vehicle as collateral.

6. CGA provides the buyer with funds upon the signing of the contract.

7. The buyer signs with the seller a vehicle purchase contract.

8. The buyer repays the loan provided by CGA on a monthly basis.

Recently CGA has narrowed its operating leasing service to internal clients for various reasons.

Figure 4 CGA Financial Leasing for Used Vehicles


Figure 3 Operating Leasing Model of Pang Da ORIX

Dealership-affiliated leasing companiesAs the proportion of new vehicle sales to total profits slips, dealerships are paying more attention to the aftermarket. As the financial strength builds up and the leasing market thrives, they’re one after another making high-profile entries to generate extra profits. Financial services, best known for leasing business, effectively promote sales and aftersales business, increase aftermarket profitability, and build immunity to periodic fluctuations.

Currently, a few well-established dealership groups have been exploiting their existing networks to launch their own leasing services. As follows are the prime examples:

Operating financial leasing – Pang Da ORIX Auto LeasingIn 2012, Pang Da ORIX Auto Leasing, a joint venture of Pangda Automobile Trade Company and Orix Corporation, was founded for financial and operating leasing. Relying on


NegotiationContractsigning

Delivery of vehicle

Vehicle in service

Return & settlement

1. Client inquiry2. Quote3. Negotiation

1. New vehicle procurement

2. Vehicle registration

3. Driver recruitment

1. Rent payment2. Repairs &

maintenance3. Annual vehicle

testing4. Accident

management5. Insurance claim

1. Expense settlement

2. Vehicle return3. Contract

renewal

1. Credentials screening

2. Contract signing

3. Payment

Buyer

1

7

2

354

8 6

CGA

Seller

Agent

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financial leasing have mounted and attraction plummeted, posing more challenges to financial leasing companies. This is why Mercedes-Benz and China Grand Auto suffered massive losses from their financial leasing operations similar to sale-and-leaseback.

In first-tier cities like Shanghai and Beijing, regulators are heavy-handed when it comes to corporate registration and license plate offering to companies entering auto leasing. Confusing enough is that they’re not effectively stopping unregistered competitors or certified companies operating unregistered vehicles. The inconsistency has created a grey area in the busines.

Development of social credit & risk management systemsLeasing is a form of credit consumption that requires credit guarantee. Risks in auto financial leasing would go beyond control without a good social credit system in place. Those incompetent systems in internal control are more vulnerable to risks. Therefore, China’s financial leasing industry is commonly inclined to direct leasing practices whereby lessors bear all the risk responsibility, while leasing companies are confronted with, among others, credit risks, or operational and financial challenges.

Creation of residual value market & improvement of exit mechanismsOff-lease vehicles are a major source of used vehicles, of which the residual value pricing is a determinant of leasing prices. However, the pricing accuracy depends on perfect competition and inventory availability. Therefore, China’s immature used vehicle market has contributed to the flawed residual value pricing mechanism, and further to the pricing of auto leasing products, whose advantages over other auto finance products are showered.

Predicaments & changesRegulations to be improvedFor the most part, the Provisional Regulations on the Administration of Auto Leasing Industry, promulgated in 1998, have proved to be outdated in terms of the industry’s recent developments. Regulation on financial leasing is even more flawed than that on operating leasing. Currently, the Ministry of Commence is mainly acting on the Administration of Foreign Investment in the Leasing Industry Procedures, introduced on 5 March 2005, and China Banking Regulatory Commission following Administration of Financial Institutions Provisions, Measures for the Banning of Illegal Financial Institutions and Illegal Financial Business Operations, and Measures for the Administration of Financial Leasing Companies, brought into force on 1 March 2007. The government also introduced the third revision of the draft financial leasing law to regulate financial leasing business, keep the market in order, protect legitimate rights and interests of parties concerned, and promote the industry’s healthy development.

The government in principle is trying to support and protect the auto financial leasing industry, especially the big companies. The Ministry of Transport made it clear in its 2011 Announcement on Promotion of the Healthy Development of Auto Leasing Industry that local transport authorities, where companies in possession of over 1,000 vehicles are setting up branches, are required to streamline administration procedures and provide satisfying services. The instruction is indicative of the government that’s supportive of big companies expanding to nationwide presence.

As part of its liquidity control, the government is committed to crackdown against shadow banking system as well as industry regulation, which comes with tougher taxation on financial leasing, to some extent frustrating auto financial leasing companies. The 2010 No. 13 Announcement, 2011 No. 111 Announcement, 2012 No. 86 Announcement, and 2013 No. 37 Announcement, along with internal notices, all led to more limitation to financial leasing. Therefore, financing costs from


Table 12 Real & Estimated Residual Value of 2006 Year Model SUVs

2006 Year Model

Estimated RV Real RV (2008)

Toyota Sequoia 55% 43%

Ford Explorer 43% 31%

Dodge Durango 39% 27%

Honda Pilot 53% 43%

Chevrolet TrailBlazer

42% 33%

Nissan Pathfinder

51% 43%

Industry Average 46% 40%

Source: 2009 Automotive News

Table 11 ALG Products & Services

In the United States, Automotive Lease Guide (ALG) specializes in auto residual value analysis. Based on its data analysis, the agency provides auto manufacturers, finance companies, and fleet management companies with consulting, tool modeling, and portfolio risk analysis. It helps clients create their own residual value workbenches, remarketing pricing models, and fleet residual models to increase profitability and avoid risks. ALG has developed a professional and authoritative guidebook that has been accepted by a number of manufacturers and financial

Products Services

•Lease guides

•Estimate calculator

•Customized pricing

•Data

•Lease calculator

•Portfolio analysis

•Depreciation estimator

•Client application

•Data analysis

ManufacturersFinancial

institutions

Fleet management

agencies

•Consulting•Residual value

estimate•Modeling tool

•Residual value estimate

•Portfolio analysis

•Consulting•Modeling tool

•Consulting•Residual value

estimate•Modeling tool

institutions as an essential lease product pricing tool. Currently, the Chinese market is only served by few residual value data providers like RedBook, and thus maintaining databases inferior to those in well-established foreign markets.

• For financial institutions, ALG can evaluate their portfolios by analyzing residual value risks, rates of return, and market data, which helps them maximize their profits from auto investments of controllable risks.

• For auto manufacturers, ALG can enlighten them on the determinants of their residual value to prepare brand-specific strategies, and optimize product lifecycles. All is done to increase the residual value of their vehicles and promote their competitiveness for better sales.

• For companies keeping a large fleet of vehicles, ALG can analyze their depreciation rates and resale value to help them more accurately control costs and increase profits.

However, in a well-established market housed by third-part residual value management agencies, residual value risks remain as major challenges - real residual value inevitably deviates from estimates. Take 2006 year model SUVs in 2008 as example.

Source: www.leaseguide.com

Figure 5 A Virtuous Cycle of Leasing & Used Vehicle Markets


Well-established leasing market

Provide used vehicles

Increasing penetration rate of lease products supports supply of off-lease vehicles for resale.

Vehicle availability contributes to the establishment of a functional residual value identification

mechanism, which in turn benefits the competitive pricing of lease products.

Well-established used vehicle market

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More refinancing instruments & expanding auto financeAuto leasing business is representative of the asset-heavy industry. It requires large investments in location establishment and vehicle procurement as well as massive input into marketing. Long-term contracts and languish capital retrieval, together with substantial follow-up funds for vehicle replacement, have added to the high debt ratio typical of the industry.

Currently, leasing companies mainly rely on equity and debt financing sources. Given limited domestic refinancing, however, it’s impossible for the combination of equity and debts to be realized in the short run. Equity financing comes with good governance structure and managerial expertise but, in the process, takes over a few shares owned by founders and the management. In debt financing, leasing companies are required to work with banks on detailed registration of financed vehicles unless convincing collateral from shareholders or real estate is provided. The procedures are so laborious that they actually keep banks away. In the future, multiple financing options, like asset-backed securities, corporate bonds, and finance bills, will prove to be effective in cutting financial expenses and broaden leasing business.

In the meanwhile, one of the main reasons for financial institutions’ hesitation in stepping into auto leasing is the risk in residual value estimate. As mentioned above, lack of a well-established residual value market and competent third-party evaluation agencies has disabled financial institutions to evaluate the residual value of vehicles to determine specific financing. In the future, with the improvement of used vehicle markets and establishment of professional residual value evaluation agencies, financial institutions, mainly comprised of commercial banks, can refer to reliable residual value estimates and thus provide larger amounts of more flexible financing for the leasing industry.

Facilitation of cooperation for development of auto leasingCurrently, different parties to the financial leasing business have their own advantages and disadvantages. Manufacturers have established widespread locations and service networks, but their influence beyond their own brands is little. Dealerships are well-connected but lacking in

sufficient funds, so much so that they have to purchase vehicles from external sellers. Despite their disadvantages, leasing companies are leading in fund sources, expertise, geography, and project information. Therefore, participants are seeking partnerships with each other to exploit their strong points hoping to create a more competitive leasing business model. Successful practices have been reported:

• Commercial vehicle manufacturers with financial leasing companies: the latter, on the former’s recommendation, buy products from dealerships and lease them to clients who can pay by instalments until the end of lease term. Financial leasing companies, with their vehicle management systems, asset management ability, and financial strength, have helped manufacturers promote commercial vehicle sales, and satisfy clients and their urgent needs.

• Dealership groups with financial leasing companies: the latter buy vehicles from the former who provide collateral for individually registered contracts. Dealership groups are responsible for material collection, credit investigation, and contract signing at early stages of financial leasing and overdue payment collection. Financial leasing products have lowered the threshold for vehicle purchase and increased sales for dealerships. Meanwhile, leasing companies are able to cut costs of establishing locations by collecting materials and overdue payments.

At a time when the automobile market returns to its normal growth rate and sales of new vehicles keep slipping, financial leasing is effective in lowering the threshold for consumers to buy vehicles, and promoting new vehicle sales which in turn brings aftermarket services. As a new profit source, it also helps operating leasing realize wholesale. However, flawed regulations, wobbly social credit and risk management systems, and lack of residual value market and functional exit mechanism have been preventing lease products from demonstrating its advantages over other auto finance products. That explains why China’s auto leasing industry remains stuck in its early stages of development with a small group of leasing companies, dealerships, and manufacturers as active participants. However, the industry’s huge potential has encouraged its players to engage in complementary partnerships in pursuit of a more competitive business model.


• China’s used vehicle market maintains fast yet steady growth, presenting hug potential.

• Contributors and limitation to the market development coexist, and commercial innovation will surface as the regulation loosens in the future.

• Car-purchase restrictions are about to stimulate the used vehicle market, while tougher environmental policies will place limitations.

• China’s auto finance, still in its infancy, is in urgent need of business changes and financial innovation.

Abstract:

Used Vehicle Financing

16

Figure 6 2005-2013 China’s Yearly Trading Volume of Used Vehicles

Industry overviewChina’s used vehicle market maintains fast yet steady growth, presenting hug potential.Since 2009, the market has been steadily growing. In 2012, 4,790,000 vehicles were traded, a 10.60% increase compared to 2011, worth RMB 263,626 million, a rise of 25.01%. By the first half of 2013, the national trading volume reached 2,312,900 vehicles worth RMB 112,918 million, up by 18.48% and 28.17% respectively. According to a recent estimate by China Automobile Dealers Association (CADA), used vehicles traded in 2013 would increase by 20-25%, or 6-6.5 million vehicles.

The supply of used vehicles mostly depends on the motor vehicle parc. By the end of 2012, recent years’ high growth had pushed the parc up to 120 million. Meanwhile, consumers are keeping their vehicles for a shorter time, which ensures the effective supply of used vehicles. On the other hand, as the market improves and consumer mindset changes, used vehicles are gaining more and more acceptance.

231

479

433

385

334

274266

191

0

100

200

300

400

500

0

5

10

15

20

25

30

35

40

2005

145

2013H12012201120102009200820072006

Source: China Automobile Dealers Association

Traded used vehicles Yearly growth rate

10,000 vehicles %


Figure 7 China’s Motor Vehicle Parc

In well-established US and European markets, traded used vehicles account for approximately 20% of the automobile parc, 2-2.5 times the new ones sold. According to data collected in 2012, the proportions were respectively 4% and 20-30%, which to a great extent reflects the market’s rather huge potential in the future. By the end of 2011, Tencent Auto and Sinotrust had found that nearly 80% of the interviewed Chinese consumers would consider buying used vehicles.

Prospects of used vehicle marketMultiple contributors to rapid developmentChina’s vehicle parc has been soaring and reached 120 million in 2012. The acceleration will continue in the next few years: it’s expected to hit 25 million around 2020, most of which are for civilian purposes. In the meantime, used vehicle sales will be stimulated.

Urbanization and income increases of urban residents are also important contributors. Judging from international experience, urbanization will accelerate the transformation to an automotive society and encourage vehicle consumption. For new migrants in urban areas, affordable used vehicles are a better choice. In 2012, as China’s rate of urbanization had reached 52.57%, urban per capita disposable income had risen to RMB 24,565, making an average used vehicle worthing RMB 50,000 much more affordable. It’s estimated that, by 2020, the urbanization rate would climb to 60% along with an urban population of 800 million with its yearly increase of 13 million.

Meanwhile, the central government has launched initiatives to double the incomes of urban residents. In the context of vehicle prices remaining noticeably unchanged, a huge demand for used vehicles is inevitably growing.

Consumers are more tolerant of used vehicles. According to a recent China Automobile Dealers Association study on potential buyers, nearly 80% of them said they would consider used vehicles, and only 5% ruled out the idea. Lower prices are the most attractive factor. Also, new drivers prefer used vehicles to develop their driving skills.

The advance of financiale leasing has contributed to the prosperity of used vehicle markets. Amid ongoing financial reforms, the financiale leasing industry has been opened even wider. In May 2013, Ping An Leasing and Ping An Asset Management signed a memorandum of cooperation in Shanghai, marking the first injection of insurance funds into China’s financiale leasing industry to ensure its fast growth in the future. Of all market-based products, related financiale leasing will facilitate used vehicle sales. On the other hand, auto manufacturers will advocate financiale leasing to promote the sales of new vehicles. After the lease term, a group of used vehicles retaining their ownership will be handed over to dealerships for resale. This extra vehicle source complements the market supply which, along with rising demand, increases the trading of used vehicles and promises prosperity.

Source: China Automobile Dealers Association

240 millionIncluding automobiles & motorcycles

As of 30 January 2013

260 millionAs of 30 January 2013

Motor Vehicle Parc

Automobile (100 millions)Motorcycles (100 millions)

Automobile drivers (100 millions)Others (100 millions)

1.2 1.22.0

0.6

Over one million in 18 medium-sized and big cities, as of 30 January 2013Over two million in Beijing, Shanghai, Tianjin, Shenzhen, and Chengdu, by the end of 2012

•

•

Motor Vehicle Drivers Automobile Parc

18

The government may come up with more favorable policies to regulate and promote the used vehicle market. In 2013, at the 4th annual meeting of the Global Automotive Forum in Wuhan City, Pang Qinghua, board chairman of Pang Da Automobile Trade Co., Ltd., said that “The used vehicle industry is actually burdened with existing taxation. The China Association of Automobile Manufacturers has talked with national authorities who may soon introduce favorable policies.” If and only when the promise is delivered, taxation will loosen up on used vehicle trading with more preferential policies, giving further impetus to the booming market.

Limitation to the market remains.It’s almost impossible for used vehicle companies to grow into the size of a group to realize scale effects. Currently, the government taxes a used vehicle at 1.48% worth of its estimated price. Tax rates may vary in different parts of the country, but they all fall under the government standards. To avoid taxes, dealerships choose to register the vehicles under private accounts, which increases their own internal risks and proves to be unattractive to investors. Currently, the used vehicle industry is surprisingly divided with a great number of minor dealers operating in local areas.

Conditions of used vehicles can hardly be traced. A 4S dealership is authorized access to any other dealership of the same brand for databases tracking any vehicle of the brand in question that has sought repairs service, while access to other brands is impossible. When the warranty expires,

on the other hand, most of the owners would chose an unauthorized garage, which makes it impossible to track that part of information. All that mentioned has disabled the used vehicle to be properly priced, and contributed to the consumer mindset that prices of used vehicles are a mess that lacks transparency. Without a reliable evaluation agency, consumers unfamiliar with automobiles are unable to get a detailed picture of the vehicle concerned.

Limited warranty coverage fuels customers’ concerns over the vehicle conditions. Despite the Measures for the Administration of the Circulation of Second-hand Automobiles requiring dealerships to provide after-sale service, it’s common practice for them not to deliver such promises. It minimizes their risks at the expense of consumers’ lawful rights, and contains their acceptance of used vehicles. Even if dealerships are willing, to say the least, they’re technically incompetent to satisfy the needs of consumers. In this context, it’s difficult to develop authoritative and accurate estimates of the residual value, discouraging consumers to buy.

Transactions to be completed in separated places cause trouble in procedures like logistics and ownership transfer. For new vehicles, dealerships simply move them from manufacturers to their own parking facilities, and then hand them over to consumers. When it comes to used ones, they have to bring together vehicles from different sellers based in various areas, which discouragingly challenges logistical arrangements and transaction convenience. Ownership transfer, from purchase to license plate registration, has to deal with a dozen of different authorities to go through necessary formalities, not to mention differentiated regulations imposed where the used vehicle concerned is being registered. To meet the mounting needs for trans-regional transactions, a functional industrial chain of purchase, transfer, and resale has been established.

In conclusion, contributors and limitation to the market development coexist, and commercial innovation will prosper as the regulation loosens in the future.


Table 13 Business Models of Leading Manufacturers’ Used Vehicle Sales

Brand CPO Non-CPO Other

BMW √ - -

Mercedes-Benz √ - -

Audi √ √ √

Volkswagen √ √ -

Toyota √ √ √

GM √ √ √

Nissan √ √ √

Peugeot √ √ √

Infiniti - - -

Hyundai - - -

Regulations governing the used vehicle industryCar-purchase restrictions are about to stimulate the market, while tougher environmental policies will place limitations.Traffic problems resulting from proliferating vehicles have urged big cities like Beijing and Guangzhou to impose car-purchase restrictions over the past few years, putting a ceiling on the number of newly issued license plates. Beijing has gone so far that it has put restrictions based on the last digit of a license plate number. Therefore, consumers only buy new vehicles after they have sold the old ones to the second-hand market. Beijing, for example, traded 700,000 used vehicles, nearly 1.2 times the new ones.

By the end of 2012, Beijing reported an automobile parc of 5 million, with Shanghai and Guangzhou both posting 2 million, all together totaling 9 million. Imagine when the ratio of traded used vehicles to the aggregate parc meets the qualification of a mature market at 20%, the three cities alone can trade nearly 2 million used vehicles.


On the other hand, economically developed first and second tier cities have been introducing new policies against air pollution. As registration of used vehicles that fail to satisfy national emission standards is either limited or denied, the market suffers from some uncertainties. The legislation has negative impacts, pushing good bargains aside to neighboring markets.

Competition in used vehicle industryNew players are entering and changing the competition landscapeSuch markets used to be dominated by a big group of local agencies. An isolated agency is usually small-sized with limited sources. In recent years, the landscape is gradually changing with the emergence of new participants. Listed below are a few trends worthy of attention.

1. Leading auto manufacturers have entered used vehicle market engaging in:

• Certified Pre-owned car (CPO)

• CPO & Non-CPO

• CPO & vehicles under different brands

20

Financing fuels consumption of used vehicleAuto finance accelerates market developmentUsed vehicle financing offers products designed for different participants in various parts of the industrial chain. It includes loan arrangements and warranty extensions.

In the future, used vehicle financing will target consumers to provide loans and warranty extensions. However, its availability to dealerships in light of wholesale loans like inventory financing is hardly insured – they’re not yet considered as normal small and mid-sized companies. AKD, for example, takes out loans from banks, and uses its fixed assets as collateral in exchange for a 10% discount on interest rates and RMB 50 million credit limits. Two of the main reasons why above-said dealerships find it difficult to use vehicles in store as collateral are:

• Financial institutions are incompetent to evaluate vehicle conditions for reasonable prices.

• Short term loans for dealerships have deprived banks of more profits from credit products. Offering of a loan for each vehicle requires a lot of evaluation efforts at high expenses, which discourages banks to follow through such services.

1. Studies on leading manufacturers in second-hand sales business found that:

• Most of foreign manufacturers or joint ventures have entered the business and offered certification services, while their domestic competitors are basically staying out of the business.

• Among foreign manufacturers, a few of luxury brands offer certification exclusive to their own brands. Mid-range manufacturers are engaged in a variety of brands, trading not only their own CPOs and Non-CPOs, but also used vehicles of other brands.

2. Online used vehicle trading is booming.

• Used vehicles are collected from 4S dealerships and then their information is posed online, which makes the trading more transparent and streamlined. It’s worth noting that some dealers would hand a selection of more functional vehicles of the same brand to their own dealerships for resale, which keeps order in the market’s supply and sales practices. With technical advances and commercial innovation, tools have been introduced for remote testing.

3. A few specialized used vehicle dealership groups like AKD Luxury Cars Mall are growing.

• AKD was founded in Shenzhen in 1999, and has developed into the largest of its kind in Southeast Asia. It’s designed to house 3,000 mid-range and luxury cars. In 2011, AKD sold over 5,000 cars, and is planning to reach out to cities like Shanghai. AKD is engaged in purchase, sale, evaluation, mortgage loan, and insurance brokerage, as well as housing a vehicle administration office for ownership transfer, traffic ticket payment, and annual testing. It also offers a wider range of services like aftersales repairs, maintenance, and accessories.

Figure 8 Used Vehicle Financing


Service providers BanksMicro loan lenders &

banks

Insurance companies

Banks & financial leasing

companies

Collateralloans

Warehousefinancing

Used car loans

Insurance

Dealerships

Buyers

Search Procurement Transport Storage Transaction DistributionWarrantyExtension

Testing & certification


Table 14 Features of Leading Used Vehicle Financing Providers

Business models of used vehicle financing of different companiesJudging from the credit forms on which loans are based, companies that offer financial services for used vehicles fall into two categories:

1. Vehicle-based: companies like GMAC-SAIC and China Grand Auto base their loan decisions on their own industry expertise and understanding of the vehicle conditions.

2. Borrower-based: lenders like Ping An Bank base their loan decisions on borrowers’ credit histories.

The two models are still in their infancy, and the competition landscape remains to be seen. The full realization of the business’ potential without double closely correlates with active financial innovation.

Status quo & visions of used vehicle financingBusiness changes and financial innovation are essential to market developmentUsed vehicle financing is faced with several limitations – higher loan risks, a much smaller

GMAC-SAIC China Grand Auto Ping An Bank

•Oldest and largest of its kind, operating in over 300 cities

•Efficient procedures taking only 2 days or more

•Multiple loan plans, and flexible payment arrangements

•Down payment as low as 30%; loans starting at RMB 30,000

• Financing maturities as long as 1-3 years (no more than 6 years after the vehicle’s first use)

•No brand-specific restrictions

•Provision of one-stop loan, insurance, and transaction services

•House properties not required for application

•Efficient approval, ideally on the same day of application

• Loans transferred as soon as the first business day on receipt of required documents

•Credit limits as generous as RMB 5 million for a single loan application

market, a rather small loan at high costs and with few profits, no used vehicle-specific evaluation agencies, vehicle instability, and high residual value – which explains the market’s slow development. In the long run, however, as vehicles are more often replaced and the residual value of the used ones increases, used vehicle trading value and its attraction to financial instructions will gradually mount. When other problems are duly addressed, used vehicle sales and financing will surely get on the fast track.

Still, used vehicle financing, credit business in particular, requires the advance of condition evaluation, residual value management, and credit line grading. Evaluation agencies, micro loan providers, and small and medium-sized company-specific lenders need to work together for the improvement of such a business model, and innovate more targeted and risk-controllable products for dealerships and consumers. When it comes to warranty extensions, manufacturers, dealerships, and insurance companies should join hands to regulate market practices and develop a China-specific model.

22

• China’s auto insurance industry is highly centralized with China Life Insurance, Ping An Insurance, and China Pacific Insurance seizing two-thirds of the market.

• On a fast growing market, most companies are challenged by insufficient profitability.

• Auto insurance is categorized as compulsory traffic accident liability insurance (CTALI) and commercial insurance.

• The launch of Zhong An Online Property Insurance has announced that the Internet, unlike the traditional dealerships and the bank insurance model, will be a game-changing auto insurance provider.

• Auto insurance extensions and the big data are going to have far-reaching effects on the auto insurance industry.

Abstract:

Auto Insurance


Figure 9 2011 Auto Insurance Market Analysis

Industry overviewStrictly speaking, China’s auto insurance goes back to the 1980s. However, it was not until July 2006 that the China Insurance Regulatory Commission (CIRC) promulgated the Regulations on Compulsory Insurance regarding the Liability in Traffic Accident of Motor Vehicles, and imposed traffic accident liability insurance on vehicle owners, marking the birth of the country’s auto insurance industry. Before the promulgation, the market was small and divided, making up only a small proportion of the non-life insurance. After the CTALI’s introduction, 7.3 million vehicles were immediately covered and helped the auto insurance market to develop into its current landscape.

The CTALI is designed as the most fundamental liability insurance that helps avoid the industry-wide losses resulting from lack of insurance contracts to reach the break-even point. Also, the CTALI also determines the country’s one and only insurance rate. Premiums are determined according to the floating rates as well as the vehicle size and usage, plus additional payments for traffic violations and accidents.

The CTALI is a huge stimulator for the voluntary insurance market. It changes consumers’ expectations, and also helps insurance companies enter the market. In 2007, the CIRC announced regulations on commercial vehicle insurance, which covers multiple risks excluded by the CTALI, including driver/passenger liability insurance, damage insurance, and theft/robbery insurance. The regulations in question include four categories of insurance and details like indemnity rates and premiums.

Over the past 5 years, the explosive growth of the vehicle parc and the introduction of the CTALI have ensured a yearly increase of 25% of auto insurance sales. Although the vehicle parc and sales have been growing at a smaller rate, the auto insurance market as a whole has maintained its momentum thanks to increasing luxury automobile sales and insurance consumption.

China’s auto insurance industry is highly centralized with China Life Insurance, Ping An Insurance, and China Pacific Insurance (CPIC) seizing two-thirds of the market. The top ten players have reported sales that account for nearly 90% of the market’s total. The policy changes in 2012 have allowed foreign companies to access to the CTALI. It is said that, they occupied only 0.5% of the market in 2011.

Years of fast growth haven’t helped auto insurance companies earn profits. It wasn’t until 2011 that the top three began to turn profits. However, intensifying competition and changing regulations have been preventing most companies from developing sustained profitability.

Instead, earlier investments brought by rapid growth and resulting business operations haven’t proved to be satisfyingly profitable. Therefore, solvency has become a major concern for insurance companies. Over the past few years, some of them have resorted to subordinated debts and premium splits, hoping to curb impending financial shortage. However, lack of mid and long-term funds remains persistent.

Source: 2012 Yearbook of China’s Insurance

Others

China Life37%

19%

CPIC

Ping An

14%

Top 4-1019%

11%

24

In addition to sales agents as major platforms, insurance companies are also seeking other channels like direct selling, telemarketing, and cyber-marketing. New marketing choices are expected to help gain market shares and cut customers’ costs, which eventually further increases the overall incomes and splits the costs.

Product AnalysisAnalysis of major insurance categoriesInsurance for motor vehicles is comprised of compulsory traffic accident liability insurance (CTALI) and commercial insurance.

The CTALI requires insurers, within the liability limits, to indemnify the victims of the insured vehicle’s accident (driver/passengers and insurants of the vehicle in question are excluded) for any injury, death, and property loss. The CTALI is the first of its kind required by a Chinese national law. Promulgated on 1 July 2006, it was introduced nationwide on 1 July 2007. The CTALI sets up 42 basic rates, and a single national rate applies to an entire vehicle category.

Commercial insurance includes primary insurance and additional insurance. The former is subdivided into vehicle damage insurance, third-party liability insurance, theft/robbery insurance, and driver/passenger liability insurance; the latter covers broken windshield/window insurance, scratch insurance, spontaneous ignition insurance, With

Figure 10 2011 Auto Insurance Market Analysis Average (WA), no-fault insurance, and Irrespective of Percentage. Broken windshield/window insurance, spontaneous ignition insurance, and additional equipment damage insurance are additional insurance terms affiliated to vehicle damage insurance that has to be bought first. Driver/passenger liability insurance, no-fault insurance, and cargo liability insurance are affiliated to third party liability insurance that has to be bought first.

Compulsory traffic accident liability insurance for motor vehiclesThe Regulations on Compulsory Insurance regarding the Liability in Traffic Accident of Motor Vehicles, promulgated on 1 July 2006, stated that owners or custodians of motor vehicles driving on roads within the territory of the People’s Republic of China are required to buy compulsory traffic accident liability insurance for their motor vehicles.

Currently, indemnity limits for an insured motor vehicle at fault are set at RMB 110,000 for injury and death, RMB 10,000 for medical care, and RMB 2,000 for property damage; otherwise the limits are RMB 11,000, RMB 1,000, and RMB 100.

The CTALI calculators:

Final premiums = basic premiums × (1 + floating rate applicable to traffic accidents) × (1 + floating rate A applicable to traffic violations)

Floating rate calculators:

A1: -10%, not responsible for any traffic accident over last calendar year

A2: -20%, not responsible for any traffic accident over last two calendar years

A3: -30%, not responsible for any traffic accident over last three calendar years

A4: 0%, responsible for one traffic accident (causing no death) over last calendar year

A5: 10%, responsible for two traffic accidents (causing no death) over last calendar year

A6: 30%, responsible for any death-causing traffic accident over last calendar year

Source: 2012 Yearbook of China’s Insurance

Indemnities/premiums

Top 3

Top 4-10

Others

0

40,000

80,000

120,000

160,000

0% 20% 40% 60% 80% 100%


Table 15 Commercial Insurance List

Vehicle damage insurance

One of the most common insurance whereby the insurer, according to the insurance contract, indemnifies the insurant for any damage to the insured vehicle incurred by natural calamities (not including earthquakes) or unforeseeable accidents within insurance coverage.

Third-party liability insurance

The insurer indemnifies the insurant for any financial responsibility that shall be borne according to the law, which causes bodily injury or death, or direct property loss of a third party incurred by an unforeseeable accident caused by the insured vehicle driven by a qualified driver.

Theft/robbery insurance

The insurer, according to the insurance contract, indemnifies the insurant for the insured vehicle being registered missing by a police authority above county level three months (or 60 days according to the life insurance) after theft, robbery, and illegal seizure activities, or for any damage or repair to any part and accessory equipment during such criminal activities.

Driver/passenger liability insurance

The insurer indemnifies the insurant for any expense cause by bodily injury or death of the driver or passenger in the insured vehicle in an accident, and for any expense for any necessary rescue or protection efforts to minimize the costs.

Broken windshield/window insurance

The insurer indemnifies the insurant for any broken windshield or window alone of the insured vehicle in use. Any other damage in the same said accident shall be covered by vehicle damage insurance.

Spontaneous ignition insurance

The insurer indemnifies the insurant for any damage to the insured vehicle in motion and any reasonable rescue expenses incurred by spontaneous ignition caused by malfunctioning electrical equipment, wires, and fuel supply system, or by goods in carriage.

Scratch insuranceThe insurer indemnifies the insurant for any expense for repairs to scratches on the insured vehicle in use without notable signs of collision by a third party.

Irrespective of percentage insurance

The insurer gives the insurant a full refund for purchasing vehicle damage insurance, third-party liability insurance, and driver/passenger liability insurance during the period of irrespective of percentage.

Additional equipment damage insurance

The insurer indemnifies the insured vehicle for any direct damage to its additional equipment caused by any accident.

Vehicle lay-off loss insurance

The insurer, according to the insurance contract, indemnifies the insured vehicle for any loss incurred by its lay-off at a repair facility after an unforeseeable accident.

Cargo liability insurance

The insurer, according to indemnity limits stated by the contract, indemnifies the insurant for any financial liability for a third party’s bodily injury, death, or direct property loss incurred by falling cargo of the insured vehicle in carriage.

No-fault insuranceIn case the insured vehicle in use causes any bodily injury, death, or direct proper loss in any traffic accident involving pedestrians or non-motor vehicles, and should the insured vehicle not be held liable, the insurer indemnifies the insurant, after his/her request for refusal of the payment is denied, for the paid yet irretrievable expenses.


26

Regulations governing auto insuranceOver the last two years, the CIRC has announced two sets of important policy adjustments. The first, put in force in May 2012, allows foreign companies to enter compulsory traffic accident liability insurance. The second, promulgated in March 2013, requires more control over commercial insurance rates and contract terms. Apart from a few additional compulsory terms in favor of consumers, it gives away more autonomy of commercial vehicle insurance pricing to well operating big companies.

Since the CTALI is subject to compulsory price controls, insurance companies have no choice but to sell it at a loss, and bundle it into more profitable commercial vehicle insurance. Over the past few years, the CTALI has estimatedly inflicted on insurers billions of losses in total. The insurance companies, however, sees the CTALI as a stepping stone to reach clients and thus continues the practice, which makes clients purchase the CTALI and commercial vehicle insurance package.

Over the past few years, foreign insurers were unable to sell the CTALI, which explains their little participation in the auto insurance market. Now, with the introduction of the mentioned first policy adjustment set, they have been able to compete more effectively. Although industry experts find it impossible for them to take up more of the market on their own, active acquisition and merger strategies will be helpful to that end. Another possibility is that they may want to partner with auto companies of their own country as their choice insurance provider to noticeably elevate their market position in China.

The long-awaited policy liberalization has created opportunities for leading players in commercial vehicle insurance, who in compliance are able to adjust pricing and venture into subdivided markets. Small players can more actively respond to competition by securing other differentiated markets, but they as a whole are at a disadvantage.

Analysis of auto insurance sales channelsAuto insurance is often sold through auto dealerships, or bank insurance, a partnership between insurance companies and financial institutions like banks.

Consumers prefer convenience and thus usually go for insurers recommended by auto dealerships where they’re purchasing new vehicles. Moreover, clients who decide to take out loans are targeted by their own lenders (like banks) to market insurance products, a practice that streamlines application procedures and quickly sells the insurance. In case a bundled insurance contract expires, consumers will choose to go directly to their insurers for renewal.

Bank insurance is an important model for life insurance that makes up 50% the total sales. In contrast, auto insurers are more reliant on dealerships instead of banks. One of the reasons is that auto loans in China are not quite popular, and dealerships are able to make more preferential offers in doing so. Studies have found that auto insurance companies prefer dealerships, and telephone/online marketing is even more acceptable than banks. By establishing partnerships with dealerships, insurance companies are more confident of reaching out to buying clients.

It’s worth noting that the launch of Zhong An Online Property Insurance in February 2013 has announced that the Internet will become another sales platform for auto insurance. On 29th September 2013, the China Insurance Regulatory Commission announced its approval to establish the insurance company.


Figure 11 Zhong An Ownership

What’s special about Zhong An is that it doesn’t open offices in any other place in China than Shanghai where it was registered. Its sales and indemnity processes are conducted completely online. The company is engaged in liability insurance and guarantee insurance which, compared with traditional auto insurance, have limited coverage but generate much more profits. This business model has proved to be a major breakthrough of Ping An Insurance and the Internet-based financial innovation.

Currently, Chinese insurance companies are struggling with bottlenecks of highly homogenized products and channels as well as lack of competitiveness. The arrangement benefits all participants. Ping An Insurance is able to explore financial marketing reforms and diversify away from the stereotypes, while exploiting the potential of reaching out to hundreds of millions of client resources of Alibaba and Tencent. On the other hand, giants outside the insurance industry, like Alibaba and Tencent, are thus able to exploit their large pools of clients and funds to engage in a second round of exploitation of their financial operations. Ping An Insurance's affiliated bank and subsidiaries covering securities, trust, funds, and life insurance (auto insurance included), can all be turned into online clients.

Development of auto insurance extensionsAuto insurance extensions, including second-hand vehicle insurance, began around 2008 in China. The past few years’ fast development has drawn wide attention. It’s estimated that the market penetration rate of China’s insurance extension business is below 5%, in sharp contrast to 30% enjoyed by a mature market. This category of service is provided through tree partnerships between:

1. Manufacturer-affiliated insurance companies and manufacturers

2. Independent service providers with manufacturers

3. Independent service providers with dealerships

Table 16

Manufacturer Model Plan Details

All 21 yr/120,000 km2 yrs/140,000 km3 yrs/160,000 km

Chevrolet & Buick series

31 yr/20,000 km2 yrs/40,000 km3 yrs/60,000 km

Teana, Sylphia, X-trial, Qashqai

11 yr/20,000 km2 yr/40,000 km

Civic, Spiror, CRV 11 yr /30,000 km2 yrs/60,000 km

New Elysee, sega, C5

11 yr/20,000 km2 yrs/50,000 km

207, 307, 408 11 yr/20,000 km2 yrs/50,000 km

All 21 yr/20,000 km2 yrs/40,000 km


In the future, the increase of the vehicle parc will encourage manufacturers and dealerships to promote the insurance extension service. Offering consumers better experiences, the business is expected to prosper in China.

20%

Ping An Insurance

TencentCtrip

15%

15%5%

Others

Alibaba

45%

28

Effects of big data on auto insuranceA popular theory in the insurance industry states that a driver with a good history deserves discounts on premiums. In the past, incompetent techniques and computational theories were limiting data analysis to a driver’s existing accident records. With technological advances and the establishment of big data theories, tracking of driving patterns has featured meticulousness and accuracy. Now, insurance companies build actuarial techniques on existent records, and apply them to put clients into different risk categories, which helps the determination of insurance premiums. The cellular technology, Internet features, and big data have enabled insurance companies to develop more accurate evaluation of driver-based risks, and ask for more reasonable premiums based on their real driving patterns.

In recent years, there has been limited innovation of the market’s major products. In well-established markets, the segmentation strategies have widely lowered prices of insurance products. The emergence of big data may turn out to be the most influential change: in the future, premium discounts are likely to be determined by multiple factors like locations, driver habits, and his/her driving age. Insurance companies may add a small device to a vehicle’s OBI part, which is designed to track the entire driving information and send it to insurers' data centers through cellular connections. According to the collected data, insurance companies are able to keep better track of risk-inducing habits, like acceleration and braking frequencies, average and peak velocities, and driving time length and frequency, which are combined with other factors to help them more accurately determine the risks of a driver's involvement with accidents.

The technology is likely to slash premium costs. The first companies to use this device will charge drivers with good habits fewer premiums, a move that secures competitiveness and attracts more clients. At the same time, it’s believed that the pros and cons brought by client-based insurance policies have created a reverse selection mechanism, where drivers with bad habits prefer companies employing traditional actuarial techniques – for them, client-based companies charge more. This mechanism has urged competitors to either impose higher average interest rates, or turn to client-based techniques. Whatever the choice is, the application of client-based insurance techniques will increase transparency, cut risks, and finally lower insurance rates.

For consumers, they’re offered what they believe is more reasonable and controllable. For insurers, first-hand evaluation of driver behaviors, instead of the frequency of claim application, helps them cut down indemnity costs. The differences come from the system’s screening process (e.g. a good driver would prefer this system), and the driver’s wish to behave knowing that he’s under watch. For regulators, the mechanism makes roads safer and more environment-friendly, which is what they like to see.


• After two years (2011 and 2012) of high growth, China’s auto industry noticeably slowed down in 2011 and 2012. The year 2013 has seen an improvement, but a lower growth rate is in sight in the long run.

• The market’s value chain has shifted its pre-sales focus to after-sales services. Auto finance have proved to the next profit source of interest to manufacturers and other market participants.

• In auto finance, participants are not going to be limited to traditional players, and outside companies will join to take their shares.

Abstract:

Conclusion & outlook

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Booming auto sales decelerate, and value chain is noticeably shifting to the aftermarket.After two decades of development and recent years (2009 and 2010) of high growth, China’s auto industry noticeably slowed down in 2011, and market is expected to see an even lower growth rate in the future.

1. The market's inelastic demand is being satisfied while alternative consumption, or elastic demand, has been absorbed into the mainstream with increasing chances of market fluctuations.

2. Dealerships have established almost saturated networks so that it’s impossible for manufacturers to increase their sales by opening up networks and building large inventories.

3. Rising costs of labor and raw materials have encouraged automobile prices to increase rather than slip deeper.

4. Worsening traffic has urged big cities to impose car-purchasing restrictions.

Figure 12 Distribution of profit contribution in well-established markets

For auto manufacturers or dealerships, profits from traditional repairs services and new vehicle sales are to be squeezed by increasing competition. Judging from the distribution of value chains in foreign markets, similar trends are expected to take place in China. It’s inevitable that manufacturers, dealerships, and banks put more focus on the aftermarket where participants can realize more of their potential.

The figure below shows that auto insurance, leasing and rental, and used vehicle sales generate considerable profits, and they’re all closely related to auto finance.

More and more companies are participating in the auto aftermarket.Traditionally, auto manufacturers, component makers, and dealerships are the main three players in the industry, while financial institutions like banks are engaged in providing funds, and auto insurers and car rental companies playing in their own industries. However, it’s going to all change in the future.

Manufacturers and dealerships are opening up more business instead of being limited to their own traditional operations. It has been noticed that a few leading manufacturers, including Volkswagen and Nissan, as well as large dealerships like Pang Da Automobile Trade Company are venturing into new business and, in the process, they have forged external partnerships to gain funds and experience and split risks.

25%

20%

15%

10%

5%

0

(Profit contribution %)

New vehicle sales

Auto financial leasing

Used

Car loans

Aftersales service

Repairs &Maintenance

Auto operating leasing

Fixed gas pricing

Auto insurance

0% 100%

Source: Harvard Business Review; Deloitte Analysis

Componentsales


Companies formerly outside the auto industry are joining with the shift of the market’s value chain. A foreseeable case is that, with the emergence of automobiles fueled by new energies, battery makers are becoming main providers of electric automobiles, a category that made up only a fraction of the traditional gasoline-powered vehicles. In the future, Internet companies like Google or electronic device makers like Apple are going to work with auto manufacturers on a number of big projects, providing technologies and equipment that meet the market needs. Unlike traditional component makers, these companies are in possession of considerable funds and resources, and they’re bound to take these opportunities to expand into the auto industry – Apple has been planning the launch of iCar. Meanwhile, different market players will enhance their cooperation to make better use of the existing resources. In the future, the nature of cars is going to change: more of a lifestyle, rather than a means of transport. Therefore, all those products in people’s lives will be seen in their cars.

The Internet finance will have far-reaching effects on auto finance.No longer a buzzword, the Internet finance was insufficiently defined. For the convenience of this report, the term is limited to the preparation and execution of the arrangements and agreements between fund providers and borrowers – the former are scattered, and the latter are either selling or buying on electric platforms which, connecting both ends of the trading, increase transparency and promote cooperation.

Amid dominance of the traditional auto finance, the Internet finance still has huge potential to explore. Despite their common goals of exploiting the market, the Internet finance and auto finance, not sharply divided, are challenged by some inherent friction. In addition to taking over market shares, the Internet finance is in many ways disturbing the traditional auto finance market.

In discussions about wholesale auto finance, the Internet finance plays a crucial role for auto manufacturers, authorized 4S dealerships, and used vehicle sellers. Some models are able to connect small-sized private lenders with big borrowers to explore new fund channels. Internet giants like Alibaba and Baidu are working to this end: putting together short-term small loans from private non-institutional lenders, and turning them into long-term whole auto loans in support of the working capital and daily operations like project finance. The platform is all about attracting a large number of lenders, and coordinating interest rates and principal with lenders according to contract terms. Considering the popularity of putting money at banks, the unwealthy population are short of more reasonable investment channels, which can be made up for by the Internet finance.

This financing mechanism is highly beneficial to small companies or start-ups, which need relatively small loans over a short period. Currently, these companies are financed by unofficial channels or licensed micro-credit lenders. However, they’re vulnerable to frail credit relationships as well as inflated interest rates of such small lenders, who are only recommendable to stat-up companies; instead, short-term funds are accessible for these companies through the Internet finance.

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Auto finance and the Internet finance are focusing on consumer auto finance. There’s a mechanism already in place which involves a serious of platforms to help consumers choose, apply for, and obtain car loans. Over the past few years, a great deal of websites have emerged to gather such lenders. Still, there’s no specific evidence that a single website has dominated the market or engaged in massive trading.

The mentioned mechanism is built on China-specific consumer habits: the purchase of a vehicle often involves various debts. Although buyers prefer a combination of different loans, they don’t like to repeatedly go through the application procedures. That’s exactly where online loans generate profits. Furthermore, these websites also succeed in increasing transparency and cutting interest rates.

Another replacement mechanism is taking shape – it manages relations between small private non-commercial lenders and vehicle buyers in need of loans. The mechanism manifests itself in different ways. Since lenders are not willing to give all their money to the same borrower, the diversity

of borrowers is an important determinant. To that end, a qualified platform should ensure such diversity, allowing lenders to grant small loans to multiple borrowers, or reach a loan agreement with other lenders.

Furthermore, such a platform has to verify the borrower’s personal information. Like what the traditional auto lenders have been doing, an expert team can be organized to go through the paperwork, or gain more competence in application evaluation by using big data or databases from a third-party source.

Meanwhile, to attract more borrowers, such a platform should be operated through streamlined processes for better efficiency.

In general, the Internet finance is expected to play an important role in the future’s auto finance. The trend involves new financing channels that make the Internet a principal part. For wholesale auto finance, the Internet finance will become new sources for small private lenders. While increasing transparency, auto consumer finance will increase the competitiveness of the auto finance, and cut down prices or interest rates.


Contacts

John HungDeloitte China Automotive Managing PartnerTel:+86 21 6141 1828Email: [email protected]

Winhon ChowDeloitte China Auto Dealership Managing PartnerTel:+86 10 8520 7119Email: [email protected]

Dr. Marco HeckerDeloitte China Automotive Consulting Managing PartnerTel: +86 21 6141 2298Email: [email protected]

Congjian WuDeloitte China Automotive Consulting DirectorTel:+86 10 8520 7812Email: [email protected]

Benjamin Chang Deloitte China Automotive Consulting Associate DirectorTel:+86 21 2316 6322Email: [email protected]

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