Amendment No. 1 to Form F-1
Table of Contents

As filed with the Securities and Exchange Commission on October 18, 2007

Registration No. 333-146605


SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549


AMENDMENT NO. 1

TO

FORM F-1

REGISTRATION STATEMENT

UNDER

THE SECURITIES ACT OF 1933


CNINSURE INC.

(Exact name of registrant as specified in its charter)

Not Applicable

(Translation of Registrant’s name into English)


Cayman Islands   6411   Not Applicable

(State or other jurisdiction of

incorporation or organization)

 

(Primary Standard Industrial

Classification Code Number)

 

(I.R.S. Employer

Identification Number)

19/F, Yinhai Building

No. 299 Yanjiang Zhong Road

Guangzhou, Guangdong 510110

People’s Republic of China

(8620) 6122-2777

(Address, including zip code, and telephone number, including area code, of registrant’s principal executive offices)


CT Corporation System

111 Eighth Avenue

New York, New York 10011

(212) 664-1666

(Name, address, including zip code, and telephone number, including area code, of agent for service)


Copies to:

David T. Zhang, Esq.

Latham & Watkins LLP

41st Floor, One Exchange Square

8 Connaught Place, Central

Hong Kong

(852) 2912-2503

 

Leiming Chen

Simpson Thacher & Bartlett LLP

35th Floor, ICBC Tower

3 Garden Road, Central

Hong Kong

(852) 2514-7600


Approximate date of commencement of proposed sale to the public:

If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box.   ¨

If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.   ¨                      

If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earliest effective registration statement for the same offering.   ¨                      

If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.   ¨                      


CALCULATION OF REGISTRATION FEE


Title of each class of securities to be registered   

Proposed maximum aggregate

offering price (1)(2)

   Amount of registration fee  

Ordinary Shares, par value US$0.001 per share(3)

   US$ 184,000,000    US$ 5,649 (4)

(1)   Estimated solely for the purpose of determining the amount of registration fee in accordance with Rule 457(o) under the Securities Act of 1933.
(2)   Includes ordinary shares initially offered and sold outside the United States that may be resold from time to time in the United States either as part of their distribution or within 40 days after the later of the effective date of this registration statement and the date the shares are first offered to the public, and also includes ordinary shares that may be purchased by the underwriters pursuant to an over-allotment option. These ordinary shares are not being registered for the purpose of sales outside the United States.
(3)   American depositary shares issuable upon deposit of the ordinary shares registered hereby will be registered under a separate registration statement on Form F-6 (Registration No.333-146765). Each American depositary share represents 20 ordinary shares.
(4)   Previously paid.

The Registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment which specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933 or until the Registration Statement shall become effective on such date as the Securities and Exchange Commission, acting pursuant to such Section 8(a), may determine.



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The information in this prospectus is not complete and may be changed. Neither we nor any of the selling shareholders may sell these securities until the registration statement filed with the Securities and Exchange Commission is effective. This prospectus is not an offer to sell these securities and neither we nor any of the shareholders are soliciting offers to buy these securities in any state where the offer or sale is not permitted.

 

PROSPECTUS (Subject To Completion)

Issued October 18, 2007

 

11,644,080 American Depositary Shares

 

LOGO

 

 

REPRESENTING 232,881,600 ORDINARY SHARES

 


 

CNinsure Inc. is offering 9,650,000 ADSs and the selling shareholders are offering 1,994,080 ADSs. Each ADS represents 20 of our ordinary shares. This is our initial public offering and no public market currently exists for the ADSs or our ordinary shares. We anticipate that the initial public offering price will be between $11.00 and $13.00 per ADS.

 


 

We have applied to list the ADSs on the Nasdaq Global Market under the symbol “CISG.”

 


 

Investing in the ADSs involves risks. See “Risk Factors” beginning on page 12.

 


 

PRICE $             AN ADS

 


 

      

Price to

Public


     Underwriting
Discounts and
Commissions


     Proceeds to
CNinsure Inc.


     Proceeds to
the Selling
Shareholders


Per ADS

     $      $      $      $

Total

     $                  $                  $                  $            

 

CNinsure Inc. has granted the underwriters the right to purchase up to an additional 1,746,612 ADSs to cover over-allotments.

 

The Securities and Exchange Commission and state securities regulators have not approved or disapproved these securities or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense.

 

The underwriters expect to deliver the ADSs to purchasers on or about                     , 2007.

 


 

MORGAN STANLEY

 

WILLIAM BLAIR & COMPANY    
FOX-PITT KELTON COCHRAN CARONIA WALLER
    PIPER JAFFRAY

 

October     , 2007


Table of Contents

LOGO


Table of Contents

TABLE OF CONTENTS

 

     Page

Prospectus Summary

   1

Risk Factors

   12

Forward-Looking Statements

   34

Use of Proceeds

   35

Dividend Policy

   36

Capitalization

   37

Dilution

   38

Exchange Rate Information

   40

Enforceability of Civil Liabilities

   41

Corporate Structure

   42

Selected Consolidated Financial Data

   49

Management’s Discussion and Analysis of Financial Condition and Results of Operations

   52

Industry

   80
     Page

Business

   88

Regulation

   98

Management

   105

Principal and Selling Shareholders

   112

Related Party Transactions

   116

Description of Share Capital

   118

Description of American Depositary Shares

   125

Shares Eligible for Future Sale

   134

Taxation

   136

Underwriters

   141

Legal Matters

   148

Experts

   148

Where You Can Find Additional Information

   149

Index to Consolidated Financial Statements

   F-1

 


 

You should rely only on the information contained in this prospectus. We have not authorized anyone to provide you with information that is different from that contained in this prospectus. We are offering to sell, and seeking offers to buy, the ADSs only in jurisdictions where offers and sales are permitted. The information contained in this prospectus is accurate only as of the date of this prospectus, regardless of the time of delivery of this prospectus or of any sale of the ADSs.

 

Until             , 2007, all dealers that buy, sell, or trade ADSs, whether or not participating in this offering, may be required to deliver a prospectus. This is in addition to the obligation of dealers to deliver a prospectus when acting as underwriters and with respect to their unsold allotments or subscriptions.

 

In this prospectus, unless the context otherwise requires, “we,” “us,” “our company,” “our” or “CNinsure” refers to CNinsure Inc. and any entity carrying on CNinsure’s current business prior to the restructuring transactions through which CNinsure became our listing vehicle, and their respective subsidiaries and consolidated affiliated entities; “ADSs” refers to American depositary shares, each representing 20 of our ordinary shares, par value US$0.001 per share; “China” or the “PRC” refers to the People’s Republic of China, excluding, for the purpose of this prospectus only, Hong Kong, Macau and Taiwan; “Renminbi” or “RMB” refers to the legal currency of China; and “US$,” “U.S. dollars” or “dollars” refers to the legal currency of the United States. This prospectus contains translations of certain RMB amounts into U.S. dollar amounts at specified rates. All translations from RMB to U.S. dollars were made at the noon buying rate in The City of New York for cable transfers of RMB as certified for customs purposes by the Federal Reserve Bank of New York. Unless otherwise stated, the translations of RMB amounts into U.S. dollar amounts have been made at the noon buying rate in effect on June 29, 2007, which was RMB7.6120 to US$1.00.


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PROSPECTUS SUMMARY

 

The following summary is qualified in its entirety by, and should be read in conjunction with, the more detailed information and financial statements appearing elsewhere in this prospectus. In addition to this summary, we urge you to read the entire prospectus carefully, especially the risks of investing in the ADSs discussed under “Risk Factors” before deciding whether to purchase the ADSs.

 

Overview

 

We are a leading independent insurance agency and brokerage company operating in China. With approximately 11,000 sales professionals and approximately 170 sales and service outlets operating in eight provinces as of September 30, 2007, our distribution network reaches some of China’s most economically developed regions and some of the most affluent cities in China, such as Beijing, Shanghai, Guangzhou and Shenzhen.

 

We began our insurance intermediary business in 1999 by distributing automobile insurance products and expanded our product offerings to other property and casualty insurance products in 2002. Our experience in the life insurance segment is more limited as we only began distributing individual life insurance products in January 2006. We intend to further broaden our service offerings by providing insurance claims adjusting services, such as assessment, survey, authentication and loss estimation, beginning in the fourth quarter of 2007.

 

As an insurance agency and brokerage company, we do not assume underwriting risks. Instead, we distribute insurance products underwritten by domestic and foreign insurance companies operating in China, and provide certain insurance-related services, such as 24-hour emergency services in select cities, damage assessment and assistance with claim settlement, to our customers—individuals and institutions that purchase insurance products through us. In addition, we also introduce customers to insurance companies, which then sell insurance products to them, either directly or through our affiliated insurance intermediaries. We are compensated for our services primarily by commissions and fees paid by insurance companies, typically based on a percentage of the premium paid by the insured. Commission and fee rates generally depend on the type of insurance products, the particular insurance company and the region in which the products are sold. As of the date of this prospectus, we have 21 affiliated insurance intermediaries in the PRC. Seventeen of them are insurance agencies, which act as agents of insurance companies when distributing insurance products to our customers, and the other four are insurance brokerages, which act on behalf of our customers in seeking insurance coverage from insurance companies. According to the Insurance Intermediary Market Development Reports published periodically by the CIRC, four of our affiliated insurance agencies ranked Nos. 3, 11, 14 and 20, respectively, among China’s top 20 insurance agencies in terms of revenue, together accounting for 4.87% of the total revenue of all insurance agencies in China in the first half of 2007, while one of our affiliated insurance brokerages ranked No. 17 among China’s top 20 insurance brokerages in terms of revenue, with 1.12% of the total revenue of all insurance brokerages in China for the same period.

 

The independent insurance agency and brokerage sector in China is at an early stage of development and highly fragmented. We believe this offers substantial opportunities for further growth and consolidation. We intend to take advantage of these opportunities to increase our market share by aggressively expanding our distribution network through selective acquisitions, recruitment of experienced and entrepreneurial sales agents and franchising. In particular, we intend to devote significant resources to distributing life insurance products in order to benefit from the recurring fee income they generate and to better capture the significant opportunities presented by China’s rapidly growing life insurance market.

 

Our business has grown substantially in recent years. Our net revenues increased from RMB 34.0 million in 2004 to RMB 143.7 million in 2005 and to RMB 246.5 million (US$32.4 million) in 2006, representing a compounded annual growth rate, or CAGR, of 169.4% in the three-year period. Our net loss decreased from RMB92.7 million in 2004 to RMB6.7 million in 2005, and we achieved profitability in 2006 with a net income of RMB57.4 million (US$7.5 million). For the six months ended June 30, 2007, our net revenues and net income were RMB172.6 million (US$22.7 million) and RMB58.7 million (US$7.7 million), respectively, representing increases of 61.6% and 142.8%, respectively, from the net revenues and net income for the same period in 2006.

 

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Industry Background

 

The Chinese insurance industry was the third largest in Asia and the 9th largest in the world by premium in 2006. The industry has grown substantially in recent years, with industry-wide insurance premiums increasing from RMB160.9 billion in 2000 to RMB492.8 billion (US$64.7 billion) in 2005, according to data published by the China Insurance Regulatory Commission, or the CIRC. Despite this substantial growth and scale, China’s insurance penetration rates, which measure industry-wide insurance premiums as a percentage of GDP, were only 1.7% for life insurance and 1.0% for non-life insurance in 2006, compared to 4.0% and 4.8%, respectively, for the United States. These low penetration rates relative to those of developed economies suggest that China’s insurance market has significant growth potential. We believe that continued economic growth and the aging of the Chinese population, among other factors, will drive the future growth of China’s insurance industry. In particular, we expect that changing demographics will generate substantial demand for life insurance products.

 

Within China’s insurance industry, independent insurance agencies and brokerages are referred to as “professional insurance intermediaries,” to differentiate them from entities that distribute insurance products as an ancillary business, such as commercial banks, postal offices and automobile dealerships. The professional insurance intermediary sector in China has also grown significantly in recent years. According to data released by the CIRC, total insurance premiums generated by independent insurance agencies and brokerages increased 91.0% and 36.0%, respectively, from 2004 to 2005; 22.0% and 6.0%, respectively, from 2005 to 2006; and 44.1% and 21.4%, respectively, from the first half of 2006 to the first half of 2007. We believe that there will continue to be substantial growth opportunities in the professional insurance intermediary sector for the following reasons:

 

   

China’s insurance industry as a whole has significant growth potential;

 

   

as competition among insurance companies intensifies, insurance companies will focus more on their core competencies and increasingly outsource part of the distribution of their products;

 

   

an increasing number of international insurance companies are entering the Chinese market and they tend to outsource the distribution of their products because they seek to quickly penetrate the market but lack a distribution network and sales force of their own;

 

   

as Chinese consumers become more sophisticated, they will increasingly seek a greater selection of insurance products and services from different insurance companies with the benefit of independent professional advice; and

 

   

the favorable regulatory environment will benefit professional insurance intermediaries with potential to grow into nation-wide service providers.

 

Despite rapid growth in recent years, the professional insurance intermediary sector in the PRC is still at an early stage of development and highly fragmented. According to the Insurance Intermediary Market Development Report for the first half of 2007 released by the CIRC, as of June 30, 2007 there were 1,688 insurance agencies and 318 insurance brokerages in the PRC.

 

Our Strengths

 

We believe the following competitive strengths contribute to our success and differentiate us from our competitors:

 

   

leading position among professional insurance intermediaries in China;

 

   

scalable unified operating platform;

 

   

extensive customer reach through distribution network and customer database;

 

   

attractive and differentiated performance-based entrepreneurial agent program;

 

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dynamic product offerings;

 

   

firm commitment to rigorous training and development; and

 

   

experienced management team.

 

Our Strategy

 

Our goal is to become the largest independent insurance agency and brokerage company in China and further develop our nationwide distribution network while delivering superior long-term returns to our shareholders. To achieve this goal, we intend to capitalize on the growth potential of China’s insurance industry and insurance intermediary sector, leverage our competitive strengths and pursue the following elements of our strategy:

 

   

further expand into the fast-growing life-insurance sector while continuing to grow our property and casualty business;

 

   

further expand our distribution network through selective acquisitions, recruitment of entrepreneurial agents and franchising;

 

   

further improve our unified operating platform to support future growth;

 

   

continue to strengthen our relationships with leading insurance companies;

 

   

expand our product and service offerings to meet customer needs; and

 

   

increase the use of new distribution channels.

 

Our Challenges

 

The successful execution of our strategies is subject to certain risks and uncertainties, including those relating to:

 

   

our limited operating history, especially our limited experience in selling life insurance products;

 

   

our ability to attract and retain productive agents, especially entrepreneurial agents;

 

   

our ability to maintain existing and develop new business relationships with insurance companies;

 

   

our ability to execute our growth strategy by successfully acquiring and integrating insurance agencies and brokerages;

 

   

our ability to adapt to the evolving regulatory environment in the Chinese insurance industry; and

 

   

our ability to compete effectively against insurance companies, professional insurance intermediaries and other entities that distribute insurance products.

 

In addition to the above risks and uncertainties, you should also consider the risks discussed in “Risk Factors” and elsewhere in this prospectus.

 

Our Corporate History and Structure

 

Our founders, Mr. Yinan Hu and Mr. Qiuping Lai, formed two PRC companies, Guangzhou Nanyun Car Rental Services Co., Ltd. and Guangdong Nanfeng Automobile Association Co., Ltd., initially to provide automobile-related services, such as car rental and emergency services. In 1999, we began distributing automobile insurance products on an ancillary basis. In 2001, our founders transferred their interests in the two PRC companies to China United Financial Services Holdings Ltd, or China United Financial Services, then known as China Automobile Association Holdings Limited, a newly established British Virgin Islands company,

 

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as part of a series of transactions in which Cathay Capital Group, a private equity group, made an investment by subscribing for 40% of the equity interests in China United Financial Services.

 

As part of its corporate restructuring to facilitate international fundraising, China United Financial Services incorporated CISG Holdings Ltd., or CISG, a British Virgin Islands company, in June 2004 as the holding company for its insurance agency and brokerage businesses and transferred to CISG all of its rights and interests in four PRC insurance intermediary companies it then controlled. In September 2004, Cathay Capital Group subscribed for approximately 27.8% of the equity interests in CISG.

 

In December 2005, an entity affiliated with CDH, a private equity firm, subscribed for approximately 26.4% of the equity interests in CISG. In connection with this investment, the shareholders of CISG entered into a shareholder agreement that provided for, among other things, the management of the affairs of CISG. In anticipation of this offering, we incorporated CNinsure Inc. in the Cayman Islands in April 2007. In July 2007, CNinsure Inc., on a 10,000-for-one basis, issued its ordinary shares to then the existing shareholders of CISG in exchange for all of the outstanding CISG shares. After this restructuring transaction, CNinsure became our ultimate holding company.

 

PRC laws and regulations place certain restrictions on foreign investment in and ownership of insurance agencies and brokerages. Accordingly, we conduct our operations in China principally through contractual arrangements among our PRC subsidiaries, the shareholders of two PRC affiliated entities, Guangdong Meidiya Investment Co., Ltd., or Meidiya Investment, and Sichuan Yihe Investment Co., Ltd., or Yihe Investment, and the subsidiaries of Meidiya Investment and Yihe Investment. Meidiya Investment and Yihe Investment together, directly or indirectly, hold equity interests ranging from 51% to 100% in 17 insurance agencies and four insurance brokerages. With the exception of the sole minority shareholder of Shenzhen Nanfeng Insurance Agency Co., Ltd., who is an executive officer of our company holding shares on our behalf, the other minority shareholders of the insurance agencies and brokerages majority-owned by Meidiya Investment and Yihe Investment are either founders of such company or entrepreneurial agents with whom we jointly set up such company. Most of those minority shareholders have been employed as managers and are in charge of the day-to-day operations of the insurance agencies and brokerages in which they hold minority interests. These subsidiaries of Meidiya Investment and Yihe Investment hold the licenses and permits necessary to conduct our insurance intermediary business in China. We have no equity interests in Meidiya Investment, Yihe Investment or any of their subsidiaries and rely entirely on contractual arrangements to control and derive economic benefit from these companies.

 

Our contractual arrangements with the shareholders of Meidiya Investment and Yihe Investment and their subsidiaries enable us to:

 

   

exercise effective control over Meidiya Investment, Yihe Investment and their subsidiaries;

 

   

receive a substantial portion of the economic benefits of the subsidiaries of Meidiya Investment and Yihe Investment in consideration for the services provided by our subsidiaries in China; and

 

   

have an exclusive option to purchase all or part of the equity interests in each of Meidiya Investment and Yihe Investment when and to the extent permitted by PRC law.

 

As a result of these contractual arrangements, we are deemed the primary beneficiary of Meidiya Investment and Yihe Investment and hence treat them and their subsidiaries as our consolidated affiliated entities. Revenues generated by the insurance agency and brokerage subsidiaries of Meidiya Investment and Yihe Investment altogether accounted for 56.4% of our total net revenues in 2006 and 51.0% of our total net revenues for the first half of 2007. The remainder of our total net revenues in those periods came from two of our subsidiaries, which run our operating platform, maintain our customer database and provide information about potential customers to insurance companies. Those insurance companies pay fees to these subsidiaries if those customers actually purchase insurance.

 

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See “Corporate Structure” for further information on our contractual arrangements with the shareholders of Meidiya Investment and Yihe Investment and their subsidiaries.

 

The following diagram illustrates our corporate structure as of the date of this prospectus:

 

LOGO

 

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Our Offices

 

Our principal executive offices are located at 19/F, Yinhai Building, No. 299 Yanjiang Zhong Road, Guangzhou, Guangdong 510110, People’s Republic of China. Our telephone number at this address is +86-20-6122-2777 and our fax number is +86-20-6122-2329. Our registered office in the Cayman Islands is c/o M&C Corporate Services Limited, P.O. Box 309 GT, Ugland House, South Church Street, George Town, Grand Cayman, Cayman Islands. Our telephone number at this address is +1-345-949-8066.

 

Investor inquiries should be directed to us at the address and telephone number of our principal executive offices set forth above. Our website address is www.cninsure.net. The information contained on our website is not part of this prospectus. Our agent for service of process in the United States is CT Corporation System, located at 111 Eighth Avenue, New York, New York 10011.

 

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THE OFFERING

 

American depositary shares offered:

 

By us

9,650,000 ADSs

 

By the selling shareholders

1,994,080 ADSs

 

Total

11,644,080 ADSs

 

Price per ADS

We currently estimate that the initial public offering price will be between US$11.00 and US$13.00 per ADS.

 

Over-allotment option

We have granted a 30-day option (commencing from the date of this prospectus) to the underwriters to purchase up to an additional 1,746,612 ADSs to cover over-allotments.

 

ADSs outstanding immediately after this offering

11,644,080 ADSs

 

Ordinary shares outstanding immediately after this offering

877,210,526 shares

 

The ADSs

Each ADS represents 20 ordinary shares, par value US$0.001 per share. The depositary will hold the shares underlying your ADSs and you will have rights as provided in the deposit agreement.

 

 

We may amend or terminate the deposit agreement without your consent. If you continue to hold your ADSs, you agree to be bound by the deposit agreement as amended.

 

 

To better understand the terms of the ADSs, you should carefully read the “Description of American Depositary Shares” section of this prospectus. You should also read the deposit agreement, which is filed as an exhibit to the registration statement that includes this prospectus.

 

Depositary

JPMorgan Chase Bank, N.A.

 

Dividend policy

We have no plan to pay dividends on our ordinary shares. We plan to retain any earnings for use in the operation of our business and to fund future growth.

 

Use of proceeds

We intend to use the net proceeds from this offering as follows:

 

 

•      up to US$60 million to fund acquisitions and establishment of joint ventures;

 

 

•      up to US$40 million to fund enhancement of our service systems; and

 

 
 

•      the balance to fund our working capital requirements.

 

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See “Use of Proceeds” for more information. We will not receive any of the proceeds from the sale of ADSs by the selling shareholders.

 

Nasdaq Global Market symbol

CISG

 

Lockup

We, our directors and executive officers and all of our existing shareholders have agreed with the underwriters not to sell, transfer or dispose of any ADSs, ordinary shares or similar securities for a period of 180 days after the date of this prospectus. See “Shares Eligible for Future Sale” and “Underwriters” for more information.

 

Risk factors

See “Risk Factors” and other information included in this prospectus for a discussion of risks you should carefully consider before investing in the ADSs.

 

The number of ordinary shares that will be outstanding immediately after this offering:

 

   

is based upon 684,210,526 ordinary shares outstanding as of the date of this prospectus;

 

   

excludes 5,473,684 ordinary shares issuable upon the exercise of options outstanding as of the date of this prospectus at an exercise price of RMB2.3214 (US$0.30) per share and an additional 42,000,000 ordinary shares issuable upon the exercise of options outstanding as of the date of this prospectus at an exercise price to be equal to the price per ordinary share in this offering; and

 

   

excludes 26,421,053 ordinary shares reserved for future issuance under our 2007 share incentive plan.

 

Except as otherwise indicated, all information in this prospectus assumes no exercise by the underwriters of their option to purchase additional ADSs.

 

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SUMMARY CONSOLIDATED FINANCIAL DATA

 

The following summary consolidated statement of operations data for the three years ended December 31, 2004, 2005 and 2006 has been derived from our audited consolidated financial statements included elsewhere in this prospectus. The following summary consolidated financial data for the six months ended June 30, 2006 and 2007 and the consolidated balance sheet data as of June 30, 2007 have been derived from our unaudited condensed consolidated financial statements included elsewhere in this prospectus and have been prepared on the same basis as our audited consolidated financial data. The unaudited financial information includes all adjustments, consisting only of normal and recurring adjustments, that we consider necessary for a fair presentation of our financial position and operating results for the periods presented. Our historical results do not necessarily indicate results expected for any future periods. In addition, our unaudited results for the six months ended June 30, 2007 may not be indicative of our results for the full year ending December 31, 2007. You should read the summary consolidated financial data in conjunction with our audited consolidated financial statements and related notes and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this prospectus. Our consolidated financial statements are prepared and presented in accordance with generally accepted accounting principles in the United States, or U.S. GAAP.

 

The historical results for the year ended December 31, 2004 are prepared to reflect, on a combined basis, all of the insurance brokerage and agency service businesses for the entire year of 2004, including those entities transferred from China United Financial Services on June 9, 2004 and those operations held by entities of China United Financial Services that we did not acquire. Accordingly, the revenues, expenses, assets and liabilities related to the insurance brokerage and agency services for the period from January 1, 2004 to June 8, 2004 and as of June 8, 2004 held by the China United Financial Services entities that we did not acquire have been “carved-out” from those entities and combined with those of our company for the entire period on a basis that our management considers to be reasonable. Accordingly, the historical financial information that has been presented for the periods prior to the reorganization on June 9, 2004 does not necessarily reflect what our financial position, results of operations and cash flows would have been had we been a separate, stand-alone entity during the periods presented. China United Financial Services did not account for us, and we were not operated, as a separate, stand-alone entity prior to June 9, 2004. We prepared our combined financial information for the year ended December 31, 2004 on the same basis as that adopted for the preparation of the consolidated financial information for the years ended December 31, 2005 and 2006. In this prospectus, our consolidated financial information for 2004, 2005, 2006 and 2007 refers collectively to our combined financial information for the year ended December 31, 2004 and the consolidated financial information for the years ended December 31, 2005 and 2006 and for the six months ended June 30, 2006 and 2007.

 

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    For the Year Ended December 31,

    For the Six Months Ended June 30,

 
        2004    

        2005    

        2006    

        2006    

        2007    

 
    RMB     RMB     RMB     US$     RMB     RMB     US$  
    (in thousands, except share, per share and per ADS data)  

Consolidated Statement of Operations Data

                                         

Net revenues:

                                         

Commissions and fees

  33,401     142,520     245,652     32,271     106,543     172,323     22,638  

Other service fees

  564     1,179     897     118     248     238     31  
   

 

 

 

 

 

 

Total net revenues

  33,965     143,699     246,549     32,389     106,791     172,561     22,669  
   

 

 

 

 

 

 

Operating costs and expenses:

                                         

Commissions and fees

  (4,256 )   (65,752 )   (133,076 )   (17,482 )   (53,321 )   (87,275 )   (11,465 )

Selling expenses

  (2,432 )   (5,527 )   (11,288 )   (1,483 )   (5,288 )   (4,196 )   (551 )

General and administrative expenses(1)

  (120,576 )   (78,879 )   (52,119 )   (6,847 )   (25,793 )   (25,915 )   (3,404 )
   

 

 

 

 

 

 

Total operating costs and expenses

  (127,264 )   (150,158 )   (196,483 )   (25,812 )   (84,402 )   (117,386 )   (15,420 )
   

 

 

 

 

 

 

Income (loss) from operations

  (93,299 )   (6,459 )   50,066     6,577     22,389     55,175     7,249  

Other income (expense), net:

                                         

Interest income

  49     445     5,364     705     1,596     1,980     260  

Interest expense

  (15 )   (19 )   (34 )   (5 )   (28 )   (66 )   (9 )

Others, net

  158     (15 )   5     1     10     15     2  
   

 

 

 

 

 

 

Net income (loss) before income taxes

  (93,107 )   (6,048 )   55,401     7,278     23,967     57,104     7,502  

Net Income tax benefit (expense)

  396     (672 )   573     75     42     (176 )   (23 )
   

 

 

 

 

 

 

Net income (loss) before minority interest

  (92,711 )   (6,720 )   55,974     7,353     24,009     56,928     7,479  

Minority interest

      27     1,421     187     160     1,762     231  
   

 

 

 

 

 

 

Net income (loss)

  (92,711 )   (6,693 )   57,395     7,540     24,169     58,690     7,710  
   

 

 

 

 

 

 

Net income (loss) per share (giving effect to the 10,000-for-1 share exchange in 2007):

                                         

Basic

  (0.5552 )   (0.0139 )   0.0883     0.0116     0.0372     0.0903     0.0119  

Diluted

  (0.5552 )   (0.0139 )   0.0875     0.0115     0.0370     0.0891     0.0117  

Net income (loss) per ADS:

                                         

Basic

  (11.104 )   (0.278 )   1.766     0.232     0.744     1.806     0.238  

Diluted

  (11.104 )   (0.278 )   1.750     0.230     0.740     1.782     0.234  

Shares used in calculating net income (loss) per share (giving effect to the 10,000-for-1 share exchange in 2007):

                                         

Basic

  166,980,000     482,770,000     650,000,000     650,000,000     650,000,000     650,000,000     650,000,000  

Diluted

  166,980,000     482,770,000     655,970,000     655,970,000     652,884,328     658,927,355     658,927,355  

Dividends declared per share(2)

 

170


 

 

523


 

 

585


 

 

75


 

           

(1)     Share-based compensation expenses included in our general and administrative expenses were RMB109.3 million, RMB56.5 million, RMB24.1 million (US$3.2 million), RMB13.0 million and RMB0.8 million (US$0.1 million) in 2004, 2005, 2006 and the six months ended June 30, 2006 and 2007, respectively.

(2)     The 2004 and 2005 dividends were declared in 2006 and the 2006 dividends were declared in 2007. These dividends were not paid at the time they were declared. In 2007, we paid out RMB28.7 million (US$3.8 million) of the previously declared but unpaid dividends, and we expect to pay out the remainder of those previously declared but unpaid dividends to our existing shareholders before the completion of this offering. The per-share amounts were determined based on the number of CISG shares outstanding as of the respective record dates for the dividends declared, without giving effect to the share exchange in July 2007.

 

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The following table presents a summary of our consolidated balance sheet data:

 

   

on an actual basis as of December 31, 2006 and June 30, 2007; and

 

   

on an as adjusted basis to give effect to the issuance and sale of the 193,000,000 ordinary shares in the form of ADSs by us in this offering, based on the initial public offering price of US$12.00 per ADS, the midpoint of the initial public offering price range as shown on the cover of this prospectus, after deducting underwriting discounts, commission and estimated offering expenses payable by us and assuming no exercise of the underwriters’ over-allotment option, as of June 30, 2007.

 

     As of
December 31,
2006


   As of June 30, 2007

     Actual

   Actual

   As Adjusted

     RMB    US$    RMB    US$    RMB    US$
               (unaudited)    (unaudited)
     (in thousands)

Consolidated Balance Sheet Data

                        

Cash and cash equivalents

   223,926    29,417    363,406    47,741    1,137,501    149,435

Total current assets

   355,703    46,729    443,436    58,255    1,217,531    159,949

Total assets

   379,622    49,871    468,999    61,613    1,243,094    163,307

Total current liabilities

   75,524    9,922    137,972    18,126    137,972    18,126

Total liabilities

   76,321    10,026    139,576    18,337    139,576    18,337

Minority interests

   13,717    1,802    18,499    2,430    18,499    2,430

Total shareholders’ equity

   289,584    38,043    310,924    40,846    1,085,019    142,540

Total liabilities and owners’ equity

   379,622    49,871    468,999    61,613    1,243,094    163,307

 

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RISK FACTORS

 

You should carefully consider the risks described below in conjunction with the other information and our consolidated financial statements and related notes included elsewhere in this prospectus before making an investment decision. Our business, financial condition or results of operations could be materially and adversely affected by any of these risks. The trading price of our ADSs could decline due to any of these risks, and you may lose all or part of your investment. This prospectus also contains forward-looking statements relating to events subject to risks and uncertainties. Our actual results could differ materially from those anticipated in these forward-looking statements due to the material risks that we face described below.

 

Risks Related to Our Business and Our Industry

 

Our limited operating history, especially our limited experience in distributing life insurance products, may not provide an adequate basis to judge our future prospects and results of operations.

 

We have a limited operating history. We commenced our insurance intermediary business in 1999 by distributing automobile insurance products and expanded our offerings to other types of property and casualty insurance products in 2002. We started distributing individual life insurance products in January 2006. In 2006, we also acquired, through our consolidated affiliated entities, majority interests in three insurance agencies that specialize in distributing life insurance products. Life insurance products accounted for 8.4% of our total commissions and fees earned in 2006 and 11.3% in the first half of 2007. We have made the distribution of life insurance products one of the focuses of our future growth strategy. We cannot assure you that this strategic move will be successfully implemented. If our life insurance business fails to grow successfully, our future growth will be significantly affected. In addition, our limited operating history, especially our limited experience in selling life insurance products, may not provide a meaningful basis for you to evaluate our business, financial performance and prospects.

 

If we fail to attract and retain productive agents, especially entrepreneurial agents, our business could suffer.

 

A substantial portion of our sales of property and casualty insurance products and our entire sales of life insurance products are conducted through our individual sales agents, who are not our employees. In 2006, individual sales agents contributed 68.9% of our commissions and fees earned from property and casualty insurance products. Some sales agents are more productive than others. Further, in recent years, some entrepreneurial management staff or senior sales agents of major insurance companies in China have chosen to leave their employers or principals and become independent agents. We refer to these individuals as entrepreneurial agents. An entrepreneurial agent is usually able to assemble and lead a team of sales agents. We have been actively recruiting and will continue to recruit entrepreneurial agents to join our distribution network as our sales agents. Entrepreneurial agents have been instrumental to the development of our life insurance business. If we are unable to attract, retain and build on the core group of highly productive agents and entrepreneurial agents, our business could be materially and adversely affected. Competition for agents from insurance companies and other insurance intermediaries may also force us to increase the compensation of our agents and in-house sales representatives, which would increase operating costs and reduce our profitability.

 

Because the commission and fee revenue we earn on the sale of insurance products is based on premiums and commission and fee rates set by insurance companies, any decrease in these premiums or commission and fee rates may have an adverse effect on our results of operation.

 

We are engaged in the insurance agency and brokerage business and derive revenues primarily from commissions and fees paid by the insurance companies whose policies our customers purchase. The commission and fee rates are set by insurance companies and are based on the premiums that the insurance companies charge. Commission and fee rates and premiums can change based on the prevailing economic, regulatory, taxation and competitive factors that affect insurance companies. These factors, which are not within our control, include the

 

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capacity of insurance companies to place new business, underwriting and non-underwriting profits of insurance companies, consumer demand for insurance products, the availability of comparable products from other insurance companies at a lower cost, the availability of alternative insurance products, such as government benefits and self-insurance plans, to consumers and the tax deductibility of commissions and fees. In addition, premium rates for certain insurance products, such as the mandatory automobile liability insurance that each automobile owner in the PRC is legally required to purchase, are tightly regulated by the CIRC.

 

Because we do not determine, and cannot predict, the timing or extent of premium or commission and fee rate changes, we cannot predict the effect any of these changes may have on our operations. Since China’s entry into the WTO in December 2001, intense competition among insurance companies has led to a gradual decline in premium rate levels of some property and casualty insurance products. Although such decline may stimulate demand for insurance products and increase our total sales volume, it also reduces the commissions and fees we earned on each policy sold. Any decrease in premiums or commission and fee rates may significantly affect our profitability. In addition, our budget for future acquisitions, capital expenditures, dividend payments, loan repayments and other expenditures may be disrupted by unexpected decreases in revenues caused by decreases in premiums or commission and fee rates, thereby adversely affecting our operations.

 

Competition in our industry is intense and, if we are unable to compete effectively, we may lose customers and our financial results may be negatively affected.

 

The insurance intermediary industry in China is highly competitive, and we expect competition to persist and intensify. We face competition from insurance companies that use their in-house sales force and exclusive sales agents to distribute their products, from business entities that distribute insurance products on an ancillary basis, such as commercial banks, postal offices and automobile dealerships, and from other professional insurance intermediaries. We compete for customers on the basis of product offerings, customer services and reputation. Many of our competitors have greater financial and marketing resources than we do and may be able to offer products and services that we do not currently offer and may not offer in the future. If we are unable to compete effectively against those competitors, we may lose customers and our financial results may be negatively affected.

 

Quarterly and annual variations in our commission and fee revenue may have unexpected impacts on our results of operations.

 

Our commission and fee income is subject to both quarterly and annual fluctuations as a result of the seasonality of our business, the timing of policy renewals and the net effect of new and lost business. Historically, our commission and fee income for the fourth quarter of any given year has been the highest among all four quarters, while our commission and fee income for the first quarter of any given year has been the lowest among all four quarters. The factors that cause the quarterly and annual variations are not within our control. Specifically, consumer demand for insurance products can influence the timing of renewals, new business and lost business, which generally includes policies that are not renewed, and cancellations. As a result, you may not be able to rely on quarterly or annual comparisons of our operating results as an indication of our future performance.

 

We may be unsuccessful in identifying and acquiring suitable acquisition candidates, which could adversely affect our growth.

 

We expect a significant portion of our future growth to come from acquisitions of high-quality independent insurance agencies or brokerages. There is no assurance that we can successfully identify suitable acquisition candidates, especially in those provinces and municipalities where we do not yet have a presence. Even if we identify suitable candidates, we may not be able to complete an acquisition on terms that are commercially acceptable to us. In addition, we compete with other entities to acquire high-quality independent insurance agencies and brokerages. Many of our competitors may have substantially greater financial resources than we do

 

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and may be able to outbid us for these acquisition targets. If we are unable to complete acquisitions, our growth strategy will be impeded and our earnings or revenue growth will be negatively affected.

 

If we fail to integrate acquired companies efficiently, or if the acquired companies do not perform to our expectations, our business and results of operations may be adversely affected.

 

Even if we succeed in acquiring other insurance agencies and brokerages, our ability to integrate an acquired entity and its operations is subject to a number of factors. These factors include difficulties in the integration of acquired operations and retention of personnel, especially the sales agents who are not employees of the acquired company, entry into unfamiliar markets, unanticipated problems or legal liabilities, and tax and accounting issues. The need to address these factors may divert management’s attention from other aspects of our business and materially and adversely affect our business prospects.

 

Furthermore, the acquired companies may not perform to our expectations for various reasons, including legislative or regulatory changes that affect the insurance products in which a company specializes, the loss of key clients after the acquisition closes, general economic factors that impact a company in a direct way and the cultural incompatibility of an acquired company’s management team with us. Our inability to successfully integrate an acquired entity or its failure to perform to our expectations may materially and adversely affect our business, prospects, results of operations and financial condition.

 

Our business and prospects could be materially and adversely affected if we are not able to manage our growth successfully.

 

We commenced our insurance intermediary business in 1999 and have expanded our operations substantially in recent years. Our distribution network has expanded from one company in one province to 21 insurance intermediaries in eight provinces as of the date of the prospectus. We anticipate significant continued growth in the future. Our expansion has placed, and will continue to place, substantial demands on our managerial, operational, technological and other resources. To manage and support our continued growth, we must continue to improve our operational, administrative, financial and technological systems, procedures and controls, and expand, train and manage our growing employee and agent base. Furthermore, our management will be required to maintain and expand our relationships with insurance companies, other insurance intermediaries, regulators and other third parties. We cannot assure you that our current and planned personnel, systems, procedures and controls will be adequate to support our future operations. Any failure to effectively and efficiently manage our expansion could materially and adversely affect our ability to capitalize on new business opportunities, which in turn could have a material adverse effect on our results of operations.

 

If our contracts with insurance companies are terminated or changed, our business and operating results could be adversely affected.

 

We primarily act as agents for insurance companies in distributing their products to retail customers. Our relationships with the insurance companies are governed by agreements between us and the insurance companies. Most of our contracts with insurance companies are entered into at a local level between their respective provincial, city and district branches and our affiliated insurance agencies and brokerages. Generally, each branch of these insurance companies has independent authority to enter into contracts with our affiliated insurance agencies and brokerages, and the termination of a contract with one branch has no effect on our contracts with the other branches. See “Business—Insurance Company Partners.” These contracts establish, among other things, the scope of our authority, the pricing of the insurance products we distribute and our fee rates. These contracts typically have a term of a year and some of them can be terminated by the insurance companies with little advance notice. Moreover, before or upon expiration of a contract, the insurance company that is a party to that contract may agree to renew it only with changes in its terms, including the amount of commissions and fees we receive, which could reduce our revenues from that contract.

 

For the year ended December 31, 2006, our top five insurance company partners, after aggregating the business conducted between their local branches and our insurance agencies and brokerages, were PICC Property

 

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and Casualty Company Limited, Ping An Property & Casualty Insurance Company of China, Ltd., AVIVA-COFCO Life Insurance Co., Ltd., Tai Ping Insurance Company Ltd. and China Pacific Property Insurance Company, Ltd. Two of these, PICC and Ping An Property, each accounted for more than 10% of our total commissions and fees in 2006, with PICC accounting for 61% and Ping An Property accounting for 11%. For the six months ended June 30, 2007, our top five insurance company partners, after similar aggregation, were PICC, Ping An Property, China Pacific Property, Yong An Property Insurance Co., Ltd. and AVIVA-COFCO Life Insurance Co., Ltd. During this period, PICC and Ping An Property accounted for 47% and 10%, respectively, of our total commissions and fees. The termination of our contracts with insurance companies that in the aggregate account for a significant portion of our business, or changes in the material terms of these contracts, could adversely affect our business and operating results.

 

The level of bonuses we receive from insurance companies is difficult to predict and any material decrease in our collection of them is likely to have an adverse impact on our operating results.

 

Some insurance companies pay us bonuses for achieving specified sales goals set by them, after considering the loss experience or renewal rate of the insurance we distribute for them and other factors. Bonuses accounted for 1.1% of our total commissions and fees in 2006. We did not receive any bonuses for 2005. Due to the contingent nature of these bonus arrangements, it is difficult to predict the amount, if any, of these payments. Bonuses from insurance companies affect our revenues, and decreases in their payment to us may have an adverse effect on our results of operations.

 

Our operating structure may make it difficult to respond quickly to operational or financial problems, which could negatively affect our financial results.

 

We operate through insurance agency and brokerage subsidiaries of our PRC affiliated entities that are located in eight provinces. These insurance agencies and brokerages report their results to our corporate headquarters monthly. If these companies delay either reporting results or informing corporate headquarters of a negative business development such as the possible loss of a relationship with an insurance company or a regulatory inquiry or other action, we may not be able to take action to remedy the situation in a timely fashion. This in turn could have a negative effect on our financial results. In addition, if one of these companies were to report inaccurate financial information, we might not learn of the inaccuracies on a timely basis and be able to take corrective measures promptly, which could negatively affect our ability to report our financial results.

 

Our dependence on the founders and key managers of the acquired firms may limit our ability to effectively manage our business.

 

In the three acquisitions we have completed to date, the founders and key managers of the acquired firms continue to manage the acquired business. They are responsible for ordinary course operational decisions, including personnel, culture and office location, subject to our oversight. They also maintain the primary relationship with customers and the local branches of insurance companies. Although we maintain internal controls that allow us to oversee our nationwide operations, this operating structure exposes us to the risk of losses resulting from day-to-day decisions of the managers of the acquired firms. Unsatisfactory performance by these managers could hinder our ability to grow and could have a material adverse effect on our business.

 

Our future success depends on the continuing efforts of our senior management team and other key personnel, and our business may be harmed if we lose their services.

 

Our future success depends heavily upon the continuing services of the members of our senior management team and other key personnel, in particular Mr. Yinan Hu, our chairman and chief executive officer, Mr. Qiuping Lai, our executive director and president, Dr. En Ming Tseng, our vice president, chief operating officer and chairman of our life insurance committee, Mr. David Tang, our chief financial officer, Mr. Peng Ge, our vice president and general manager of our finance and accounting department, and Mr. Chunlin Wang, our vice president and chairman of our property and casualty insurance committee. In addition, because of the importance

 

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of training to our business, our team of dedicated training professionals plays a key role in our operations. If one or more of our senior executives or other key personnel, including key training personnel, are unable or unwilling to continue in their present positions, we may not be able to replace them easily or at all, and our business may be disrupted and our financial condition and results of operations may be materially and adversely affected. Competition for senior management and key personnel is intense, the pool of qualified candidates is very limited, and we may not be able to retain the services of our senior executives or key personnel, or attract and retain high-quality senior executives or key personnel in the future. As is customary in the PRC, we do not have insurance coverage for the loss of our senior management team or other key personnel.

 

In addition, if any member of our senior management team or any of our other key personnel joins a competitor or forms a competing company, we may lose customers, sensitive trade information and key professionals and staff members. Each of our executive officers and key employees has entered into an employment agreement with us which contains confidentiality and non-competition provisions. These agreements generally have an initial term of three years, and are automatically extended for successive one-year terms unless terminated earlier pursuant to the terms of the agreement. See “Management—Employment Agreements” for a more detailed description of the key terms of these employment agreements. If any disputes arise between any of our senior executives or key personnel and us, we cannot assure you of the extent to which any of these agreements may be enforced.

 

Agent and employee misconduct is difficult to detect and deter and could harm our reputation or lead to regulatory sanctions or litigation costs.

 

Agent or employee misconduct could result in violations of law by us, regulatory sanctions, litigation or serious reputational or financial harm. Misconduct could include:

 

   

engaging in misrepresentation or fraudulent activities when marketing or selling insurance products to customers;

 

   

hiding unauthorized or unsuccessful activities, resulting in unknown and unmanaged risks or losses; or

 

   

otherwise not complying with laws and regulations or our control policies or procedures.

 

We cannot always deter agent or employee misconduct, and the precautions we take to prevent and detect these activities may not be effective in all cases. We cannot assure you, therefore, that agent or employee misconduct will not lead to a material adverse effect on our business, results of operations or financial condition.

 

All of our personnel engaging in insurance agency or brokering activities are required under relevant PRC regulations to have a qualification certificate issued by the CIRC. If these qualification requirements are strictly enforced, our business may be materially and adversely affected.

 

All of our personnel who engage in insurance agency or brokering activities are required under relevant PRC regulations to obtain a qualification certificate from the CIRC in order to conduct insurance agency or brokering business. See “Regulation.” Under these regulations, insurance agencies and brokerages that retain unqualified personnel to engage in insurance sales activities may be fined up to RMB10,000. As of December 31, 2006, approximately 79% of our sales professionals had received a qualification certificate, compared with a national average qualification rate of approximately 75% for insurance intermediaries as reported by the CIRC.

 

In addition, we understand that the CIRC may require, in the near future, that every individual agent carry credentials showing specified information when conducting agency business. If more local CIRC agencies were to strictly enforce these regulations in the future, and if a substantial number of our sales forces remain unqualified, our business may be adversely affected. Moreover, we may be subject to fines and other administrative proceedings for the failure of our insurance professionals to obtain the necessary CIRC qualification certificate. Any such fines or administrative proceedings could materially and adversely affect our business, financial condition and results of operations.

 

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Our businesses are highly regulated, and the administration, interpretation and enforcement of the laws and regulations currently applicable to us involve uncertainties, which could materially and adversely affect our business and results of operations.

 

We operate in a highly regulated industry. The CIRC has extensive authority to supervise and regulate the insurance industry in China. In exercising its authority, the CIRC is given wide discretion, and the administration, interpretation and enforcement of the laws and regulations applicable to us involve uncertainties that could materially and adversely affect our business and results of operations. For example, it is not clear when the CIRC will start strictly enforcing the qualification requirements for sales professionals affiliated with professional insurance intermediaries like us. Although we have not had any material violations to date, we cannot assure you that our operations will always be consistent with the interpretation and enforcement of the laws and regulations by the CIRC from time to time.

 

Further development of regulations in China may impose additional costs and restrictions on our activities.

 

China’s insurance regulatory regime is undergoing significant changes. Some of these changes and the further development of regulations applicable to us may result in additional restrictions on our activities or more intensive competition in this industry. For example, under the consultation paper for administration of insurance agencies and brokerages promulgated by the CIRC, insurance agency or brokerage companies will likely be required to increase their guaranty deposit, which generally cannot be withdrawn without the CIRC’s approval, when they open any new branches. Such increase would reduce the amount of cash available for other business purposes. Under the same consultation paper, sole-proprietor insurance agencies will likely be allowed, which could lead to intensified competition among insurance agencies. Such development of regulations could materially and adversely affect our business and results of operations.

 

We conduct some of our business through two of our subsidiaries, which do not possess insurance agency or brokerage licenses.

 

Two of our subsidiaries run our operating platform and maintain our customer database. In addition, they provide information about potential customers to insurance companies, which pay fees to these subsidiaries if these customers purchase insurance policies. Our PRC counsel, Commerce & Finance Law Offices, has informed us that, in its opinion, the provision of customer information to and the collection of fees from insurance companies by our subsidiaries comply with existing PRC laws and regulations. We cannot assure you, however, that the relevant PRC regulatory authorities will not take a view contrary to ours or that of our PRC counsel. If the CIRC clarifies existing regulations on insurance agencies and brokerages or adopts new regulations that classify the provision of customer information to insurance companies as a form of insurance agency or brokerage services, our subsidiaries may be deemed to have engaged in insurance agency or brokerage services without proper license and, as a result, we may be subject to administrative penalties, which may have a material adverse effect on our results of operations.

 

We have identified several significant deficiencies in our internal control over financial reporting. If we fail to maintain an effective system of internal controls over financial reporting, we may not be able to accurately report our financial results or prevent fraud.

 

We will be subject to reporting obligations under U.S. securities laws. The Securities and Exchange Commission, as required by Section 404 of the Sarbanes-Oxley Act of 2002, adopted rules requiring every public company to include a management report on such company’s internal controls over financial reporting in its annual report, which contains management’s assessment of the effectiveness of the company’s internal controls over financial reporting. In addition, an independent registered public accounting firm must attest to and report on management’s assessment of the effectiveness of the company’s internal controls over financial reporting. These requirements will first apply to our annual report on Form 20-F for the fiscal year ending on December 31, 2008.

 

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Our management may conclude that our internal controls over financial reporting are not effective. Moreover, even if our management concludes that our internal controls over financial reporting are effective, our independent registered public accounting firm may still decline to attest to our management’s assessment or may issue a report that is qualified if it is not satisfied with our internal controls or the level at which our controls are documented, designed, operated or reviewed, or if it interprets the relevant requirements differently from us. Our reporting obligations as a public company will place a significant strain on our management, operational and financial resources and systems for the foreseeable future.

 

Prior to this offering, we have been a private company with limited accounting personnel with U.S. GAAP experience and other resources with which to adequately address our internal control over our financial closing and reporting process and other procedures. During the course of preparing our consolidated financial statements as of and for the three years ended December 31, 2004, 2005 and 2006 in connection with this offering, we identified a number of control deficiencies, which include significant deficiencies, in our internal control over financial reporting. Many of the deficiencies noted below were communicated to us from our independent registered public accounting firm as observations which stemmed from their audit. However, as noted in their report, their audit included consideration of internal control over financial reporting as a basis for designing the audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of our internal control over financial reporting. The significant deficiencies identified include: (1) a lack of formal internal controls over financial closing and reporting processes; (2) a lack of a formal risk assessment process; (3) a lack of accounting personnel with knowledge of U.S. GAAP and SEC financial reporting requirements; (4) a lack of regular preparation of U.S. GAAP consolidated management accounts; and (5) the absence of an audit committee. It is important to note that we did not undertake a comprehensive assessment of our internal controls for purposes of identifying and reporting control deficiencies as we will be required to do after we are a public company. Had we undertaken such an assessment, additional significant deficiencies and/or material weaknesses may have been identified.

 

We plan to take a number of measures to tackle the control deficiencies identified, including: (1) preparing a comprehensive accounting policies and procedures manual that covers U.S. GAAP and ensuring that accounting personnel are familiar with and follow the manual; (2) establishing a risk assessment process that complies with the framework set forth by the Committee of Sponsoring Organizations of the Treadway Commission, a private sector organization dedicated to improving the quality of financial reporting; (3) hiring additional accounting personnel with external reporting experience, including knowledge of the SEC reporting requirements and U.S. GAAP, and investor relations personnel; (4) developing formal procedures to prepare U.S. GAAP consolidated financial information on a monthly basis; and (5) establishing an audit committee complying with SEC and applicable Nasdaq Global Market requirements.

 

We plan to remediate these significant deficiencies in time to meet the deadline for compliance with the requirements of Section 404 of the Sarbanes-Oxley Act. If, however, we fail to timely achieve and maintain the adequacy of our internal controls, we may not be able to conclude that we have effective internal controls over financial reporting. Moreover, effective internal controls over financial reporting are necessary for us to produce reliable financial reports and are important to help prevent fraud. As a result, our failure to achieve and maintain effective internal controls over financial reporting could result in the loss of investor confidence in the reliability of our financial statements, which in turn could harm our business and negatively impact the trading price of our ADSs. Furthermore, we anticipate that we will incur considerable costs and devote significant management time and efforts and other resources to comply with Section 404 of the Sarbanes-Oxley Act.

 

We may face legal action by the former employers or principals of entrepreneurial agents who join our distribution network.

 

Competition for productive sales agents is intense within the Chinese insurance industry. When an entrepreneurial agent leaves his or her employer or principal to join our distribution network as our sales agent, we may face legal action by the former employer or principal of the entrepreneurial agent on the ground of unfair competition or breach of contract. As of the date of this prospectus, there has been no such action filed or

 

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threatened against us. We cannot assure you that this will not happen in the future. Any such legal actions, regardless of merit, could be expensive and timing consuming and could divert resources and management attention from the operation of our business. If we were found liable in such a legal action, we might be required to pay substantial damages to the former employer or principal of the entrepreneurial agent, and our business reputation might be harmed. Moreover, the filing of such a legal action may discourage potential entrepreneurial agents from leaving their employers or principals, thus reducing the number of entrepreneurial agents we can recruit and potentially harming our growth prospects.

 

If we are required to write down goodwill and other intangible assets, our financial condition and results may be materially and adversely affected.

 

When we acquire a business, a substantial portion of the purchase price of the acquisition is generally allocated to goodwill and other identifiable intangible assets. The amount of the purchase price that is allocated to goodwill and other intangible assets is determined by the excess of the purchase price over the net identifiable assets acquired. As of June 30, 2007, goodwill represented RMB7.0 million (US$0.9 million), or 2.3% of our total shareholders’ equity of RMB310.9 million (US$40.8 million). As of June 30, 2007, other intangible assets represented RMB4.3 million (US$0.6 million), or 1.4% of our total shareholders’ equity. Under current accounting standards, if we determine goodwill or intangible assets are impaired, we will be required to write down the value of such assets and recognize corresponding impairment charges. As we implement our growth strategy through acquisitions, goodwill and intangible assets may comprise an increasingly larger percentage of our shareholders’ equity and any writedown related to such goodwill and intangible assets may adversely and materially affect our shareholders’ equity and financial results.

 

Any significant failure in our information technology systems could have a material adverse effect on our business and profitability.

 

Our business is highly dependent on the ability of our information technology systems to timely process a large number of transactions across different markets and products at a time when transaction processes have become increasingly complex and the volume of such transactions is growing rapidly. The proper functioning of our financial control, accounting, customer database, customer service and other data processing systems, together with the communication systems between our various subsidiaries and our main offices in Guangzhou, is critical to our business and to our ability to compete effectively. We cannot assure you that our business activities would not be materially disrupted in the event of a partial or complete failure of any of these primary information technology or communication systems, which could be caused by, among other things, software malfunction, computer virus attacks or conversion errors due to system upgrading. In addition, a prolonged failure of our information technology system could damage our reputation and materially and adversely affect our future prospects and profitability.

 

If we are unable to respond in a timely and cost-effective manner to rapid technological change in the insurance intermediary industry, there may be a resulting adverse effect on business and operating results.

 

The insurance industry is increasingly influenced by rapid technological change, frequent new product and service introductions and evolving industry standards. For example, the insurance intermediary industry has increased use of the Internet to communicate benefits and related information to consumers and to facilitate information exchange and transactions. We believe that our future success will depend on our ability to continue to anticipate technological changes and to offer additional product and service opportunities that meet evolving standards on a timely and cost-effective basis. There is a risk that we may not successfully identify new product and service opportunities or develop and introduce these opportunities in a timely and cost-effective manner. In addition, product and service opportunities that our competitors develop or introduce may render our products and services noncompetitive. As a result, we can give no assurances that technological changes that may affect our industry in the future will not have a material adverse effect on our business and results of operations.

 

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We face risks related to health epidemics and other outbreaks, which could result in reduced activity level of our sales force.

 

Our business could be materially and adversely affected by the outbreak of avian flu, severe acute respiratory syndrome, or SARS, or another epidemic. In 2005 and 2006, there have been reports on the occurrences of avian flu in various parts of China, including a few confirmed human cases and deaths. Because our business operations rely heavily on the sales efforts of individual sales agents and in-house sales representatives, any prolonged recurrence of avian flu, SARS or other adverse public health developments in China may significantly disrupt our staffing and otherwise reduce the activity level of our sales force, thus causing a material and adverse effect on our business operations.

 

Risks Related to Our Corporate Structure

 

If the PRC government finds that the agreements that establish the structure for operating our China business do not comply with applicable PRC laws and regulations, we could be subject to severe penalties.

 

PRC laws and regulations place certain restrictions on foreign investment in and ownership of insurance agencies and brokerages. We conduct our operations in China principally through contractual arrangements among our PRC subsidiaries, the shareholders of two PRC companies, Meidiya Investment and Yihe Investment, and the subsidiaries of Meidiya Investment and Yihe Investment. Meidiya Investment and Yihe Investment together, directly or indirectly, hold equity interests ranging from 51% to 100% in 21 PRC insurance agencies and brokerages. These wholly and majority-owned subsidiaries of Meidiya Investment and Yihe Investment hold the licenses and permits necessary to conduct our insurance intermediary business in China.

 

Our contractual arrangements with the shareholders of Meidiya Investment and Yihe Investment enable us to:

 

   

Exercise effective control over Meidiya Investment, Yihe Investment and their subsidiaries;

 

   

Receive a substantial portion of the economic benefits of the subsidiaries of Meidiya Investment and Yihe Investment in consideration for the services provided by our wholly-owned subsidiaries in China; and

 

   

Have an exclusive option to purchase all or part of the equity interests in each of Meidiya Investment, Yihe Investment and their subsidiaries when and to the extent permitted by PRC law.

 

Because of these contractual arrangements, Meidiya Investment and Yihe Investment are treated as our consolidated affiliated entities. If we, our PRC subsidiaries, Meidiya Investment, Yihe Investment or any of the existing and future subsidiaries of Meidiya Investment and Yihe Investment are found to be in violation of any existing or future PRC laws or regulations or fail to obtain or maintain any of the required permits or approvals, the relevant PRC regulatory authorities, including the CIRC, would have broad discretion in dealing with such violations, including:

 

   

revoking the business and operating licenses of our PRC subsidiaries and affiliated entities;

 

   

restricting or prohibiting any related-party transactions among our PRC subsidiaries and affiliated entities;

 

   

imposing fines or other requirements with which we or our PRC subsidiaries and affiliated entities may not be able to comply;

 

   

requiring us or our PRC subsidiaries and affiliated entities to restructure the relevant ownership structure or operations; or

 

   

restricting or prohibiting our use of the proceeds of this offering to finance our business and operations in China.

 

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The imposition of any of these penalties could result in a material and adverse effect on our ability to conduct our business.

 

We rely on contractual arrangements with our PRC affiliated entities and their subsidiaries and shareholders for our China operations, which may not be as effective in providing operational control as direct ownership.

 

We have relied and expect to continue to rely on contractual arrangements with our PRC affiliated entities, Meidiya Investment and Yihe Investment, and their subsidiaries and shareholders to operate our business in China. For a description of these contractual arrangements, see “Corporate Structure—Our Corporate Structure and Contractual Arrangements” and “Related Party Transactions—Contractual Arrangements with Our PRC Affiliated Entities, Their Shareholders and Their Subsidiaries.” These contractual arrangements may not be as effective in providing us with control over Meidiya Investment, Yihe Investment and their subsidiaries as direct ownership. We have no direct or indirect equity interests in Meidiya Investment, Yihe Investment or any of their subsidiaries.

 

If we had direct ownership of Meidiya Investment, Yihe Investment and their subsidiaries, we would be able to exercise our rights as a shareholder to effect changes in the board of directors of Meidiya Investment, Yihe Investment and their subsidiaries, which in turn could effect changes, subject to any applicable fiduciary obligations, at the management level. But under the current contractual arrangements, as a legal matter, if Meidiya Investment, Yihe Investment or any of their subsidiaries and shareholders fails to perform their obligations under these contractual arrangements, we may have to incur substantial costs and resources to enforce such arrangements and rely on legal remedies under PRC law, including seeking specific performance or injunctive relief and claiming damages, which may not be effective. For example, if the shareholders of Meidiya Investment and Yihe Investment were to refuse to transfer their equity interest in Meidiya Investment and Yihe Investment to us or our designee when we exercise the call option pursuant to these contractual arrangements, or if they were otherwise to act in bad faith toward us, then we may have to take legal action to compel them to fulfill their contractual obligations.

 

To secure our loans to the three individual shareholders of Meidiya Investment and Yihe Investment, we entered into equity pledge agreements with them under which they pledged their equity interests in Meidiya Investment and Yihe Investment to us. But we were unable to register the pledges because the relevant local administration for industry and commerce, which maintain public records of business entities, did not handle this kind of pledge at the time when our equity pledge agreements became effective. This could allow the shareholders to dishonor their pledges and re-pledge the equity interests to another person. Due to the lack of registration with the relevant administration for industry and commerce, we rely on these individuals to abide by the contracts laws of China and honor their contracts with us. According to the Property Rights Law, which became effective as of October 1, 2007, pledge rights for a pledge of equity are created at the time of the processing of the registration of the pledge by the relevant administration for industry and commerce. Although the PRC Property Rights Law does not have retrospective effect on pledges created prior to its effectiveness, we would need to register our existing pledges with the relevant administration for industry and commerce before any third party could register its pledge rights in order to protect our pledge rights against any third party to whom the shareholders might re-pledge their equity interests after the effectiveness of the Property Rights Law. Due to the lack of operational procedures under the Property Rights Law applicable to the registration of equity pledges, we cannot assure you that we will be able to get our equity pledge registration processed by the relevant administration for industry and commerce before any third party would be able to complete the registration.

 

Many of these contractual arrangements are governed by PRC law and provide for the resolution of disputes through arbitration in the PRC. Accordingly, these contracts would be interpreted in accordance with PRC law and any disputes would be resolved in accordance with PRC legal procedures. The legal environment in the PRC is not as developed as in some other jurisdictions, such as the United States. As a result, uncertainties in the PRC legal system could limit our ability to enforce these contractual arrangements. In the event we are unable to enforce these contractual arrangements, we may not be able to exert effective control over our affiliated entities, and our ability to conduct our business may be negatively affected.

 

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The shareholders of our PRC affiliated entities may have potential conflicts of interest with us, which may materially and adversely affect our business and financial condition.

 

Three individual shareholders, Mr. Jianguo Cui, Mr. Zhenyu Wang and Mr. Qiuping Lai, hold 100% of the equity interests in each of Meidiya Investment and Yihe Investment. Mr. Wang was designated by CDH Inservice Limited, one of our principal shareholders. Mr. Lai is our co-founder and president. Mr. Cui was designated by Cathay Auto Services Limited, another of our principal shareholders. Conflicts of interest may arise between Mr. Wang’s or Mr. Cui’s dual role as a shareholder of our affiliated entities subject to various contractual arrangements with us and as a director or officer of CDH Inservice Limited or Cathay Auto Services Limited. Similarly, Mr. Lai’s dual role as a shareholder of our affiliated entities and as our president may cause conflicts of interest. We do not have existing arrangements to address these potential conflicts of interest and cannot assure you that when conflicts arise, those individuals will act in the best interest of our company or that conflicts will be resolved in our favor.

 

Contractual arrangements we have entered into among our subsidiaries and our PRC affiliated entities and their subsidiaries may be subject to scrutiny by the PRC tax authorities and a finding that we or our PRC affiliated entities and their subsidiaries owe additional taxes could substantially reduce our consolidated net income and the value of your investment.

 

Under PRC laws and regulations, arrangements and transactions among related parties may be subject to audit or challenge by the PRC tax authorities. We could face material and adverse tax consequences if the PRC tax authorities determine that the contractual arrangements among Yiqiman Management, our wholly owned subsidiary in China, Meidiya Investment and Yihe Investment and their subsidiaries do not represent an arm’s- length price and adjust Meidiya Investment, Yihe Investment or any of their subsidiaries’ income in the form of a transfer pricing adjustment. A transfer pricing adjustment could, among other things, result in a reduction, for PRC tax purposes, of expense deductions recorded by Meidiya Investment, Yihe Investment or any of their subsidiaries, which could in turn increase their respective tax liabilities. In addition, the PRC tax authorities may impose late payment fees and other penalties on our affiliated entities for underpayment of taxes. Our consolidated net income may be materially and adversely affected if our affiliated entities’ tax liabilities increase or if they are found to be subject to late payment fees or other penalties.

 

PRC regulation of loans and direct investment by offshore holding companies to PRC entities may delay or prevent us from using the proceeds we expect to receive from this offering to make loans to our PRC subsidiaries and PRC affiliated entities or to make additional capital contributions to our PRC subsidiaries, which could materially and adversely affect our liquidity and our ability to fund and expand our business.

 

We are an offshore holding company conducting our operations in China through PRC subsidiaries and PRC affiliated entities. In utilizing the proceeds we expect to receive from this offering for the purposes described in “Use of Proceeds,” we may make loans to our PRC subsidiaries and PRC affiliated entities, or we may make additional capital contributions to our PRC subsidiaries.

 

Any loans we make to either of our directly-held PRC subsidiaries, Haidileji Enterprise or Yiqiman Management, both of which are treated as foreign-invested enterprises under PRC law, cannot exceed statutory limits and must be registered with the State Administration of Foreign Exchange, or SAFE, or its local counterparts. Under applicable PRC law, the Chinese regulators must approve the amount of a foreign-invested enterprise’s registered capital, which represents shareholders’ equity investments over a defined period of time, and the foreign-invested enterprise’s total investment, which represents the total of the company’s registered capital plus permitted loans. The registered capital/total investment ratio cannot be lower than the minimum statutory requirement and the excess of the total investment over the registered capital represents the maximum amount of borrowings that a foreign invested enterprise is permitted to have under PRC law. Our directly-held PRC subsidiaries are allowed to incur a total of HK$184 million in foreign debts as of the date of this prospectus. We expect that the net proceeds we will receive from this offering will exceed the maximum amount of foreign debt our directly-held PRC subsidiaries are permitted to incur. If we were to advance some net proceeds to our

 

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directly-held PRC subsidiaries in the form of loans, we would have to apply to the relevant government authorities for an increase in their permitted total investment amounts. The various applications could be time consuming and their outcomes would be uncertain. Concurrently with the loans, we might have to make capital contributions to these subsidiaries in order to maintain the statutory minimum registered capital/total investment ratio, and such capital contributions involve uncertainties of their own, as discussed below. Furthermore, even if we make loans to our directly-held PRC subsidiaries that do not exceed their current maximum amount of borrowings, we will have to register each loan with SAFE or its local counterpart within 15 days after the signing of the relevant loan agreement. Subject to the conditions stipulated by SAFE, SAFE or its local counterpart will issue a registration certificate of foreign debts to us within 20 days after reviewing and accepting our application. In practice, it may take longer to complete such SAFE registration process.

 

Any loans we make to any of our indirectly-held PRC subsidiaries (those PRC subsidiaries which we hold indirectly through Haidileji Enterprise and Yiqiman Management) or to any of our PRC affiliated entities, all of which are treated as PRC domestic companies rather than foreign-invested enterprises under PRC law, are also subject to various PRC regulations and approvals. Under applicable PRC regulations, medium- and long-term international commercial loans to PRC domestic companies are subject to approval by the National Development and Reform Commission, and short-term international commercial loans to PRC domestic companies are subject to the balance control system effected by SAFE. Due to the above restrictions, we are not likely to make loans to any of our indirectly-held PRC subsidiaries or to any of our PRC affiliated entities.

 

Any capital contributions we make to our PRC subsidiaries, including directly-held and indirectly-held PRC subsidiaries, must be approved by the PRC Ministry of Commerce or its local counterparts and registered with SAFE or its local counterparts. Such applications and registrations could be time consuming and their outcomes would be uncertain.

 

We cannot assure you that we will be able to complete the necessary government registrations or obtain the necessary government approvals on a timely basis, if at all, with respect to future loans by us to our PRC subsidiaries or PRC affiliated entities or with respect to future capital contributions by us to our PRC subsidiaries. If we fail to complete such registrations or obtain such approvals, our ability to use the proceeds we expect to receive from this offering and to capitalize or otherwise fund our PRC operations may be negatively affected, which could adversely and materially affect our liquidity and our ability to fund and expand our business.

 

Risks Related to Doing Business in China

 

Adverse changes in economic and political policies of the PRC government could have a material adverse effect on the overall economic growth of China, which could adversely affect our business.

 

Substantially all of our business operations are conducted in China. Accordingly, our results of operations, financial condition and prospects are subject to a significant degree to economic, political and legal developments in China. China’s economy differs from the economies of most developed countries in many respects, including with respect to the amount of government involvement, level of development, growth rate, control of foreign exchange and allocation of resources. While the PRC economy has experienced significant growth in the past 30 years or so, growth has been uneven across different regions and among various economic sectors of China. The PRC government has implemented various measures to encourage economic development and guide the allocation of resources. While some of these measures benefit the overall PRC economy, they may also have a negative effect on us. For example, our financial condition and results of operations may be adversely affected by government control over capital investments or changes in tax regulations that are applicable to us.

 

The PRC economy has been transitioning from a planned economy to a more market-oriented economy. Although the PRC government has implemented measures since the late 1970s emphasizing the utilization of market forces for economic reform, the reduction of state ownership of productive assets and the establishment of improved corporate governance in business enterprises, the PRC government still owns a substantial portion of productive assets in China. In addition, the PRC government continues to play a significant role in regulating industry development by imposing industrial policies. The PRC government also exercises significant control

 

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over China’s economic growth through the allocation of resources, controlling payment of foreign currency-denominated obligations, setting monetary policy and providing preferential treatment to particular industries or companies. Since late 2003, the PRC government implemented a number of measures, such as raising interest rates and bank reserve requirements to place additional limitations on the ability of commercial banks to make loans, in order to contain the growth of specific segments of China’s economy that it believed to be overheating. These actions, as well as future actions and policies of the PRC government, could materially affect our liquidity and access to capital and our ability to operate our business.

 

Our revenue and earnings from the distribution of life insurance products may be affected by fluctuations in interest rates and other general economic conditions in China.

 

General economic and market factors in China, such as changes in interest rates and in the securities markets, can affect our commission and fee revenue from the sale of life insurance products. These factors can affect the volume of new sales and the extent to which our customers keep their policies in force year after year. Due to China’s recent fast growing economy, the Chinese government may take further measures, including further raising interest rates, in an effort to ensure sustainable economic growth. If interest rates were to further increase in the future, competing investment products offering higher returns could become more attractive to potential purchasers than the life insurance products we market and distribute. Increases in interest rates also may lead our customers to surrender and withdraw some life insurance policies purchased from us in order to seek other investments with higher returns. These surrenders and withdrawals will end the recurring fee revenue we would otherwise earn if the insurance polices were maintained. China’s stock market has experienced substantial growth since 2005. The perceived higher returns of investments in the stock market also may lead to reduced sales, and early terminations, of certain life insurance policies, thus adversely affecting our commission and fee revenue. We cannot guarantee that we will be able to compete with alternative products if these market forces make the life insurance products we sell unattractive to our target customers.

 

Uncertainties with respect to the PRC legal system could adversely affect us.

 

We conduct our business primarily through our subsidiaries and affiliated entities in China. Our operations in China are governed by PRC laws and regulations. Our subsidiaries are generally subject to laws and regulations applicable to foreign investments in China and, in particular, laws applicable to wholly foreign-owned enterprises. The PRC legal system is based on written statutes. Prior court decisions may be cited for reference but have limited precedential value.

 

Although since 1979, PRC legislation and regulations have significantly enhanced the protections afforded to various forms of foreign investments in China, China has not developed a fully integrated legal system, and recently enacted laws and regulations may not sufficiently cover all aspects of economic activities in China. In particular, because these laws and regulations are relatively new, and because of the limited volume of published decisions and their nonbinding nature, the interpretation and enforcement of these laws and regulations involve uncertainties. In addition, the PRC legal system is based in part on government policies and internal rules (some of which are not published on a timely basis or at all) that may have a retroactive effect. As a result, we may not be aware of our violation of these policies and rules until some time after the violation. In addition, any litigation in China may be protracted and result in substantial costs and diversion of resources and management attention.

 

You may experience difficulties in effecting service of legal process, enforcing foreign judgments or bringing original actions in China based on United States or other foreign laws against us or our management named in the prospectus.

 

We conduct substantially all of our operations in China and substantially all of our assets are located in China. In addition, all of our senior executive officers reside within China. As a result, it may not be possible to effect service of process within the United States or elsewhere outside China upon our senior executive officers, including with respect to matters arising under U.S. federal securities laws or applicable state securities laws. Moreover, our PRC counsel has advised us that the PRC does not have treaties with the United States or many other countries providing for the reciprocal recognition and enforcement of judgment of courts.

 

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Governmental control of currency conversion may affect the value of your investment.

 

The PRC government imposes controls on the convertibility of the RMB into foreign currencies and, in certain cases, the remittance of currency out of China. We receive substantially all of our revenues in RMB. Under our current corporate structure, our income is primarily derived from dividend payments from our PRC subsidiaries. Shortages in the availability of foreign currency may restrict the ability of our PRC subsidiaries and our affiliated entities to remit sufficient foreign currency to pay dividends or other payments to us, or otherwise satisfy their foreign currency denominated obligations. Under existing PRC foreign exchange regulations, payments of current account items, including profit distributions, interest payments and expenditures from trade-related transactions, can be made in foreign currencies without prior approval from SAFE by complying with certain procedural requirements. But approval from appropriate government authorities is required where RMB is to be converted into foreign currency and remitted out of China to pay capital expenses such as the repayment of loans denominated in foreign currencies. The PRC government may also at its discretion restrict access in the future to foreign currencies for current account transactions. If the foreign exchange control system prevents us from obtaining sufficient foreign currency to satisfy our currency demands, we may not be able to pay dividends in foreign currencies to our shareholders, including holders of our ADSs.

 

If we are considered a “resident enterprise” under the new PRC tax law or if income tax on the dividends that we receive from our PRC subsidiaries cannot be exempted, our results of operations and financial conditions would be materially and adversely affected.

 

On March 16, 2007, the National People’s Congress of China enacted the Enterprise Income Tax Law, or the new tax law, which will become effective on January 1, 2008. Under currently applicable PRC tax laws, we are exempted from withholding tax on the dividends received from our subsidiaries in China. Under the new tax law, enterprises established under the laws of foreign countries or regions whose “de facto management bodies” are located within the PRC territory are considered as “resident enterprises” and thus will normally be subject to the enterprise income tax, or EIT, at the rate of 25% on global income. Non-resident enterprises with an institution or establishment inside China must pay enterprise income tax at the rate of 25% on income derived from inside China as well as on income earned outside China but which has a connection with such institution or establishment. Non-resident enterprises without any institution or establishment inside China or non-resident enterprises whose income has no connection to its institution or establishment inside China must pay a withholding enterprise income tax at the rate of 20% on income derived from inside China. Under the new tax law, dividends, bonuses and other equity investment proceeds received by an enterprise are exempt from EIT if distributed between qualified resident enterprises or if obtained by a non-resident enterprise with institutions or establishments in China from a resident enterprise and which have a connection with such institutions or establishments.

 

The new tax law allows for exemptions or reductions from withholding of EIT in respect of dividends, bonuses and other equity investment proceeds obtained by non-resident enterprises without any institution or establishment inside China, or by non-resident enterprises with an institution or establishment inside China if the relevant proceeds have no connection to such institution or establishment inside China. However, the new tax law does not define the term “de facto management bodies” nor does it clarify the scope of eligibility for exemptions or reductions from the withholding tax. Therefore, we cannot assure you that we will not be considered a “resident enterprise” under the new tax law and therefore be subject to the new tax law at the rate of 25% on our global income. We also cannot assure you that the withholding EIT on the dividends we receive from our subsidiaries will be exempted or reduced.

 

We rely principally on dividends and other distributions on equity paid by our subsidiaries to fund any cash and financing requirements we may have, and any limitation on the ability of our subsidiaries entities to make payments to us could have a material adverse effect on our ability to conduct our business.

 

We are a holding company, and we rely principally on dividends from our subsidiaries in China and service, license and other fees paid to our wholly owned subsidiaries by some of our affiliated entities for our cash requirements, including any debt we may incur. As of the date of this prospectus, our subsidiaries in China have

 

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declared dividends of RMB7.0 million, RMB25.0 million, RMB38.0 million (US$5.0 million) for the years 2004, 2005 and 2006, respectively. We allowed our subsidiaries in China to defer payment of these dividends in order to use the additional cash to grow their businesses. In 2007, we paid out RMB28.7 million (US$3.8 million) of the previously declared but unpaid dividends, and we expect to pay out the remainder to our existing shareholders before the completion of this offering. In October 2007, we declared dividends of RMB70.0 million (US$9.2 million) for the year 2007 and we expect to pay out these declared dividends before the completion of this offering. Current PRC regulations permit our subsidiaries to pay dividends to us only out of their accumulated profits, if any, determined in accordance with PRC accounting standards and regulations. In addition, each of our subsidiaries and affiliated entities in China is required to set aside at least 10% of its after-tax profits each year as reported in its PRC statutory financial statements, if any, to fund a statutory reserve until such reserve reaches 50% of its registered capital, and each of our subsidiaries that are considered foreign invested enterprises is required to further set aside a portion of its after-tax profits as reported in its PRC statutory financial statements to fund the employee welfare fund at the discretion of the board. These reserves are not distributable as cash dividends. As of December 31, 2006, the total retained earnings of our PRC subsidiaries available for dividend distributions were RMB81.8 million (US$10.8 million). Furthermore, if our subsidiaries and affiliated entities in China incur debt on their own behalf in the future, the instruments governing the debt may restrict their ability to pay dividends or make other payments to us. In addition, the PRC tax authorities may require us to adjust our taxable income under the contractual arrangements we currently have in place in a manner that would materially and adversely affect our subsidiaries’ ability to pay dividends and other distributions to us. Any limitation on the ability of our subsidiaries and affiliated entities to distribute dividends or other payments to us could materially and adversely limit our ability to grow, make investments or acquisitions that could be beneficial to our businesses, pay dividends, or otherwise fund and conduct our business.

 

Recent PRC regulations relating to the establishment of offshore special purpose companies by PRC residents may subject our PRC resident shareholders to personal liability and limit our ability to inject capital into our PRC subsidiaries, limit our PRC subsidiaries’ ability to distribute profits to us, or otherwise adversely affect us.

 

The SAFE issued a public notice in October 2005, commonly known in China as “SAFE Circular 75,” requiring PRC residents to register with the local SAFE branch before establishing or controlling any company outside of China, referred to in the notice as an “offshore special purpose company,” for the purpose of raising capital backed by assets or equities of PRC companies. PRC residents that are shareholders of offshore special purpose companies established before November 1, 2005 were required to register with the local SAFE branch before March 31, 2006. See “Regulation—Regulations on Foreign Exchange—Foreign Exchange Registration of Offshore Investment by PRC Residents.”

 

Almost all of the shareholders of CAA Holdings Company Limited and Kingsford Resources Limited, two British Virgin Islands companies that indirectly held beneficial ownership interests in CISG, our wholly-owned subsidiary, before our restructuring in July 2007, are PRC residents. After our restructuring, the shareholders of CAA Holdings Company Limited and Kingsford Resources Limited became our indirect beneficial owners. To our knowledge, a total of 167 beneficial owners of our company will need to either file initial registrations or amend their previously filed registrations with SAFE in connection with our restructuring and this offering. We have requested our beneficial owners who are PRC residents to make the necessary applications, filings and amendments as required under SAFE Circular 75 and other related rules. We attempt to comply, and attempt to ensure that our beneficial owners who are subject to these rules comply, with the relevant requirements. However, we cannot assure you that all of our beneficial owners who are PRC residents will comply with our request to make or obtain any applicable registrations or comply with other requirements under SAFE Circular 75 or other related rules. The failure of these beneficial owners to timely amend their SAFE registrations pursuant to SAFE Circular 75 or the failure of future beneficial owners of our company who are PRC residents to comply with the registration procedures set forth in SAFE Circular 75 may subject such beneficial owners to fines and legal sanctions and may also limit our ability to contribute capital into our PRC subsidiaries, limit our PRC subsidiaries’ ability to distribute dividends to our company or otherwise adversely affect our business.

 

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On December 25, 2006, the People’s Bank of China promulgated the “Measures for the Administration of Individual Foreign Exchange,” and on January 5, 2007, the SAFE further promulgated implementation rules for those measures (collectively, referred to as the “Individual Foreign Exchange Rules”). Both became effective on February 1, 2007. According to the implementation rules, PRC citizens who are granted shares or share options by a company listed on an overseas stock market according to its employee share option or share incentive plan are required, through the PRC subsidiary of such overseas listed company or any other qualified PRC agent, to register with the SAFE and to complete certain other procedures related to the share option or other share incentive plan. Foreign exchange income received from the sale of shares or dividends distributed by the overseas listed company may be remitted into a foreign currency account of such PRC citizen or be exchanged into Renminbi. Our PRC citizen employees who have been granted share options will be subject to the Individual Foreign Exchange Rules upon the listing of our ADSs on the Nasdaq Global Market. If we or our PRC citizen employees fail to comply with these regulations, we or our PRC option holders may be subject to fines and legal sanctions.

 

Fluctuation in the value of the RMB may have a material adverse effect on your investment.

 

The value of the RMB against the U.S. dollar and other currencies may fluctuate and is affected by, among other things, changes in political and economic conditions. On July 21, 2005, the PRC government changed its decade-old policy of pegging the value of the RMB to the U.S. dollar. Under the new policy, the RMB is permitted to fluctuate within a narrow and managed band against a basket of certain foreign currencies. This change in policy has resulted in an approximately 9.5% appreciation of the RMB against the U.S. dollar between July 21, 2005 and September 30, 2007. While the international reaction to the RMB revaluation has generally been positive, there remains significant international pressure on the PRC government to adopt an even more flexible currency policy, which could result in a further and more significant appreciation of the RMB against the U.S. dollar. But on the other hand, there is no assurance that the RMB would not depreciate against the U.S. dollar in the future.

 

Our revenues and costs are mostly denominated in the RMB, and a significant portion of our financial assets are also denominated in RMB. We rely entirely on dividends and other fees paid to us by our subsidiaries and affiliated entities in China. Any significant appreciation or depreciation of the RMB against the U.S. dollar may affect our cash flows, revenues, earnings and financial position, and the value of, and any dividends payable on, our ADSs in U.S. dollars. For example, a further appreciation of the RMB against the U.S. dollar would make any new RMB-denominated investments or expenditures more costly to us, to the extent that we need to convert U.S. dollars into the RMB for such purposes. An appreciation of the RMB against the U.S. dollar would also result in foreign currency translation losses for financial reporting purposes when we translate our U.S. dollar denominated financial assets into the RMB, as the RMB is our reporting currency. Conversely, a significant depreciation of the RMB against the U.S. dollar may significantly reduce the U.S. equivalent of the earnings of our PRC subsidiaries and affiliated entities, and may adversely affect the price of our ADSs.

 

The approval of the China Securities Regulatory Commission, or the CSRC, may be required in connection with this offering under a recently adopted PRC regulation. Based on advice of our PRC counsel, we do not intend to seek CSRC’s approval for this offering. Any requirement to obtain prior CSRC approval could delay this offering and a failure to obtain this approval, if required, could have a material adverse effect on our business, operating results, reputation and trading price of our ADSs, and may also create uncertainties for this offering.

 

On August 8, 2006, six PRC regulatory agencies, namely, the PRC Ministry of Commerce, the State Assets Supervision and Administration Commission, the State Administration for Taxation, the State Administration for Industry and Commerce, the CSRC and the SAFE, jointly adopted the Regulations on Mergers and Acquisitions of Domestic Enterprises by Foreign Investors, which became effective on September 8, 2006. The new regulations purport, among other things, to require offshore special purpose vehicles, or SPVs, formed for overseas listing purposes and controlled by PRC companies or individuals to obtain the approval of the CSRC prior to publicly listing their securities on an overseas stock exchange. On September 21, 2006, the CSRC

 

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published a notice on its official website specifying documents and materials required to be submitted to it by SPVs seeking CSRC approval of their overseas listings.

 

While the application of the new regulations remain unclear, our PRC counsel, Commerce & Finance Law Offices, has advised us that, based on their understanding of the current PRC laws and regulations as well as the procedures announced on September 21, 2006:

 

   

the CSRC has jurisdiction over our offering;

 

   

the CSRC currently has not issued any definitive rule or interpretation concerning whether offerings like ours under this prospectus are subject to this new procedure; and

 

   

despite the above, given that we have completed our inbound investment before September 8, 2006, the effective date of the new regulations, an application is not required under the new regulations to be submitted to the CSRC for its approval of the listing and trading of our ADSs on the Nasdaq Global Market, unless we are clearly required to do so by subsequent rules of the CSRC.

 

Based on advice of our PRC counsel, we do not intend to seek CSRC’s approval for this offering. We, however, cannot assure you that the relevant PRC government agencies, including the CSRC, would reach the same conclusion as our PRC counsel. If the CSRC or other PRC regulatory agencies subsequently determines that we need to obtain the CSRC’s approval for this offering, we may face sanctions by the CSRC or other PRC regulatory agencies. In such event, these regulatory agencies may impose fines and penalties on our operations in the PRC, limit our operating privileges in the PRC, delay or restrict the repatriation of the proceeds from this offering into the PRC, or take other actions that could have a material adverse effect on our business, financial condition, results of operations, reputation and prospects, as well as the trading price of our ADSs. The CSRC or other PRC regulatory agencies may also take actions requiring us, or making it advisable for us, to halt this offering before settlement and delivery of the ADSs offered by this prospectus.

 

The recently adopted regulation discussed above could also make it more difficult for us to pursue growth through acquisitions.

 

The new regulations discussed in the preceding risk factor also established additional procedures and requirements that could make merger and acquisition activities by foreign investors more time-consuming and complex, including requirements in some instances that the Ministry of Commerce be notified in advance of any change-of-control transaction in which a foreign investor takes control of a PRC domestic enterprise. To date, we have conducted our acquisitions in China exclusively through our PRC affiliated entities. In the future, we may grow our business in part by directly acquiring complementary businesses rather than through our PRC affiliated entities, although we do not have any plans to do so at this time. Complying with the requirements of the new regulations to complete such transactions could be time consuming, and any required approval processes, including obtaining approval from the Ministry of Commerce, may delay or inhibit our ability to complete such transactions, which could affect our ability to expand our business or maintain our market share.

 

Risks Related to Our ADSs and This Offering

 

There has been no public market for our shares or ADSs prior to this offering, and you may not be able to resell our ADSs at or above the price you paid, or at all.

 

Prior to this initial public offering, there has been no public market for our shares or ADSs. We have applied to list our ADSs on the Nasdaq Global Market. Our ordinary shares will not be listed on any exchange or quoted for trading on any automated quotation system. If an active trading market for our ADSs does not develop after this offering, the market price and liquidity of our ADSs will be materially and adversely affected.

 

The initial public offering price for our ADSs will be determined by negotiations between us and the underwriters and may bear no relationship to the market price for our ADSs after the initial public offering. An

 

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active trading market for our ADSs may not develop and the market price of our ADSs may decline below the initial public offering price.

 

The market price for our ADSs may be volatile.

 

The market price for our ADSs may be volatile and subject to wide fluctuations in response to factors including the following:

 

   

actual or anticipated fluctuations in our quarterly operating results;

 

   

changes in financial estimates by securities research analysts;

 

   

conditions in the Chinese insurance industry;

 

   

changes in the economic performance or market valuations of other insurance intermediaries;

 

   

announcements by us or our competitors of new products, acquisitions, strategic partnerships, joint ventures or capital commitments;

 

   

addition or departure of key personnel;

 

   

fluctuations of exchange rates between the RMB and U.S. dollar or other foreign currencies;

 

   

potential litigation or administrative investigations;

 

   

release of lock-up or other transfer restrictions on our outstanding ADSs or ordinary shares or sales of additional ADSs; and

 

   

general economic or political conditions in China.

 

In addition, the securities market has from time to time experienced significant price and volume fluctuations that are not related to the operating performance of particular companies. These market fluctuations may also materially and adversely affect the market price of our ADSs.

 

You will experience immediate and substantial dilution in the net tangible book value of ADSs purchased.

 

The initial public offering price per ADS will be substantially higher than the net tangible book value per ADS prior to the offering. Consequently, when you purchase ADSs in the offering at the initial public offering price of US$12.00 per ADS (the midpoint of the estimated initial public offering price range shown on the front cover of this prospectus), you will incur immediate dilution of US$8.68 per ADS, representing the difference between our net tangible book value per ADS as of June 30, 2007, after giving effect to this offering but without considering the effect of the issuance of 34,210,526 ordinary shares after June 30, 2007, and the assumed initial public offering price. In other words, investors who purchase our ADSs in this offering will contribute 70.12% of the total amount we received from our shareholders, but will own only 22.89% of our total shares outstanding immediately after this offering without considering the effect of the issuance of 34,210,526 ordinary shares after June 30, 2007. See “Dilution.” In addition, you may experience further dilution to the extent that additional ordinary shares are issued upon exercise of outstanding options and options we may grant from time to time. As of the date of this prospectus, there are 5,473,684 ordinary shares issuable upon the exercise of outstanding options at an exercise price below the price per share in this offering; the exercise price of these options is RMB2.3214 (US$0.30) per share.

 

We may need additional capital, and the sale of additional ADSs or other equity securities could result in additional dilution to our shareholders.

 

We believe that our current cash and cash equivalents, anticipated cash flow from operations and the proceeds from this offering will be sufficient to meet our anticipated cash needs for the foreseeable future. We may, however, require additional cash resources due to changed business conditions or other future developments, including any investments or acquisitions we may decide to pursue. If these resources are

 

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insufficient to satisfy our cash requirements, we may seek to sell additional equity or debt securities or obtain a credit facility. The sale of additional equity securities could result in additional dilution to our shareholders. The incurrence of indebtedness would result in increased debt service obligations and could result in operating and financing covenants that would restrict our operations. We cannot assure you that financing will be available in amounts or on terms acceptable to us, if at all.

 

Substantial future sales of our ordinary shares or ADSs in the public market, or the perception that these sales could occur, could cause the price of our ADSs to decline.

 

Additional sales of our ordinary shares or ADSs in the public market after this offering, or the perception that these sales could occur, could cause the market price of our ADSs to decline. Upon completion of this offering, we will have 877,210,526 ordinary shares outstanding, including 232,881,600 ordinary shares represented by 11,644,080 ADSs. In addition, options to purchase 47,473,684 ordinary shares of our company are outstanding as of the date of this prospectus. All ADSs sold in this offering will be freely transferable without restriction or additional registration under the Securities Act of 1933. The remaining ordinary shares outstanding after this offering will be available for sale, upon the expiration of the 180-day lock-up period beginning from the date of the prospectus, subject to volume and other restrictions as applicable under Rule 144 and Rule 701 under the Securities Act. See “Shares Eligible for Future Sale” and “Underwriters” for a detailed description of the lock-up restrictions. Any or all of these shares may be released prior to expiration of the lock-up period at the discretion of the lead underwriters for this offering. To the extent shares are released before the expiration of the lock-up period and these shares are sold into the market in the form of ADSs, the market price of our ADSs could decline.

 

In addition, certain holders of our ordinary shares after the completion of this offering will have the right to require us to register the sale of a total of 684,210,526 shares under the Securities Act. Sales of these shares in the form of ADSs in the public market under an effective registration statement could cause the price of our ADSs to decline.

 

Our corporate actions are substantially controlled by our officers, directors and principal shareholders.

 

After this offering, our executive officers, directors and principal shareholders will beneficially own approximately 71.8% of our outstanding shares. These shareholders could exert substantial influence over matters requiring approval by our shareholders, including electing directors and approving mergers or other business combination transactions, and they may not act in the best interests of other minority shareholders. This concentration of our share ownership also may discourage, delay or prevent a change in control of our company, which could deprive our shareholders of an opportunity to receive a premium for their shares as part of a sale of our company and might reduce the price of our ADSs. These actions may be taken even if they are opposed by our other shareholders, including those who purchase ADSs in this offering.

 

You may not have the same voting rights as the holders of our ordinary shares and may not receive voting materials in time to be able to exercise your right to vote.

 

As a holder of ADSs, you will not be treated as one of our shareholders. Instead, the depositary will be treated as the holder of the shares underlying your ADSs. However, you may exercise some of the shareholders’ rights through the depositary, and you will have the right to withdraw the shares underlying your ADSs from the deposit facility as described in “Description of American Depositary Shares—Deposit, Withdrawal and Cancellation” and “—Your Right to Receive the Shares Underlying Your ADRs.”

 

Except as described in this prospectus and in the deposit agreement, holders of our ADSs will not be able to exercise voting rights attaching to the shares evidenced by our ADSs on an individual basis. Holders of ADSs may instruct the depositary to exercise the voting rights attaching to the Shares represented by the ADSs. If no instructions are received by the depositary on or before a date established by the depositary, the depositary shall deem the holders to have instructed it to give a discretionary proxy to a person designated by us to exercise their voting rights. You may not receive voting materials in time to instruct the depositary to vote, and it is possible

 

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that you, or persons who hold their ADSs through brokers, dealers or other third parties, will not have the opportunity to exercise a right to vote.

 

You may not be able to participate in rights offerings and may experience dilution of your holdings as a result.

 

We may from time to time distribute rights to our shareholders, including rights to acquire our securities. Under the deposit agreement for the ADSs, the depositary will not offer those rights to ADS holders unless both the rights and the underlying securities to be distributed to ADS holders are either registered under the Securities Act or exempt from registration under the Securities Act with respect to all holders of ADSs. We are under no obligation to file a registration statement with respect to any such rights or underlying securities or to endeavor to cause such a registration statement to be declared effective. In addition, we may not be able to take advantage of any exemptions from registration under the Securities Act. Accordingly, holders of our ADSs may be unable to participate in our rights offerings and may experience dilution in their holdings as a result.

 

You may be subject to limitations on transfer of your ADSs.

 

Your ADSs are transferable on the books of the depositary. However, the depositary may close its transfer books at any time or from time to time when it deems expedient in connection with the performance of its duties. In addition, the depositary may refuse to deliver, transfer or register transfers of ADSs generally when our books or the books of the depositary are closed, or at any time if we or the depositary deem it advisable to do so because of any requirement of law or of any government or governmental body, or under any provision of the deposit agreement, or for any other reason.

 

You may face difficulties in protecting your interests, and your ability to protect your rights through the U.S. federal courts may be limited, because we are incorporated under Cayman Islands law, conduct substantially all of our operations in China and most of our directors and officers reside outside the United States. In addition, Cayman Islands securities laws provide significantly less protection to investors as compared to U.S. laws.

 

We are incorporated in the Cayman Islands, and conduct substantially all of our operations in China through our wholly owned subsidiaries and consolidated affiliated entities in China. Most of our directors and officers reside outside the United States and some or all of the assets of those persons are located outside of the United States. As a result, it may be difficult or impossible for you to bring an action against us or against these individuals in the Cayman Islands or in China in the event that you believe that your rights have been infringed under the securities laws or otherwise. Even if you are successful in bringing an action of this kind, the laws of the Cayman Islands and of China may render you unable to enforce a judgment against our assets or the assets of our directors and officers. There is no statutory recognition in the Cayman Islands of judgments obtained in the United States, although the courts of the Cayman Islands will generally recognize and enforce a non-penal judgment of a foreign court of competent jurisdiction without retrial on the merits. For more information regarding the relevant laws of the Cayman Islands and China, see “Enforceability of Civil Liabilities.”

 

Our corporate affairs are governed by our memorandum and articles of association and by the Companies Law (2007 Revision) and common law of the Cayman Islands. The rights of shareholders to take legal action against our directors and us, actions by minority shareholders and the fiduciary responsibilities of our directors to us under Cayman Islands law are to a large extent governed by the common law of the Cayman Islands. The common law of the Cayman Islands is derived in part from comparatively limited judicial precedent in the Cayman Islands as well as from English common law, which has persuasive, but not binding, authority on a court in the Cayman Islands. The rights of our shareholders and the fiduciary responsibilities of our directors under Cayman Islands law are not as clearly established as they would be under statutes or judicial precedents in the United States. In particular, because Cayman Islands law has no legislation specifically dedicated to the rights of investors in securities, and thus no statutorily defined private causes of action specific to investors in securities such as those found under the Securities Act of 1933 or the Securities Exchange Act of 1934 in the United States,

 

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it provides significantly less protection to investors. In addition, Cayman Islands companies may not have standing to initiate a shareholder derivative action before the federal courts of the United States.

 

As a result of all of the above, our public shareholders may have more difficulty in protecting their interests through actions against our management, directors or major shareholders than would shareholders of a corporation incorporated in a jurisdiction in the United States.

 

Our articles of association contain anti-takeover provisions that could have a material adverse effect on the rights of holders of our ordinary shares and ADSs.

 

We intend to adopt amended and restated articles of association that will become effective upon the completion of this offering. Our new articles of association will contain provisions limiting the ability of others to acquire control of our company or cause us to enter into change-of-control transactions. These provisions could have the effect of depriving our shareholders of an opportunity to sell their shares at a premium over prevailing market prices by discouraging third parties from seeking to obtain control of our company in a tender offer or similar transaction. For example, our board of directors will have the authority, without further action by our shareholders, to issue preferred shares in one or more series and to fix their designations, powers, preferences, privileges, and relative participating, optional or special rights and the qualifications, limitations or restrictions, including dividend rights, conversion rights, voting rights, terms of redemption and liquidation preferences, any or all of which may be greater than the rights associated with our ordinary shares, in the form of ADS or otherwise. Preferred shares could be issued quickly with terms calculated to delay or prevent a change in control of our company or make removal of management more difficult. If our board of directors decides to issue preferred shares, the price of our ADSs may fall and the voting and other rights of the holders of our ordinary shares and ADSs may be materially and adversely affected.

 

Our management will have considerable discretion as to the use of the net proceeds from this offering.

 

Our management will have considerable discretion in the application of the net proceeds received by us. You will not have the opportunity, as part of your investment decision, to assess whether proceeds are being used appropriately. You must rely on the judgment of our management regarding the application of the net proceeds of this offering. The net proceeds may be used for corporate purposes that do not improve our efforts to maintain profitability or increase the price of our ADSs. The net proceeds from this offering may be placed in investments that do not produce income or that lose value.

 

Because we do not expect to pay dividends in the foreseeable future, you must rely on price appreciation of our ADSs for any return on your investment.

 

Although we have declared cash dividends in the past, we currently intend to retain most, if not all, of our available funds and any future earnings to fund the development and growth of our business. As a result, we do not expect to pay any cash dividends in the foreseeable future. Therefore, you should not rely on an investment in our ADSs as a source for any future dividend income.

 

Our board of directors has complete discretion as to whether to distribute dividends. Even if our board of directors decides to declare and pay dividends, the timing, amount and form of future dividends, if any, will depend on, among other things, our future results of operations and cash flow, our capital requirements and surplus, the amount of distributions, if any, received by us from our subsidiaries, our financial condition, contractual restrictions and other factors deemed relevant by our board of directors. Accordingly, the return on your investment in our ADSs will likely depend entirely upon any future price appreciation of our ADSs. There is no guarantee that our ADSs will appreciate in value after this offering or even maintain the price at which you purchased the ADSs. You may not realize a return on your investment in our ADSs and you may even lose your entire investment in our ADSs.

 

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We may be classified as a passive foreign investment company, which could result in adverse United States federal income tax consequences for U.S. Holders.

 

Based on the estimated value of our company before this offering, the price of the ADSs in this offering, as well as the expected price of our ADSs and ordinary shares following this offering, and the composition of our income and assets, we do not expect to be considered a “passive foreign investment company,” or PFIC, for United States federal income tax purposes for our current taxable year ending December 31, 2007. However, we must make a separate determination each year as to whether we are a PFIC (after the close of each taxable year). Accordingly, we cannot assure you that we will not be a PFIC for our current taxable year ending December 31, 2007 or any future taxable year. A non-U.S. corporation will be considered a PFIC for any taxable year if either (i) at least 75% of its gross income is passive income or (ii) at least 50% of the value of its assets (based on an average of the quarterly values of the assets during a taxable year) is attributable to assets that produce or are held for the production of passive income. The value of our assets generally will be determined by reference to the market price of our ADSs or ordinary shares, which may fluctuate considerably. In addition, the composition of our income and assets will be affected by how, and how quickly, we spend the cash we raise in any offering. If we were treated as a PFIC for any taxable year during which a U.S. Holder held an ADS or an ordinary share, a U.S. Holder directly or indirectly owning the ADSs or ordinary shares would be required to (i) pay an interest charge together with tax calculated at maximum ordinary income rates on “excess distributions,” which are defined to include gain on a sale or other disposition of the ADSs or ordinary shares, or (ii) so long as the ADSs or ordinary shares are regularly traded on a qualified exchange, elect to recognize as ordinary income each year the excess in the fair market value, if any, of the ADSs or ordinary shares held (or deemed held) by the holder at the end of the taxable year over such holder’s adjusted basis in such ADSs or ordinary shares and, to the extent of prior inclusions of ordinary income, recognize ordinary loss for the decrease in value of such ADSs or ordinary shares. For the definition of “U.S. Holder” and a more detailed discussion of United States federal income tax consequences to U.S. Holders, see “Taxation—United States Federal Income Taxation—Passive Foreign Investment Company.”

 

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FORWARD-LOOKING STATEMENTS

 

This prospectus contains forward-looking statements that reflect our current expectations and views of future events. The forward looking statements are contained principally in the sections entitled “Prospectus Summary,” “Risk Factors,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Business.” Known and unknown risks, uncertainties and other factors may cause our actual results, performance or achievements to be materially different from those expressed or implied by the forward-looking statements.

 

You can identify some of these forward-looking statements by words or phrases such as “may,” “will,” “expect,” “anticipate,” “aim,” “estimate,” “intend,” “plan,” “believe,” “is/are likely to” or other similar expressions. We have based these forward-looking statements largely on our current expectations and projections about future events and financial trends that we believe may affect our financial condition, results of operations, business strategy and financial needs. These forward-looking statements include statements relating to:

 

   

our anticipated growth strategies;

 

   

the anticipated growth of our life insurance business;

 

   

our future business development, results of operations and financial condition;

 

   

factors that affect our future revenues and expenses;

 

   

the future growth of the Chinese insurance industry as a whole and the professional insurance intermediary sector in particular;

 

   

trends and competition in the Chinese insurance industry; and

 

   

economic and demographic trends in the PRC.

 

You should read thoroughly this prospectus and the documents that we refer to with the understanding that our actual future results may be materially different from and worse than what we expect. We qualify all of our forward-looking statements by these cautionary statements. Other sections of this prospectus include additional factors which could adversely impact our business and financial performance.

 

This prospectus contains statistical data that we obtained from various government publications. We have not independently verified the data in these reports. Statistical data in these publications also may include projections based on a number of assumptions. If any one or more of the assumptions underlying the statistical data turns out to be incorrect, actual results may differ from the projections based on these assumptions. You should not place undue reliance on these forward-looking statements.

 

You should not rely upon forward-looking statements as predictions of future events. We undertake no obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

 

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USE OF PROCEEDS

 

We estimate that, assuming an initial public offering price of US$12.00 per ADS, the midpoint of the estimated range of the initial public offering price, the net proceeds to us from this offering, after deducting underwriting discounts and commissions and the estimated offering expenses payable by us and assuming no exercise of the underwriters’ over-allotment option, will be approximately US$101.7 million. If the underwriters exercise their over-allotment option in full, we estimate that the net proceeds to us will be approximately US$121.2 million. Assuming the number of ADSs offered by us as set forth on the cover page of this prospectus remains the same, a US$1.00 increase (decrease) in the assumed initial public offering price of US$12.00 per ADS would increase (decrease) the net proceeds of this offering to us by US$9.0 million after deducting underwriting discounts and commissions and the estimated offering expenses payable by us.

 

We intend to use the net proceeds from this offering as follows:

 

   

up to US$60 million to fund acquisitions and establishment of joint ventures in order to enter new geographical markets and further expand our product and service offerings;

 

   

up to US$40 million to fund enhancement of our service systems, including approximately US$28 million for the upgrading of our IT infrastructure, approximately US$8 million for the expansion of our call center operations and the establishment of Internet-based direct sales operations, and approximately US$4 million for other capital expenditures; and

 

   

the balance to fund our working capital requirements.

 

At this time, we have not entered into advanced discussions or negotiations with respect to any potential material acquisitions. Our management will have significant flexibility in applying the net proceeds we receive from this offering. Depending on future events and other changes in the business climate, we may determine at a later time to use the net proceeds for different purposes. Pending their use, we intend to invest our net proceeds in short-term, interest-bearing bank deposits.

 

We intend to make capital contributions or loans to our directly-held PRC subsidiaries and have our directly-held PRC subsidiaries make loans to our PRC affiliated entities so that the net proceeds of the offering can be used in the manner described above. Such capital contributions or loans are subject to a number of limitations and approval processes under PRC laws and regulations. We cannot assure you that we can obtain the approvals from the relevant governmental authorities, or complete the registration and filing procedures required to use our net proceeds as described above, in each case on a timely basis, or at all. See “Risk Factors—Risks Related to Our Corporate Structure—PRC regulation of loans and direct investment by offshore holding companies to PRC entities may delay or prevent us from using the proceeds of this offering to make loans or additional capital contributions to our PRC operating subsidiaries and affiliated entities, which could materially and adversely affect our liquidity and our ability to fund and expand our business.”

 

We will not receive any of the proceeds from the sale of ADSs by the selling shareholders.

 

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DIVIDEND POLICY

 

In 2006, we declared dividends of RMB170 and RMB523 per share for 2004 and 2005, respectively. In March 2007, we declared a dividend of RMB585 (US$77) per share for 2006. These dividends were not paid at the time they were declared. In 2007, we paid out RMB28.7 million (US$3.8 million) of the previously declared but unpaid dividends, and we expect to pay out the remainder of those previously declared but unpaid dividends to our existing shareholders before the completion of this offering. In October 2007, after we issued new ordinary shares on a 10,000 for-one basis in exchange for CISG shares, we declared a dividend of RMB0.102308 per share for 2007 and we expect to pay out these declared dividends before the completion of this offering. We have no plan to declare and pay cash dividends in the foreseeable future. We currently intend to retain most, if not all, of our available funds and any future earnings to operate and expand our business.

 

Our board of directors has complete discretion as to whether to distribute dividends. Even if our board of directors decides to pay dividends, the timing, amount and form of future dividends, if any, will depend on, among other things, our future results of operations and cash flow, our capital requirements and surplus, the amount of distributions, if any, received by us from our subsidiaries, our financial condition, contractual restrictions and other factors deemed relevant by our board of directors.

 

If we pay any dividends, we will pay our ADS holders to the same extent as holders of our ordinary shares, subject to the terms of the deposit agreement, including the fees and expenses payable thereunder. See “Description of American Depositary Shares.” Cash dividends on our ordinary shares, if any, will be paid in U.S. dollars.

 

We are a holding company incorporated in the Cayman Islands. We rely on dividends from our subsidiaries in China to fund our payment of dividends, if any, to our shareholders. Current PRC regulations permit our subsidiaries to pay dividends to us only out of their accumulated profits, if any, determined in accordance with PRC accounting standards and regulations. In addition, each of our subsidiaries in China is required to set aside a certain amount of its accumulated after-tax profits each year, if any, to fund certain statutory reserves. These reserves may not be distributed as cash dividends. Further, if our subsidiaries in China incur debt on their own behalf, the instruments governing the debt may restrict their ability to pay dividends or make other payments to us. Furthermore, the new PRC enterprise income tax law scheduled to take effect on January 1, 2008 may eliminate the current exemption of enterprise income tax on dividends derived by foreign investors from foreign invested enterprises and may impose on our subsidiaries in China an obligation to withhold tax on dividend distributions to us.

 

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CAPITALIZATION

 

The following table sets forth our capitalization as of June 30, 2007:

 

   

on an actual basis; and

 

   

on an adjusted basis to give effect to the issuance and sale of 193,000,000 ordinary shares in the form of ADSs by us in this offering, assuming an initial public offering price of US$12.00 per ADS, the mid-point of the estimated range of the initial public offering price, after deducting underwriting discounts, commissions and estimated offering expenses and assuming no exercise of the underwriters’ over-allotment option.

 

You should read this table together with our consolidated financial statements and the related notes included elsewhere in this prospectus and the information under “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

 

     As of June 30, 2007

 
     Actual

    As Adjusted

 
     RMB

    US$

    RMB

    US$

 
     (in thousands)  

Indebtedness:

                        

Long-term borrowings

   99     13     99     13  

Shareholders’ equity:

                        

Ordinary shares, US$0.001 par value, 1,000,000,000 authorized shares, 650,000,000 shares issued and outstanding

   5,073     667     6,542     859  

Additional paid-in capital

   370,618     48,688     1,143,244     150,190  

Accumulative other comprehensive loss

   (61 )   (8 )   (61 )   (8 )

Accumulated deficit

   (64,706 )   (8,501 )   (64,706 )   (8,501 )
    

 

 

 

Total shareholders’ equity

   310,924     40,846     1,085,019     142,540  
    

 

 

 

Total capitalization

   311,023     40,859     1,085,118     142,553  
    

 

 

 

 

Assuming the number of ADSs offered by us as set forth on the cover page of this prospectus remains the same, and after deduction of underwriting discounts and commissions and the estimated offering expenses payable by us, a US$1.00 increase (decrease) in the assumed initial public offering price of US$12.00 would increase (decrease) each of total shareholders equity and total capitalization by RMB68.3 million (US$9.0 million).

 

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DILUTION

 

If you invest in our ADSs, your interest will be diluted to the extent of the difference between the initial public offering price per ADS and our net tangible book value per ADS after this offering. Dilution results from the fact that the initial public offering price per ordinary share is substantially in excess of the book value per ordinary share attributable to the existing shareholders for our presently outstanding ordinary shares.

 

Our net tangible book value as of June 30, 2007 was approximately RMB299.6 million (US$39.4 million), or RMB0.46 (US$0.06) per ordinary share as of that date, and US$1.21 per ADS. Net tangible book value represents the amount of our total consolidated tangible assets, less the amount of our total consolidated liabilities. Dilution is determined by subtracting net tangible book value per ordinary share, after giving effect to the additional proceeds we will receive from this offering, from the assumed initial public offering price per ordinary share, which is the midpoint of the estimated initial public offering price range set forth on the cover page of this prospectus, and after deducting underwriting discounts and commissions and estimated offering expenses payable by us.

 

Without taking into account any other changes in net tangible book value after June 30, 2007, other than to give effect to our sale of the ADSs offered in this offering at the initial public offering price of US$12.00 per ADS, the midpoint of the estimated range of the initial offering price, after deduction of the underwriting discounts and commissions and estimated offering expenses payable by us, our pro forma net tangible book value as of June 30, 2007 would have been RMB1,073.7 million (US$141.0 million), or RMB1.27 (US$0.17) per outstanding ordinary share, and RMB25.50 (US$3.35) per ADS. This represents an immediate increase in net tangible book value of US$0.11 per ordinary share and US$2.20 per ADS, to the existing shareholders and an immediate dilution in net tangible book value of US$0.43 per ordinary share and US$8.68 per ADS, to investors purchasing ADSs in this offering. The following table illustrates such dilution:

 

Assumed initial public offering price per ordinary share

   US$ 0.60

Net tangible book value per ordinary share as of June 30, 2007

   US$ 0.06

Pro forma net tangible book value per ordinary share after giving effect to this offering

   US$ 0.17

Pro forma net tangible book value per ADS after giving effect to this offering

   US$ 3.35

Amount of dilution in net tangible book value per ordinary share to new investors in the offering

   US$ 0.43

Amount of dilution in net tangible book value per ADS to new investors in the offering

   US$ 8.68

 

The following table summarizes, on a pro forma basis as of June 30, 2007, the differences between existing shareholders and the new investors with respect to the number of ordinary shares (in the form of ADSs or shares) purchased from us, the total consideration paid and the average price per ordinary share/ADS paid before deducting the underwriting discounts and commissions and estimated offering expenses. The total number of ordinary shares does not include ordinary shares underlying the ADSs issuable upon the exercise of the overallotment option granted to the underwriters.

 

     Ordinary Shares Purchased

    Total Consideration

    Average
Price Per
Ordinary
Share


   Average
Price Per
ADS


     Number

   Percent

    Amount

   Percent

      

Existing shareholders

   650,000,000    77.11 %   US$ 49,355,000    29.88 %   US$ 0.08    US$ 1.52

New investors

   193,000,000    22.89       115,800,000    70.12       0.60      12.00
    
  

 

  

            

Total

   843,000,000    100.00 %   US$ 165,155,000    100.00 %             
    
  

 

  

            

 

A US$1.00 increase (decrease) in the assumed public offering price of US$12.00 per ADS would increase (decrease) our pro forma net tangible book value after giving effect to the offering by US$9.0 million, the pro

 

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forma net tangible book value per ordinary share and per ADS after giving effect to this offering by US$0.01 per ordinary share and US$0.21 per ADS and the dilution in pro forma net tangible book value per ordinary share and per ADS to new investors in this offering by US$0.04 per ordinary share and US$0.76 per ADS, assuming no charge to the number of ADSs offered by us as set forth on the cover page of this prospectus, and after deducting underwriting discounts and commissions and other offering expenses.

 

The pro forma information discussed above is illustrative only. Our net tangible book value following the completion of this offering is subject to adjustment based on the actual initial public offering price of our ADSs and other terms of this offering determined at pricing.

 

The discussion and tables above also assume no exercise of any outstanding stock options. In July 2007, 34,210,526 ordinary shares were issued upon the exercise of share options. As of the date of this prospectus, there were 5,473,684 ordinary shares issuable upon exercise of outstanding stock options at an exercise price of RMB2.3214 (US$0.30) per share and an additional 42,000,000 ordinary shares issuable upon the exercise of options outstanding at an exercise price to be equal to the price per ordinary share in this offering, and there were 26,421,053 ordinary shares available for future issuance upon the exercise of future grants under our 2007 share incentive plan. To the extent that any of these options are exercised, there will be further dilution to new investors.

 

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EXCHANGE RATE INFORMATION

 

Our business is primarily conducted in China and all of our revenues are denominated in Renminbi. This prospectus contains translations of RMB amounts into U.S. dollars at specific rates solely for the convenience of the reader. The conversion of RMB into U.S. dollars in this prospectus is based on the noon buying rate in The City of New York for cable transfers of RMB as certified for customs purposes by the Federal Reserve Bank of New York. Unless otherwise noted, all translations from RMB to U.S. dollars and from U.S. dollars to RMB in this prospectus were made at a rate of RMB7.6120 to US$1.00, the noon buying rate in effect as of June 29, 2007. We make no representation that any RMB or U.S. dollar amounts could have been, or could be, converted into U.S. dollars or RMB, as the case may be, at any particular rate, the rates stated below, or at all. The Chinese government imposes control over its foreign currency reserves in part through direct regulation of the conversion of RMB into foreign exchange and through restrictions on foreign trade. On October 17, 2007, the noon buying rate was RMB7.5156 to US$1.00.

 

The following table sets forth information concerning exchange rates between the RMB and the U.S. dollar for the periods indicated. These rates are provided solely for your convenience and are not necessarily the exchange rates that we used in this prospectus or will use in the preparation of our periodic reports or any other information to be provided to you. The source of these rates is the Federal Reserve Bank of New York.

 

     Noon Buying Rate

Period


   Period End

   Average(1)

   Low

   High

     (RMB per US$1.00)

2002

   8.2800    8.2772    8.2800    8.2700

2003

   8.2767    8.2771    8.2800    8.2765

2004

   8.2765    8.2768    8.2774    8.2764

2005

   8.0702    8.1826    8.2765    8.0702

2006

   7.8041    7.9579    8.0702    7.8041

2007

                   

Six months ended June 30

   7.6120    7.7014    7.8127    7.6120

April

   7.7090    7.7247    7.7345    7.7090

May

   7.6516    7.6773    7.7065    7.6463

June

   7.6120    7.6333    7.6680    7.6120

July

   7.5720    7.5757    7.6055    7.5580

August

   7.5462    7.5734    7.6181    7.5420

September

   7.4928    7.5196    7.5540    7.4928

October (through October 17)

   7.5156    7.5099    7.5158    7.5000

  (1)   Averages for a period are calculated by using the average of the exchange rates on the end of each month during the period. Monthly averages are calculated by using the average of the daily rates during the relevant period.

 

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ENFORCEABILITY OF CIVIL LIABILITIES

 

We were incorporated in the Cayman Islands in order to enjoy certain benefits, such as political and economic stability, an effective judicial system, a favorable tax system, the absence of exchange control or currency restrictions, and the availability of professional and support services. However, certain disadvantages accompany incorporation in the Cayman Islands. These disadvantages include a less developed body of Cayman Islands securities laws that provide significantly less protection to investors as compared to the laws of the United States, and the potential lack of standing by Cayman Islands companies to sue before the federal courts of the United States.

 

Our organizational documents do not contain provisions requiring that disputes, including those arising under the securities laws of the United States, between us, our officers, directors and shareholders, be arbitrated.

 

Substantially all of our operations are conducted in China, and substantially all of our assets are located in China. A majority of our directors and officers are nationals or residents of jurisdictions other than the United States and a substantial portion of their assets are located outside the United States. As a result, it may be difficult for a shareholder to effect service of process within the United States upon these persons, or to enforce against us or them judgments obtained in United States courts, including judgments predicated upon the civil liability provisions of the securities laws of the United States or any state in the United States.

 

We have appointed CT Corporation System, 111 Eighth Avenue, New York, NY 10011, as our agent upon whom process may be served in any action brought against us under the securities laws of the United States.

 

Maples and Calder, our counsel as to Cayman Islands law, and Commerce and Finance Law Offices, our counsel as to PRC law, have advised us, respectively, that there is uncertainty as to whether the courts of the Cayman Islands and China, respectively, would:

 

   

recognize or enforce judgments of United States courts obtained against us or our directors or officers predicated upon the civil liability provisions of the securities laws of the United States or any state in the United States; or

 

   

entertain original actions brought in each respective jurisdiction against us or our directors or officers predicated upon the securities laws of the United States or any state in the United States.

 

Maples and Calder has further advised us that a final and conclusive judgment in the federal or state courts of the United States under which a sum of money is payable, other than a sum payable in respect of taxes, fines, penalties or similar charges, may be subject to enforcement proceedings as a debt in the courts of the Cayman Islands under the common law doctrine of obligation.

 

Commerce & Finance Law Offices has further advised us that the recognition and enforcement of foreign judgments are provided for under the PRC Civil Procedures Law. PRC courts may recognize and enforce foreign judgments in accordance with the requirements of the PRC Civil Procedures Law based either on treaties between China and the country where the judgment is made or on reciprocity between jurisdictions. China does not have any treaties or other agreements that provide for the reciprocal recognition and enforcement of foreign judgments with the United States. In addition, according to the PRC Civil Procedures Law, courts in the PRC will not enforce a foreign judgment against us or our directors and officers if they decide that the judgment violates the basic principles of PRC law or national sovereignty, security or public interest. So, it is uncertain whether a PRC court would enforce a judgment rendered by a court in the United States.

 

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CORPORATE STRUCTURE

 

Our History

 

Our founders, Mr. Yinan Hu and Mr. Qiuping Lai, formed two PRC companies, Guangzhou Nanyun Car Rental Services Co., Ltd. and Guangdong Nanfeng Automobile Association Co., Ltd., initially to provide automobile-related services, such as car rental and emergency services. In 1999, we began distributing automobile insurance products on an ancillary basis. In 2001, our founders transferred their interests in the two PRC companies to China United Financial Services, then known as China Automobile Association Holdings Limited, a newly established British Virgin Islands company, as part of a series of transactions in which Cathay Capital Group, a private equity group, made an investment in China United Financial Services by subscribing for 40% of the equity interests. We established two insurance agencies, Beijing Fanlian Insurance Agency Co., Ltd. and Guangdong Nanfeng Insurance Agency Co., Ltd., in April and May 2002, respectively, and obtained professional agency licenses to distribute insurance products in Beijing and Guangdong.

 

As part of its corporate restructuring to facilitate international fundraising, China United Financial Services incorporated CISG, a British Virgin Islands company, in June 2004 as the holding company for its insurance agency and brokerage businesses and transferred to CISG all of its rights and interests in four PRC insurance intermediary companies it then controlled. In September 2004, Cathay Capital Group subscribed for approximately 27.8% of the equity interests in CISG. Between June 2004 and December 2005, we expanded our operations by establishing eight insurance agencies and brokerages in Beijing, Sichuan and Guangdong.

 

In December 2005, an entity affiliated with CDH, a private equity firm, subscribed for approximately 26.4% of the equity interests in CISG. In connection with this investment, the shareholders of CISG entered into a shareholder agreement that provided for, among other things, the management of the affairs of CISG. With the assistance of the CDH investment, we further expanded our operations by acquiring three insurance agencies in Sichuan, Hebei and Fujian, respectively, and establishing four insurance agencies in Shandong, Hunan, Shenzhen and Shanghai, respectively, in 2006. We established one insurance agency in Fujian and one insurance brokerage in Guangdong, respectively, in early 2007. In anticipation of this offering, we incorporated CNinsure Inc. in the Cayman Islands in April 2007. In July 2007, CNinsure Inc., on a 10,000-for-one basis, issued its ordinary shares to then the existing shareholders of CISG in exchange for all of the outstanding shares of CISG. After this restructuring transaction, CNinsure became the ultimate holding company of our group.

 

Our Corporate Structure and Contractual Arrangements

 

PRC laws and regulations place certain restrictions on foreign investment in and ownership of insurance agencies and brokerages. Accordingly, we conduct our operations in China principally through contractual arrangements among three of our PRC subsidiaries, two PRC affiliated entities and their shareholders, and the subsidiaries of the two PRC affiliated entities.

 

The three PRC subsidiaries are:

 

   

Yiqiman Management, which is party to various agreements with the shareholders of our PRC affiliated entities;

 

   

Guangzhou Zhongqi Enterprise Management Consulting Company Limited, or Zhongqi Consulting, which is party to a number of technology consulting and service agreements with some subsidiaries of our PRC affiliated entities; and

 

   

Beijing Ruisike Management Consulting Company Limited, or Ruisike Consulting, which is party to a number of technology consulting and service agreements and trademark licensing agreement with some subsidiaries of our PRC affiliated entities.

 

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The two PRC affiliated entities are:

 

   

Meidiya Investment; and

 

   

Yihe Investment.

 

Three individual shareholders, Mr. Jianguo Cui, Mr. Zhenyu Wang and Mr. Qiuping Lai, hold 100% of the equity interests in each of Meidiya Investment and Yihe Investment. Mr. Zhenyu Wang was designated by our shareholder CDH Inservice Limited. Mr. Qiuping Lai is our co-founder and president. Mr. Jianguo Cui is designated by our shareholder Cathay Auto Services Limited. All of the three individual shareholders are PRC citizens. Meidiya Investment and Yihe Investment together hold equity interests, directly or indirectly, ranging from 51% to 100% in 17 insurance agencies and four insurance brokerages. With the exception of the sole minority shareholder of Shenzhen Nanfeng Insurance Agency Co., Ltd., who is an executive officer of our company holding shares on our behalf, the other minority shareholders of the insurance agencies and brokerages majority-owned by Meidiya Investment and Yihe Investment are either founders of such company or entrepreneurial agents with whom we jointly set up the such company. Most of those minority shareholders are in charge of the day-to-day operations of the insurance agencies and brokerages in which they hold minority interests. The subsidiaries of Meidiya Investment and Yihe Investment hold the licenses and permits necessary to conduct our insurance intermediary business in China. We have no equity interests in Meidiya Investment, Yihe Investment or any of their subsidiaries and rely entirely on contractual arrangements to control and derive economic benefit from these companies.

 

Our contractual arrangements with the shareholders of Meidiya Investment and Yihe Investment enable us to:

 

   

exercise effective control over Meidiya Investment, Yihe Investment and their subsidiaries;

 

   

receive a substantial portion of the economic benefits of the subsidiaries of Meidiya Investment and Yihe Investment in consideration for the services provided by our subsidiaries in China; and

 

   

have an exclusive option to purchase all or part of the equity interests in each of Meidiya Investment and Yihe Investment when and to the extent permitted by PRC law.

 

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The following diagram illustrates our corporate structure as of the date of this prospectus:

 

LOGO

 

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Table of Contents

Agreements that Provide Us Effective Control over Meidiya Investment, Yihe Investment and Their Subsidiaries

 

Loan Agreements.    Each shareholder of Meidiya Investment entered into a loan agreement on December 20, 2005 with our subsidiary Yiqiman Management, evidencing a zero interest loan granted to such shareholder. The principal amounts of the loans to Mr. Lai, Mr. Wang and Mr. Cui were RMB2.94 million, RMB1.58 million and RMB1.48 million, respectively. The term of the loan agreement is 10 years and may be extended upon written agreement of the parties. Upon the expiration of its term and subject to then applicable PRC laws, the loan can be repaid only with the proceeds from the transfer of the shareholder’s equity interest in Meidiya Investment to Yiqiman Management or another person designated by Yiqiman Management. Yiqiman Management may accelerate the loan repayment upon certain events, including if the shareholder quits or is dismissed or if Yiqiman Management exercises its option to purchase the shareholder’s equity interest in Meidiya Investment pursuant to the exclusive equity purchase option agreement described below.

 

The loan agreement contains a number of covenants that restrict the actions the shareholder can take or cause Meidiya Investment to take, or that require the shareholder to take or cause Meidiya Investment to take specific actions. For example, these covenants provide that the shareholder will:

 

   

not transfer, pledge or otherwise dispose of or encumber his equity interest in Meidiya Investment without the prior written consent of Yiqiman Management, except for equity pledge for the benefit of Yiqiman Management.

 

   

not take any action without the prior written consent of Yiqiman Management, if the action will have a material impact on the assets, business and liabilities of Meidiya Investment.

 

   

not vote for, or execute any resolutions to approve, the sale, transfer, mortgage, or disposal of, or the creation of any encumbrance on, any legal or beneficial interests in the equity of Meidiya Investment without the prior written consent of Yiqiman Management, except to Yiqiman Management or its designee.

 

   

not vote for, or execute any resolutions to approve, any merger or consolidation with any person, or any acquisition of or investment in any person by Meidiya Investment without the prior written consent of Yiqiman Management.

 

   

vote to elect the directors candidates nominated by Yiqiman Management.

 

   

cause Meidiya Investment not to supplement, amend or modify its articles of association in any manner, increase or decrease registered capital or change the capital structure in any way without the prior written consent of Yiqiman Management.

 

   

cause Meidiya Investment not to execute any contract with a value exceeding RMB100,000 without the prior written consent of Yiqiman Management, except in the ordinary course of business.

 

Each shareholder of Yihe Investment entered into a loan agreement on December 20, 2005 with Yiqiman Management that is substantially similar to the loan agreements described above, except that the principal amounts of the loans to Mr. Lai, Mr. Wang and Mr. Cui under these loan agreements were RMB9.78 million, RMB 5.28 million and RMB4.93 million, respectively.

 

Equity Pledge Agreements.    Pursuant to the equity pledge agreements entered into on December 20, 2005 among Yiqiman Management, each shareholder of Meidiya Investment, and Meidiya Investment, each shareholder agreed to pledge his equity interest in Meidiya Investment to Yiqiman Management to secure his obligations under the loan agreement with Yiqiman Management. The shareholder also agreed not to transfer or create any encumbrance adverse to Yiqiman Management on his equity interest in Meidiya Investment. During the term of the equity pledge agreement, Yiqiman Management is entitled to all the dividends declared on the pledged equity interest. The equity pledge agreement will expire when the shareholder fully performed his obligations under the loan agreement. The equity pledges were recorded on the shareholders register of Meidiya

 

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Investment, but we have not been able to register the pledges because the relevant local administration of industry and commerce, which maintain public records of business entities, refuse to register this kind of pledges. See “Risk Factors—Risks Related to Our Corporate Structure—We rely on contractual arrangements with our PRC affiliated entities and their subsidiaries and shareholders for our China operations, which may not be as effective in providing operational control as direct ownership.”

 

Each shareholder of Yihe Investment entered into an equity pledge agreement on December 20, 2005 with Yiqiman Management and Yihe Investment that is substantially similar to the equity pledge agreements described above.

 

Irrevocable Power of Attorney.    Each shareholder of Meidiya Investment and Yihe Investment executed an irrevocable power of attorney on December 20, 2005, appointing a person designated by Yiqiman Management as his attorney-in-fact to vote on his behalf on all matters requiring shareholder approval. If Yiqiman Management designates the shareholder to attend a shareholder’s meeting of Meidiya Investment or Yihe Investment, the shareholder agrees to vote his shares as instructed by Yiqiman Management. The term of the power of attorney is ten years from December 20, 2005.

 

Agreements that Provide Us the Option to Purchase the Equity Interest in Meidiya Investment and Yihe Investment

 

Exclusive Purchase Option Agreements.    Pursuant to the exclusive purchase option agreements entered into on December 20, 2005 among Yiqiman Management, each shareholder of Meidiya Investment, and Meidiya Investment, each shareholder irrevocably granted Yiqiman Management an exclusive option to purchase part or all of his equity interest in Meidiya Investment, when and to the extent permitted by applicable PRC law. The purchase price to be paid by Yiqiman Management will be equal to the amount of the shareholder’s actual capital contribution to Meidiya Investment, unless applicable PRC law requires otherwise. The actual capital contributions to Meidiya Investment by Mr. Lai, Mr. Wang and Mr. Cui were RMB2.94 million, RMB1.58 million and RMB1.48 million, respectively. If applicable PRC law requires appraisals of the equity interest or has other restrictions on the transfer price, the purchase price will be the minimum price permitted under applicable PRC law. Under current applicable PRC law, if a foreign-invested enterprise, such as Yiqiman Management, intends to acquire the equity interests in a domestic enterprise, such as Meidiya Investment or Yihe Investment, the transfer price must be determined based on appraisal conducted by a qualified domestic asset appraisal institution using internationally recognized appraisal methodology, and it is prohibited to transfer any equities at a price clearly lower than the result of the appraisal.

 

Each shareholder of Yihe Investment entered into an exclusive purchase option agreement on December 20, 2005 with Yiqiman Management and Yihe Investment that is substantially similar to the exclusive purchase option agreements described above, except that the actual capital contributions to Yihe Investment by Mr. Lai, Mr. Wang and Mr. Cui under these agreements were RMB9.78 million, RMB 5.28 million and RMB4.93 million, respectively.

 

Agreements that Transfer Economic Benefits to Us

 

Technology Consulting and Service Agreements.    Pursuant to the technology consulting and service agreements entered into on December 20, 2005 between our PRC subsidiary Ruisike Consulting and each of 12 insurance agency and brokerage subsidiaries of Meidiya Investment and Yihe Investment, and later on August 10, 2007 between Ruiske Consulting and each of nine additional insurance agency and brokerage subsidiaries of Meidiya Investment and Yihe Investment, Ruisike Consulting agreed to provide consulting and other services relating to management software, risk assessment, training, corporate image and branding, marketing and corporate management. In exchange, the insurance agencies or brokerages that are parties to these agreements each agreed to pay a monthly fee calculated primarily based on a percentage of the premiums generated by such agency or brokerage firm. Each of these agreements has an initial term of ten years from the signing date, which will be automatically renewed for one-year terms unless Ruisike Consulting decides not

 

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renew the agreement. Each agreement may be terminated by the insurance agency or brokerage firm only upon gross negligence, fraud, other illegal conduct or bankruptcy of Ruisike, and by Ruisike upon 30 days notice.

 

Zhongqi Consulting, another PRC subsidiary of ours, entered into substantially similar technology consulting and service agreements with the same insurance agencies and brokerages and on the same dates as described above.

 

Trademark Licensing Agreements.    Pursuant to the trademark licensing agreements entered into on December 21, 2005 between Ruisike Consulting and each of 12 insurance agency and brokerage subsidiaries of Meidiya Investment and Yihe Investment, and later on August 10, 2007 between Ruiske Consulting and each of nine additional insurance agency and brokerage subsidiaries of Meidiya Investment and Yihe Investment, Ruisike Consulting agreed to grant a nonexclusive right to use the trademark owned by it to each of the insurance agencies and brokerages, in exchange for a fixed annual fee of RMB10,000. Each of these agreements has an initial term of ten years from the signing date, which will be automatically renewed for one-year terms unless Ruisike Consulting decides not to renew the agreement. Each agreement may be terminated by a party if there has been a material breach by the other party and the breach is not cured within 30 days after the breaching party receives a written notice from the non-breaching party. In addition, Ruisike Consulting may terminate each agreement at any time during the term of the agreement upon 30-day notice.

 

In 2006, twelve of our affiliated insurance agencies and brokerages paid a total of RMB33.3 million under the technology consulting and service agreements and the trademark licensing agreements to our subsidiaries, representing approximately 79.2% of the net income before income taxes of these 12 affiliated entities. In the first half of 2007, these 12 affiliated insurance agencies and brokerages paid a total of RMB8.63 million under the technology consulting and service agreements and the trademark licensing agreements to our subsidiaries, representing approximately 50% of the net income before income taxes of these 12 affiliated entities for those six months.

 

Because of these contractual arrangements, we are deemed the primary beneficiary of Meidiya Investment and Yihe Investment and hence they and their subsidiaries are treated as our consolidated affiliated entities. Revenues generated by the insurance agency and brokerage subsidiaries of Meidiya Investment and Yihe Investment accounted for 56.4% of our total revenues in 2006 and 51.0% of our total net revenues for the first half of 2007. The remainder of our total net revenues in those periods came from two of our subsidiaries, which run our operating platform, maintain our customer database and provide information about potential customers to insurance companies. Those insurance companies pay fees to these subsidiaries if those customers actually purchase insurance.

 

In the opinion of Commerce & Finance Law Offices, our PRC legal counsel:

 

   

the ownership structures of our affiliated entities, their subsidiaries and our subsidiaries in China, both currently and after giving effect to this offering, comply with all existing PRC laws and regulations;

 

   

the contractual arrangements among our PRC subsidiaries, affiliated entities and their shareholders governed by PRC law are valid, binding and enforceable, and will not result in any violation of PRC laws or regulations currently in effect; and

 

   

the business operations of our PRC subsidiaries, our affiliated entities and their subsidiaries comply in all material respects with existing PRC laws and regulations.

 

We have been advised by our PRC legal counsel, however, that there are substantial uncertainties regarding the interpretation and application of current and future PRC laws and regulations. Accordingly, the PRC regulatory authorities may in the future take a view that is contrary to the above opinion of our PRC legal counsel. We have been further advised by our PRC counsel that if the PRC government finds that the agreements that establish the structure for operating our PRC insurance intermediary businesses do not comply with PRC government restrictions on foreign investment in the insurance intermediary industry, we could be subject to severe penalties including being prohibited from continuing operation. See “Risk Factors—Risks Related to Our

 

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Corporate Structure—If the PRC government finds that the agreements that establish the structure for operating our China business do not comply with applicable PRC laws and regulations, we could be subject to severe penalties” and “Risk Factors—Risks Related to Doing Business in China—Uncertainties with respect to the PRC legal system could adversely affect us.”

 

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SELECTED CONSOLIDATED FINANCIAL DATA

 

The following selected combined/consolidated financial data for the three years ended December 31, 2004, 2005 and 2006 and the combined/consolidated balance sheet data as of December 31, 2005 and 2006 have been derived from our audited consolidated financial statements, which are included elsewhere in this prospectus. The following summary consolidated financial data for the six months ended June 30, 2006 and 2007 and the consolidated balance sheet data as of June 30, 2007 have been derived from our unaudited condensed consolidated financial statements included elsewhere in this prospectus and have been prepared on the same basis as our audited consolidated financial data. The unaudited financial information includes all adjustments, consisting only of normal and recurring adjustments, that we consider necessary for a fair presentation of our financial position and operating results for the periods presented. Our historical results do not necessarily indicate results expected for any future periods. In addition, our unaudited results for the six months ended June 30, 2007 may not be indicative of our results for the full year ending December 31, 2007. The selected consolidated financial data should be read in conjunction with our audited consolidated financial statements and related notes and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this prospectus. Our audited consolidated financial statements are prepared and presented in accordance with U.S. GAAP.

 

Our selected combined financial data for the two years ended December 2002 and 2003 and as of December 31, 2002 and 2003 have been derived from our unaudited combined financial statements, which are not included in this prospectus. Our selected consolidated balance sheet data for the year ended December 31, 2004 have been derived from our audited consolidated balance sheet as of December 31, 2004, which is not included in this prospectus. Our unaudited combined financial statements have been prepared on the same basis as our audited consolidated financial statements.

 

The historical results for years ended December 31, 2002, 2003 and 2004 are prepared to reflect, on a combined basis, all of the insurance brokerage and agency service businesses for the entire years of 2002, 2003 and 2004, including those entities transferred from China United Financial Services on June 9, 2004 and those operations held by entities of China United Financial Services that we did not acquire. Accordingly, the revenues, expenses, assets and liabilities related to the insurance brokerage and agency services for the years ended December 31, 2002 and 2003 and for the period from January 1, 2004 to June 8, 2004 and as of December 31, 2002, 2003 and June 8, 2004 held by China United Financial Services entities that we did not acquire have been “carved out” from those entities and combined with those of our company for the entire period on a basis that our management considers to be reasonable. Accordingly, the historical financial information that has been presented for the periods prior to the reorganization on June 9, 2004 does not necessarily reflect what our financial position, results of operations and cash flows would have been had we been a separate, stand-alone entity during the periods presented. China United Financial Services did not account for us, and we were not operated, as a separate, stand-alone entity prior to June 9, 2004. We prepared our combined financial information on the same basis as we adopted for the preparation of the consolidated financial information for the years ended December 31, 2005 and 2006. In this prospectus, our consolidated financial information for 2002 through 2007 refers collectively to our combined financial information for the years ended December 31, 2002, 2003 and 2004 and the consolidated financial information for the years ended December 31, 2005 and 2006 and for the six months ended June 30, 2006 and 2007.

 

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    For the Year Ended December 31,

    For the Six Months Ended
June 30,


 
    2002

    2003

    2004

    2005

    2006

    2006

    2007

 
    RMB     RMB     RMB     RMB     RMB     US$     RMB     RMB     RMB  
    (in thousands, except share, per share and per ADS data)  

Consolidated Statement of Operations Data

                                                     

Net revenues:

                                                     

Commissions and fees

  18,660     26,893     33,401     142,520     245,652     32,271     106,543     172,323     22,638  

Other service fees

  3,158     3,263     564     1,179     897     118     248     238     31  
   

 

 

 

 

 

 

 

 

Total net revenues

  21,818     30,156     33,965     143,699     246,549     32,389     106,791     172,561     22,669  
   

 

 

 

 

 

 

 

 

Operating costs and expenses:

                                                     

Commissions and fees

  (5,643 )   (5,915 )   (4,256 )   (65,752 )   (133,076 )   (17,482 )   (53,321 )   (87,275 )   (11,465 )

Selling expenses

  (1,003 )   (1,221 )   (2,432 )   (5,527 )   (11,288 )   (1,483 )   (5,288 )   (4,196 )   (551 )

General and administrative expenses(1)

  (11,431 )   (17,520 )   (120,576 )   (78,879 )   (52,119 )   (6,847 )   (25,793 )   (25,915 )   (3,404 )
   

 

 

 

 

 

 

 

 

Total operating costs and expenses

  (18,077 )   (24,656 )   (127,264 )   (150,158 )   (196,483 )   (25,812 )   (84,402 )   (117,386 )   (15,420 )
   

 

 

 

 

 

 

 

 

Income (loss) from operations

  3,741     5,500     (93,299 )   (6,459 )   50,066     6,577     22,389     55,175     7,249  

Other income (expense), net:

                                                     

Interest income

  11     36     49     445     5,364     705     1,596     1,980     260  

Interest expense

  (99 )   (5 )   (15 )   (19 )   (34 )   (5 )   (28 )   (66 )   (9 )

Others, net

  8     0     158     (15 )   5     1     10     15     2  
   

 

 

 

 

 

 

 

 

Net income (loss) before income taxes

  3,661     5,531     (93,107 )   (6,048 )   55,401     7,278     23,967     57,104     7,502  

Net income tax benefit (expense)

  (1,380 )   (1,350 )   396     (672 )   573     75     42     (176 )   (23 )
   

 

 

 

 

 

 

 

 

Net income (loss) before minority interest

  2,281     4,181     (92,711 )   (6,720 )   55,974     7,353     24,009     56,928     7,479  

Minority interest

  —       —       —       27     1,421     187     160     1,762     231  
   

 

 

 

 

 

 

 

 

Net income (loss)

  2,281     4,181     (92,711 )   (6,693 )   57,395     7,540     24,169     58,690     7,710  
   

 

 

 

 

 

 

 

 

Net income (loss) per share (giving effect to the 10,000-for-1 share exchange in 2007):

                                                     

—Basic

  0.014     0.0250     (0.5552 )   (0.0139 )   0.0883     0.0116     0.0372     0.0903     0.0119  

—Diluted

  0.014     0.0250     (0.5552 )   (0.0139 )   0.0875     0.0115     0.0370     0.0891     0.0117  

Net income (loss) per ADS:

                                                     

—Basic

  0.280     0.500     (11.104 )   (0.278 )   1.766     0.232     0.744     1.806     0.238  

—Diluted

  0.280     0.500     (11.104 )   (0.278 )   1.750     0.230     0.740     1.782     0.234  

Shares used in calculating net income (loss) per share (giving effect to the 10,000-for-1 share exchange in 2007):

                                                     

—Basic

  166,980,000     166,980,000     166,980,000     482,770,000     650,000,000     650,000,000     650,000,000     650,000,000     650,000,000  

—Diluted

  166,980,000     166,980,000     166,980,000     482,770,000     655,970,000     655,970,000     652,884,328     658,927,355     658,927,355  

Dividends declared per share(2)

  —       —       170     523     585     75     —       —       —    

 

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(1)     Share-based compensation expenses included in our general and administrative expenses were RMB109.3 million, RMB56.5 million, RMB24.1 million (US$3.2 million) RMB13.0 million and RMB0.8 million (US$0.1 million) in 2004, 2005, 2006 and the six months ended June 30, 2006 and 2007, respectively.

(2)     The 2004 and 2005 dividends were declared in 2006 and the 2006 dividends were declared in 2007. These dividends were not paid at the time they were declared. In 2007, we paid out RMB28.7 million (US$3.8 million) of the previously declared but unpaid dividends, and we expect to pay out the remainder of those previously declared but unpaid dividends to our existing shareholders before this offering. The per-share amounts were determined based on the number of CISG shares outstanding as of the respective record dates for the dividends declared, without giving effect to the share exchange in July 2007.

 

     As of December 31,

   As of June 30,
2007


     2002

   2003

   2004

   2005

   2006

  
     RMB    RMB    RMB    RMB    RMB    US$    RBM    US$
     (in thousands)

Consolidated Balance Sheets Data

                                       

Cash and cash equivalents

   2,164    11,924    29,123    174,634    223,926    29,417    363,406    47,741

Total current assets

   31,951    79,302    53,664    281,752    355,703    46,729    443,436    58,255

Total assets

   32,856    80,952    56,922    286,736    379,622    49,871    468,999    61,613

Total current liabilities

   15,327    38,337    14,005    43,049    75,524    9,922    137,972    18,126

Total liabilities

   15,603    38,955    14,591    43,370    76,321    10,026    139,576    18,337

Minority interests

   —      —      —      2,423    13,717    1,802    18,499    2,430

Total shareholders’ equity

   17,253    41,997    42,331    240,943    289,584    38,043    310,924    40,846

Total liabilities and owners’ equity

   32,856    80,952    56,922    286,736    379,622    49,871    468,999    61,613

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

 

You should read the following discussion and analysis of our financial condition and results of operations in conjunction with our consolidated financial statements and the related notes included elsewhere in this prospectus. This discussion may contain forward-looking statements based upon current expectations that involve risks and uncertainties. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of various factors, including those set forth under “Risk Factors” or in other parts of this prospectus.

 

Overview

 

We are a leading independent insurance agency and brokerage company operating in China. With approximately 11,000 sales professionals and approximately 171 sales and service outlets operating in eight provinces as of September 30, 2007, our distribution network reaches some of the most economically developed regions and some of the most affluent cities in China. Our business has grown substantially in recent years. Our net revenues increased from RMB34.0 million in 2004 to RMB143.7 million in 2005 and to RMB246.5 million (US$32.4 million) in 2006, representing a CAGR of 169.4% in the three-year period. Our net loss decreased from RMB92.7 million in 2004 to RMB6.7 million in 2005, and we achieved profitability in 2006 with a net income of RMB57.4 million (US$7.5 million). For the six months ended June 30, 2007, our net revenues and net income were RMB172.6 million (US$22.7 million) and RMB58.7 million (US$7.7 million), respectively, representing increases of 61.6% and 142.8%, respectively, from the net revenues and net income for the same period in 2006.

 

As an insurance agency and brokerage company, we do not assume underwriting risks. Instead, we distribute insurance products underwritten by domestic and foreign insurance companies operating in China, and provide certain insurance-related services to our customers—individuals and institutions that purchase insurance products through us. In addition, we also introduce customers to insurance companies, which then sell insurance products to them, either directly or through our affiliated insurance intermediaries. We generate revenue primarily from commissions and fees paid by insurance companies, typically based on a percentage of the premium paid by the insured. Commission and fee rates generally depend on the type of insurance products, the particular insurance company and the region in which the products are sold. Some of the commissions and fees are paid to us in the form of performance bonuses pursuant to written agreements between the insurance companies and us after we have achieved specified premium volume goals. Where there is no written agreement requiring payment of bonuses, insurance companies may pay us discretionary bonuses as a reward for achieving certain premium volume, loss ratio or renewal rate.

 

Factors Affecting Our Results of Operations

 

Our financial condition and results of operations are primarily affected by the following factors:

 

   

the overall premium growth of the Chinese insurance industry;

 

   

the extent to which insurance companies in the PRC outsource the distribution of their products;

 

   

premium rate levels and commission and fee rates;

 

   

the size and productivity of our sale force;

 

   

commission rates for individual sales agents;

 

   

product and service mix;

 

   

share-based compensation expenses;

 

   

acquisitions; and

 

   

seasonality.

 

The Overall Premium Growth of the Chinese Insurance Industry

 

The Chinese insurance industry has grown substantially in recent years. Between 2000 and 2005, total insurance premiums increased from RMB160.9 billion to RMB492.8 billion, representing a CAGR of 25.1%,

 

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according to data published by the CIRC. We believe that certain macroeconomic and demographic factors, such as per capita GDP growth and aging of the population, have contributed to and will continue to drive the growth of the Chinese insurance industry. See “Industry” for a more detailed discussion of the Chinese insurance industry and its growth factors.

 

We derive our revenue primarily from commissions and fees paid by insurance companies, typically calculated as a percentage of premiums paid by our customers to the insurance companies. Accordingly, continued industry-wide premium growth will have a positive impact on us. However, there is no assurance that the growth trend will continue. Any downturn in the Chinese insurance industry, whether caused by a general slowdown of the PRC economy or otherwise, may adversely affect our financial condition and results of operations.

 

The Extent to Which Insurance Companies in the PRC Outsource the Distribution of Their Products

 

Historically, insurance companies in the PRC have relied primarily on their exclusive individual sales agents and direct sales force to sell their products. Only in recent years, as a result of increased competition, have some insurance companies gradually expanded their distribution channels to include insurance intermediaries such as commercial banks, postal offices, insurance agencies and insurance brokerages. In addition, because of a lack of established distribution network of their own, some newly established insurance companies have chosen to rely primarily on insurance intermediaries to distribute their products while they focus on other aspects of their business.

 

As insurance companies in the PRC become more accustomed to outsourcing the distribution of their products to insurance intermediaries, they may allow insurance intermediaries to distribute a wider variety of insurance products and may provide more monetary incentives to more productive and effective insurance intermediaries. These and other similar measures designed to boost sales through insurance intermediaries will have a positive impact on our financial condition and results of operations.

 

Premium Rate Levels and Commission and Fee Rates

 

Because the commissions and fees we receive from insurance companies are generally calculated as a percentage of premiums paid by our customers to the insurance companies, our revenue and results of operations are affected by premium rate levels and commission and fee rates. Premium rate levels and commission and fee rates can change based on the prevailing economic conditions, competitive and regulatory landscape, and other factors that affect insurance companies. These other factors include the ability of insurance companies to place new business, underwriting and non-underwriting profits of insurance companies, consumer demand for insurance products, the availability of comparable products from other insurance companies at a lower cost, and the tax deductibility of commissions and fees. In addition, premium rates for certain insurance products, such as the mandatory automobile liability insurance that each automobile owner in the PRC is legally required to purchase, are tightly regulated by the CIRC. In some instance, we can negotiate for better rates as an incentive for generating larger volume of business.

 

Since China’s entry into the WTO in December 2001, competition among insurance companies has intensified as a result of a significant increase in the number of insurance companies and the existing insurance companies’ expansion into new geographic markets. This competition has led to a gradual increase in the commission and fee rates offered to insurance intermediaries, and such increase has had a positive impact on our results of operations. Meanwhile, the intense competition among insurance companies also has led to a gradual decline in premium rate levels of some property and casualty insurance products. While such decline has had a negative impact on the commissions and fees we earned on a per policy sold basis, it also may have had a positive impact on our total commissions and fees revenue by increasing demand for, and our total sales volume of, those policies.

 

The Size and Productivity of Our Sale Force

 

As a distributor of insurance products, we generate revenue primarily through our sales force, which consists of individual sales agents in our distribution network and a relatively small number of in-house sales

 

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representatives. The size of our sales force and its productivity, as measured by the average number of insurance products sold per person, the average premium per product sold and the average premiums generated per person during any specified period, directly affect our revenue and results of operations. In recent years, some entrepreneurial management staffs or senior sales agents of major insurance companies in China have chosen to leave their employers or principals and become independent agents. We refer to these independent agents as “entrepreneurial agents.” An entrepreneurial agent is usually able to assemble and lead a team of sales agents. We have been actively recruiting and will continue to recruit entrepreneurial agents to join our distribution network as our sales agents. Entrepreneurial agents have been instrumental to the development of our life insurance business.

 

Commission Rates for Individual Sales Agents

 

A large component of our operating costs and expenses is commissions paid to our individual sales agents. In order to retain sales agents, we must pay commissions at a level comparable to the commissions paid by our competitors. Competition for productive sales agents has been intense within the Chinese insurance industry and has led to a gradual increase in commission rates in recent years. The increase in commission rates has had a negative impact on our results of operations If we are forced to further increase our commission rates for individual sales agents due to competition or otherwise, our operating costs and expenses will increase correspondingly.

 

Product and Service Mix

 

We began distributing automobile insurance products in 1999 and expanded our product offerings to other property and casualty insurance products in 2002 and then to individual life insurance products in 2006. The property and casualty insurance policies we distribute are typically for one-year terms, with a single premium payable at the beginning of the term. Accordingly, we receive a single commission or fee for each property and casualty policy our customers purchase. In order for us to have recurring commission and fee revenue from property and casualty insurance products, our customers have to renew their policies or purchase new policies through us every year. Most individual life insurance policies we sell require periodic payment of premiums, typically annually, during a pre-determined payment period, generally ranging from five to 25 years. For such policies we sell, insurance companies will pay us a first-year commission and fee based on a percentage of the first year’s gross premiums, and subsequent commissions and fees based on smaller percentages of the renewal premiums paid by the insured throughout the payment period of the policy. Therefore, once we sell a life insurance policy with a periodic payment schedule, it can bring us a steady flow of commission and fee revenue throughout the payment period as long as the insured meets his or her premium payment commitment.

 

Because insurance companies pay us first-year commission and fee for most life insurance products at rates higher than those for property and casualty insurance products, we expect increased distribution of life insurance products will have a positive impact on our revenue. However, we will also incur a corresponding increase in operating costs because we pay our sales agents a higher commission and fee for distributing life insurance products. Accordingly, the operating margin attributable to life insurance products may not be as high as that for property and casualty insurance products, and may initially have a negative impact on our overall operating margin. We expect that the operating margin for life insurance products will improve because we only need to pay commissions to our sales agents for the first five years of a policy, but continue to earn renewal fees from the insurance company for the entire payment period of the policy, which could be up to 25 years.

 

Share-based Compensation Expenses

 

Our historical results of operations have been materially affected by the share-based compensation expenses incurred. In 2004, 2005, 2006 and the six months ended June 30, 2007, we incurred share-based compensation expenses of RMB109.3 million, RMB56.5 million, RMB24.1 million (US$3.2 million) and RMB0.8 million (US$0.1 million), respectively. See “—Key Performance Indicators—Operating Costs and Expenses—Share-based Compensation Expenses” for a more detailed discussion of our historical share-based compensation expenses. In order to attract and retain the best personnel for positions of substantial responsibility, provide additional incentive to employees, directors and consultants and promote the

 

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success of our business, we adopted a new share incentive plan in 2007. See “Management—Share Incentives—2007 Share Incentive Plan.” In October 2007, our board of directors voted to grant options under our 2007 share incentive plan to certain of our directors and employees to purchase an aggregate of 42,000,000 ordinary shares of our company at an exercise price equal to the offering price per ordinary share in this offering. As we grant share options and other equity-based awards under our 2007 share incentive plan, we expect to incur additional share-based compensation expenses.

 

Acquisitions

 

The professional insurance intermediary sector in China is still at an early development stage and highly fragmented. We believe this offers substantial opportunities for consolidation. We intend to grow our distribution network in part through selective acquisitions of high-quality independent insurance agencies and brokerages. In 2006, we, through our consolidated affiliated entities in the PRC, acquired majority interests in three insurance agencies. See “—Recent Acquisitions.” We expect these acquisitions to have a positive impact on our results of operations in the near future. However, acquisitions also involve significant risks and uncertainties. See “Risk Factors—Risks Related to Our Business and Our Industry—If we fail to integrate acquired companies efficiently, or if the acquired companies do not perform to our expectations, our business and results of operations may be adversely affected.” In addition, any write-down of goodwill due to impairment and the amortization of intangible assets acquired could have a negative impact on our results of operations.

 

Key Performance Indicators

 

Net Revenues

 

Our revenues are net of PRC business tax. In 2004, 2005, 2006 and the six months ended June 30, 2007, we generated net revenues of RMB34.0 million, RMB143.7 million, RMB246.5 million (US$32.4 million) and RMB172.6 million (US$22.7 million), respectively. We derive net revenues from the following sources:

 

   

commissions and fees paid by insurance companies, which accounted for 98.3%, 99.2%, 99.6% and 99.9% of our net revenues for 2004, 2005, 2006 and the six months ended June 30, 2007, respectively; and

 

   

other service fees, which refers to fees paid by insurance companies for certain settlement-related services provided by us to the insured on behalf of the insurance companies and accounted for 1.7%, 0.8%, 0.4% and 0.1% of our net revenues for 2004, 2005, 2006 and the six months ended June 30, 2007, respectively.

 

Commissions and Fees

 

In 2004, 2005, 2006 and the six months ended June 30, 2007, we generated commissions and fees of RMB33.4 million, RMB142.5 million, RMB245.7 million (US$32.3 million) and RMB172.3 million (US$22.6 million), respectively. We derive commissions and fees from the distributions of the following insurance products:

 

   

property and casualty insurance products, including automobile insurance products, commercial property and homeowner insurance products, individual accident insurance products, cargo insurance products, liability insurance products, construction insurance products and hull insurance products; and

 

   

life insurance products, including individual endowment products, individual whole life and term life insurance products, individual education annuity products, health insurance products, universal insurance products and group life insurance products.

 

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The following table sets forth our commissions and fees earned from the distributions of different insurance products, both in absolute amount and as a percentage of total commissions and fees, for the periods indicated:

 

    For the Year Ended December 31,

  For the Six Months Ended June 30,

    2004

  2005

  2006

  2006

  2007

    RMB   %   RMB   %   RMB   US$   %   RMB   %   RMB   US$   %
    (in thousands except percentages)

Property and casualty insurance products

  33,401   100.0   142,520   100.0   225,027   29,562   91.6   101,362   95.1   152,817   20,076   88.7

Life insurance products

          20,625   2,709   8.4   5,181   4.9   19,506   2,562   11.3
   
 
 
 
 
 
 
 
 
 
 
 

Total commissions and fees earned

  33,401   100.0   142,520   100.0   245,652   32,271   100.0   106,543   100.0   172,323   22,638   100.0
   
 
 
 
 
 
 
 
 
 
 
 

 

Commissions and fees earned from property and casualty insurance products, in particular automobile insurance products, have been our primary source of revenue since our inception. With the continued growth in automobile sales and private car ownership in China, we expect automobile insurance products to continue to be a major contributor to our net revenues. We began distributing individual life insurance products in 2006 and expect commissions and fees from life insurance products to constitute an increasingly significant portion of our net revenues in the next several years.

 

The commissions and fees we receive are based on a percentage of the premiums paid by the insured. Commission and fee rates generally depend on the type of insurance products, the particular insurance company and the region in which the insurance products are sold. We typically receive payment of the commissions and fees from insurance companies on a monthly basis. Some of the fees are paid to us annually or semi-annually in the form of performance bonuses after we have achieved specified premium volume or policy renewal goals as agreed upon between the insurance companies and us.

 

Other Service Fees

 

In connection with the distribution of automobile insurance products, we provide some insurance-related services, such as damage assessment and claim settlement services, to the insured on behalf of insurance companies. In 2004, 2005, 2006 and the six months ended June 30, 2007, we generated other service fees of RMB0.6 million, RMB1.2 million, RMB0.9 million (US$0.1 million) and RMB238,000 (US$31,000), respectively, for providing these services. We intend to take advantage of the experience we have gained from providing settlement-related services and begin providing insurance claims adjusting services in the fourth quarter of 2007. However, we do not expect claims adjusting services to constitute a significant portion of our revenue in the near future.

 

Operating Costs and Expenses

 

Our operating costs and expenses consist of commissions and fees incurred in connection with the distribution of insurance products, selling expenses and general and administrative expenses. The following table sets forth the components of our operating costs and expenses, both in absolute amount and as a percentage of our net revenues, for the periods indicated.

 

    For the Year Ended December 31,

    For the Six Months Ended June 30,

 
    2004

    2005

    2006

    2006

    2007

 
    RMB     %     RMB     %     RMB     US$     %     RMB     %     RMB     US$     %  
    (in thousands except percentages)  

Net revenues

  33,965     100.0     143,699     100.0     246,549     32,389     100.0     106,791     100.0     172,561     22,669     100.0  
   

 

 

 

 

 

 

 

 

 

 

 

Operating costs and expenses:

                                                                       

Commissions and fees

  (4,256 )   (12.5 )   (65,752 )   (45.8 )   (133,076 )   (17,482 )   (54.0 )   (53,321 )   (49.9 )   (87,275 )   (11,465 )   (50.6 )

Selling expenses

  (2,432 )   (7.2 )   (5,527 )   (3.8 )   (11,288 )   (1,483 )   (4.6 )   (5,288 )   (5.0 )   (4,196 )   (551 )   (2.4 )

General and administrative expenses

  (120,576 )   (355.0 )   (78,879 )   (54.9 )   (52,119 )   (6,847 )   (21.1 )   (25,793 )   (24.1 )   (25,915 )   (3,404 )   (15.0 )
   

 

 

 

 

 

 

 

 

 

 

 

Total operating costs and expenses

  (127,264 )   (374.7 )   (150,158 )   (104.5 )   (196,483 )   (25,812 )   (79.7 )   (84,402 )   (79.0 )   (117,386 )   (15,420 )   (68.0 )
   

 

 

 

 

 

 

 

 

 

 

 

 

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Commissions and Fees

 

We incur commissions and fees in connection with the distributions of insurance products. The commissions and fees that we incurred increased each year from 2004 to 2006 and in the first half of 2007 compared to the same period in 2006 primarily as a result of increase in net revenues and increase in the size of our sales force. Commissions and fees incurred as a percentage of net revenues also increased each year during the three-year period and slightly in the first half of 2007 compared to the same period in 2006, primarily due to the change in the composition of our sales force and commission rate increase caused by competition. In 2004, our sales force was entirely composed of in-house sales representatives. In 2005, we started the transition from a sales model that relied exclusively on in-house sales representatives to one that relies principally on sales agents. By the end of 2006, our sales force was primarily composed of individual sales agents. Sales agents as a percentage of our sales force increased slightly from 93.8% as of December 31, 2006 to 94.7% as of June 30, 2007. Commissions paid to individual sales agents on average are higher than commissions and base salary paid to our in-house sales representatives. We anticipate that our commissions and fees will continue to increase as we add more sales agents to our sales force and increase our distributions of insurance products.

 

Selling Expenses

 

Our selling expenses primarily consist of:

 

   

employment benefits for our in-house sales staff;

 

   

office rental, telecommunications expenses and office supply expenses incurred in connection with sales activities; and

 

   

advertising expenses.

 

We expect that our selling expenses will continue to increase as we expand our distribution network in both existing markets and new geographic regions. As we grow in size, we also intend to spend more on marketing and advertising to enhance our brand recognition.

 

General and Administrative Expenses

 

Our general and administrative expenses principally comprise of:

 

   

share-based compensation expenses for managerial and administrative staff;

 

   

salaries and benefits for our administrative staff;

 

   

office rental expenses;

 

   

travel expenses;

 

   

professional fees paid for certain PRC tax planning, market research, legal and auditing services;

 

   

depreciations and amortizations;

 

   

entertainment expenses; and

 

   

office supply expenses for our administrative staff.

 

We expect that our general and administrative expenses will increase as we hire additional administrative personnel and incur additional costs in connection with the expansion of our business and with our becoming a publicly traded company, including costs to enhance our internal controls.

 

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Share-based Compensation Expenses

 

The largest component of our general and administrative expenses in each of 2004, 2005 and 2006 was share-based compensation expenses. In 2004, 2005, 2006 and the six months ended June 30, 2007, we incurred share-based compensation only with respect to certain managerial and administrative staff and accordingly, allocated all share-based compensation expenses to general and administrative expenses. The following table sets forth our share-based compensation expenses, both in absolute amount and as a percentage of our general and administrative expenses, for the periods indicated.

 

    For the Year Ended December 31,

  For the Six Months Ended June 30,

    2004

  2005

  2006

  2006

  2007

    RMB   %   RMB   %   RMB   US$   %   RMB   %   RMB   US$   %
    (in thousands, except percentages)

General and administrative expenses

  120,576   100.0   78,879   100.0   52,119   6,847   100.0   25,793   100.0   25,915   3,404   100.0

Share-based compensation expenses

  109,262   90.6   56,501   71.6   24,142   3,172   46.3   12,978   50.3   837   110   3.2

 

Our share-based compensation expenses in the first half of 2007 were attributable to the grant of options to purchase 5,473,684 ordinary shares of our company (after giving effect to the 10,000-for-1 share exchange in July 2007) to our Chief Financial Officer in February 2007.

 

Our share-based compensation expenses of RMB24.1 million in 2006 consist of three elements. The first element is RMB3.6 million incurred in connection with our grant of options to purchase 3,421 ordinary shares of CISG to certain management staff under our 2006 share option plan. Pursuant to the subscription agreement, dated December 22, 2005, in connection with our private placement of 17,160 ordinary shares of CISG to CDH Inservice Limited, Mr. Qiuping Lai, our president, granted to the shareholders of CISG call options to purchase his entire shareholdings in Kingsford Resources Limited, a British Virgin Islands company that was then a direct shareholder of CISG, if CISG fails to achieve specified financial targets in 2005 and 2006. Because CISG has achieved those financial targets, Mr. Lai was entitled to retain his shareholdings in Kingsford Resources Limited and, as a result, we recognized share-based compensation expenses of RMB18.8 million in 2006. Finally, in connection with our waiver of certain performance goals for Sichuan Xintai Insurance Agency Co., Ltd., an insurance agency we acquired in March 2006, we recorded share-based compensation expenses of RMB1.7 million. See “—Recent Acquisitions” for a more detailed discussion of this acquisition.

 

Our share-based compensation expenses of RMB56.5 million in 2005 arose from the issuance of 6,655 CISG shares at par value to Kingsford Resource Limited, which was controlled by certain members of our senior management. The share-based compensation expenses of RMB109.3 million in 2004 were attributable to the issuance of options to purchase 12,357 CISG shares to certain members of our senior management at an exercise price of RMB0.1 per share.

 

In August 2007, we adopted our 2007 Share Incentive Plan, under which we are authorized to issue share options to our employees, directors and consultants. See “Management—Share Incentives—2007 Share Incentive Plan.” Because our 2007 Share Incentive Plan covers all of our employees, the change in the amount of share-based compensation expenses will affect our reported net income, earnings per share selling expenses and general and administrative expenses. In October 2007, our board of directors voted to grant options under our 2007 share incentive plan to certain of our directors and employees to purchase an aggregate of 42,000,000 ordinary shares of our company at an exercise price equal to the offering price per ordinary share in this offering.

 

As of June 30, 2007, the intrinsic value of our outstanding vested and unvested options based on the estimated price of the initial public offering are RMB145,873,683 and RMB15,417,726, respectively. As of the date of this prospectus, there were outstanding options to purchase 47,473,684 ordinary shares of our company (giving effects to the 10,000-for-1 share exchange in July 2007).

 

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Taxation

 

We and each of our subsidiaries and affiliated entities file separate income tax returns.

 

The Cayman Islands, the British Virgin Islands and Hong Kong

 

Under the current laws of the Cayman Islands and the British Virgin Islands, we and our subsidiaries incorporated in the British Virgin Islands are not subject to income or capital gains taxes. In addition, dividend payments are not subject to withholding tax in those jurisdictions. Our subsidiary incorporated in Hong Kong is subject to a profits tax rate of 17.5% of its assessable profits. Payment of dividends is not subject to withholding tax in Hong Kong.

 

PRC

 

Pursuant to the current PRC enterprise income tax laws, enterprise income tax is calculated based on taxable income. Most of our subsidiaries and consolidated affiliated entities in China are subject to the standard enterprise income tax rate, which currently is 33.0% (30.0% of state income tax plus 3.0% of local income tax). Our subsidiaries and affiliated entities located in Shenzhen, a special economic zone, are subject to an enterprise income tax rate of 15%. The enterprise income tax is calculated based on taxable income under PRC accounting principles. For some entities, the enterprise income tax is calculated based on the actual revenue at a deemed tax rate according to the local practices of the respective local tax bureaus in charge. In addition, our subsidiaries and affiliated entities in China are subject to a 5.0% business tax on gross revenues generated from providing services and two additional fees, the city construction fee and the education fee, which are generally calculated at 7.0% and 3.0%, respectively, on business tax.

 

Pursuant to the Notice Regarding Certain Taxation Policy Issues Relating to the Reemployment of the Laid-off and Unemployed Persons, jointed issued by the PRC Ministry of Finance and the State Administration of Taxation and effective from January 1, 2003, a newly established enterprise in the service industry (with limited exceptions) will be entitled to an exemption from enterprise income tax for three years if at least 30% of its work force is composed of previously “laid-off or unemployed persons” and the enterprise has entered into employment agreements with these individuals with a term of more than three years. “Laid-off or unemployed persons” are defined in the notice to include primarily laid-off or unemployed persons who are former employees of state-owned enterprises. Existing enterprises in the service industry (with limited exceptions) are entitled to a 30% reduction of enterprise income tax if they meet similar hiring requirements. Some of our subsidiaries and affiliated entities in the PRC are entitled to an exemption from enterprise income tax for a period ranging from two to three years. The following table sets forth the entities that are entitled to the tax exemption under this notice.

 

Entities Name


  

Tax Holiday Period


Beijing Fanhua Insurance Agency Co., Ltd.

  

January 1, 2005 – December 31, 2007

Beijing Fanlian Investment Co., Ltd.

  

January 1, 2004 – December 31, 2006

Beijing Fumin Insurance Agency Co., Ltd.

  

January 11, 2005 – December 31, 2007

Guangzhou Xiangxing Insurance Agency Co., Ltd.

  

January 1, 2005 – December 31, 2006

Guangzhou Zhongqi Enterprise Management Consulting Co., Ltd.

  

March 14, 2005 – December 31, 2007

Beijing Ruisike Management Consulting Co., Ltd.

  

March 28, 2005 – December 31, 2007

Guangdong Kafusi Insurance Brokerage Co., Ltd.

  

September 16, 2003 – December 31, 2005

Guangzhou Yian Insurance Agency Co., Ltd.

  

January 1, 2005 – December 31, 2007

 

The preferential tax treatments granted to our subsidiaries and affiliated entities in the PRC are subject to review and may be adjusted or revoked by relevant PRC tax authorities. In addition, if the PRC government were to phase out the tax benefits for service enterprises that hire laid-off or unemployed persons as described in the preceding paragraph, our subsidiaries and affiliated entities that have been entitled to such tax benefits would be subject to the standard statutory tax rate. The discontinuation of any preferential tax treatments currently available to us could cause our effective tax rate to increase, which could have a material and adverse effect on our results of operations.

 

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On March 16, 2007, the National People’s Congress of the PRC passed the PRC Enterprise Income Tax Law, which will take effect as of January 1, 2008. Under the new tax law, a unified enterprise income tax rate of 25% and unified tax deduction standards will be applied equally to both domestic-invested enterprises and foreign-invested enterprises such as some of our PRC subsidiaries. Enterprises established prior to March 16, 2007 that are eligible for preferential tax treatment in accordance with current tax laws and regulations will, under regulations to be adopted by the State Council, gradually become subject to the new tax rate over a five- year transition period starting from January 1, 2008. We expect details of the five-year transitional arrangement to be spelled out in implementing rules to be adopted in the future. The applicable tax rate of some of our PRC subsidiaries may gradually increase from their existing tax rate of 15% to the unified tax rate of 25% by January 1, 2013 under the new tax law. Any increase in our effective tax rate as a result of the above may adversely affect our operating results.

 

Recent Acquisitions

 

Historically, we have expanded our distribution network primarily by establishing new insurance agencies and brokerages and, to a lesser extent, by acquiring controlling interests in existing insurance agencies. In 2006, we, through our PRC consolidated affiliated entities, Meidiya Investment and Yihe Investment, acquired majority interests in three insurance agencies that specialize in the distribution of life insurance products:

 

   

Sichuan Xintai Insurance Agency Co., Ltd., or Xintai Agency;

 

   

Fujian Xinheng Insurance Agency Co., Ltd., or Xinheng Agency; and

 

   

Hebei Anxin Insurance Agency Co., Ltd., or Anxin Agency.

 

The founder of each acquired company has entered into an employment agreement with the acquired company. Under this agreement, the founder is employed as an executive officer of the acquired company for an initial term of three to five years. The parties will engage in good-faith negotiation for a renewal of the agreement one month before the expiration of the initial term. The acquired company may terminate the employment for cause, at any time, without notice or remuneration, for certain acts of the founder, including material violation of company policies, dereliction of duty, dishonesty and leaking of trade secret to the acquired company’s detriment, and criminal conviction. The acquired company also may terminate the agreement upon 30-day written notice if the founder is incapable of performing his duties after training and change of position or if the accumulated loss of the acquired company reaches a certain level. The founder may terminate the agreement without notice if the acquired company fails to pay his compensation or comply with other obligations of the acquired company specified in the agreement. The employment agreement also contains customary confidentiality and non-competition requirements applicable to the founder.

 

Xintai Agency

 

In March 2006, we, through Yihe Investment, acquired 70% of the common shares of Xintai Agency at a total purchase price of RMB10.19 million (US$1.3 million). Under our agreement with the sellers, Xintai Agency’s pre-acquisition valuation would be adjusted downward, and our shareholding would be adjusted upwards correspondingly by up to 12 percentage points, if Xintai Agency failed to achieve certain operational and financial goals in 2006 and 2007. We have waived those operational and financial goals and our adjustment right to reflect our control of the acquired entity, to facilitate the integration of the acquired entity into our operations and to focus the efforts of the founders on helping us build our group-wide business platform. The same agreement provides that Xintai’s board of directors will consist of five members, of which three will be appointed by us. In addition, the agreement sets forth a non-exclusive list of material corporate matters, such as amendments of the articles of association, mergers, acquisitions and disposal of material assets, and change of business scope, that require approval of at least three directors.

 

Xinheng Agency

 

In June 2006, we, through Meidiya Investment, acquired 51.22% of the common shares of Xinheng Agency at a total purchase price of RMB1.1 million (US$0.1 million). We also agreed to make an interest-free

 

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convertible loan of RMB4.95 million and to convert the loan into common shares, such that our total ownership interest in Xinheng Agency will be increased to 55% upon the conversion, if Xinheng Agency achieves certain operational and financial goals in 2006. Xinheng Agency’s pre-acquisition valuation would be adjusted downward, and our shareholding would be adjusted upwards correspondingly by up to 16 percentage points, if Xinheng Agency failed to achieve certain operational and financial goals in 2006 and 2007. We waived those operational and financial goals and our adjustment right in September 2006 to reflect our control of the acquired entity, to facilitate the integration of the acquired entity into our operations and to focus the efforts of the founders on helping us build our group-wide business platform. As a result, our shareholding in Xinheng Agency increased to 55% at the beginning of 2007. The same agreement provides that Xinheng’s board of directors will consist of five members, of which three will be appointed by us. In addition, the agreement sets forth a non-exclusive list of material corporate matters, such as amendments of the articles of association, mergers, acquisitions and disposal of material assets, and change of business scope, that require approval of at least three directors.

 

Anxin Agency

 

In October 2006, we, through Yihe Investment, acquired 55% of the common shares of Anxin Agency at a total purchase price of RMB8.0 million (US$1.1 million). Anxin Agency’s pre-acquisition valuation would be adjusted downward, and our shareholding would be adjusted upwards correspondingly by up to 16 percentage points, if Anxin Agency failed to achieve certain operational and financial goals in 2006 and 2007. We have waived those operational and financial goals and our adjustment right to reflect our control of the acquired entity, to facilitate the integration of the acquired entity into our operations and to focus the efforts of the founders on helping us build our group-wide business platform. The same agreement provides that Anxin’s board of directors will consist of five members, of which three will be appointed by us. In addition, the agreement sets forth a non-exclusive list of material corporate matters, such as amendments of the articles of association, mergers, acquisitions and disposal of material assets, and change of business scope, that require approval of at least four directors.

 

Critical Accounting Policies

 

We prepare financial statements in accordance with U.S. GAAP, which requires us to make judgments, estimates and assumptions that affect the reported amounts of our assets and liabilities and the disclosure of our contingent assets and liabilities at the end of each fiscal period and the reported amounts of revenues and expenses during each fiscal period. We continually evaluate these judgments and estimates based on our own historical experience, knowledge and assessment of current business and other conditions, our expectations regarding the future based on available information and assumptions that we believe to be reasonable, which together form our basis for making judgments about matters that are not readily apparent from other sources. Since the use of estimates is an integral component of the financial reporting process, our actual results could differ from those estimates. Some of our accounting policies require a higher degree of judgment than others in their application.

 

The selection of critical accounting policies, the judgments and other uncertainties affecting application of those policies and the sensitivity of reported results to changes in conditions and assumptions are factors that should be considered when reviewing our financial statements. We believe the following accounting policies involve the most significant judgments and estimates used in the preparation of our financial statements.

 

Revenue Recognition

 

We recognize revenue when all of the following have occurred: persuasive evidence of an agreement with the insurance company exists; services have been provided; the fees for such services are fixed or determinable; and collectibility of the fees is reasonably assured.

 

Brokerage and agency services are considered to be rendered and completed, and revenue is recognized, at the time the insurance policy becomes effective, that is, when the signed insurance policy is in place and the premium is collected from the insured. We believe that we have met all the four criteria of revenue recognition when the premiums are collected by us or the respective insurance companies and not before, because

 

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collectibility is not ensured until receipt of the premium. Accordingly, we do not accrue any commissions and fees prior to the receipt of the related premiums. No allowance for cancellation has been recognized as we estimate that, based on our past experience, policy cancellations rarely occur. Any subsequent commission and fee adjustments in connection with policy cancellations, which have been de minimis to date, are recognized upon notification from the insurance companies. Actual commission and fee adjustments in connection with the cancellation of policies were approximately 0.3%, 0.1%, 0.1%, 0.1% and 0.04% of the total commission and fee revenues for the years ended December 31, 2004, 2005 and 2006 and for the six months ended June 30, 2006 and 2007, respectively, and 0.1%, 2.0%, 0.4%, 0.5% and 0.1% of the actual net income (loss) for each of those periods, respectively. Other service fees include revenue from the provision of certain settlement-related services on behalf of the insurance companies. We recognize this type of revenue when the services are rendered.

 

In connection with the distribution of insurance products, our affiliated insurance agencies may receive performance bonuses from insurance companies pursuant to agreements between the insurance agency and the insurance company. Once the agency achieves its performance target, generally a certain sales volume, the bonus will become due. The bonus amount is calculated by multiplying the insurance premium volume by an agreed-upon percentage. In addition, we record discretionary bonuses as revenue when we receive them; in many cases, that is when insurance companies first notify us of the payment of the discretionary bonuses.

 

Share-based Compensation

 

We early adopted SFAS No. 123(R), which became effective on January 1, 2006. We treat all forms of share-based payments to employees, including employee stock options and employee stock purchase plans, the same as any other form of compensation and recognize the related cost in the statement of operations. Compensation cost related to employee stock option or similar equity instruments is measured at the grant date based on the fair value of the award and is recognized over the service period, which is usually the vesting period. We use the Black-Scholes option-pricing model to determine the fair value of stock options.

 

We engaged American Appraisal China Limited, or AAC, an unrelated and independent valuation specialist, to assist in our determination of the fair value of the ordinary shares and options as of each relevant grant date. The valuation report from AAC has been used as part of our analysis in reaching our conclusion of value. We reviewed the valuation methodologies used by AAC and believe the methodologies used are appropriate and the valuation results are representative of the fair value of our ordinary shares and options. Therefore, we have adopted the valuation opinion of AAC in our calculation of the option expenses.

 

Determining the fair values of the ordinary shares requires making complex and subjective judgments regarding projected financial and operating results, our unique business risks, the liquidity of the ordinary shares and our operating history and prospects at the time of grant. Therefore, these fair values are inherently uncertain and highly subjective.

 

The assumptions used to derive the fair values of the ordinary shares include:

 

   

no material changes in the existing political, legal, fiscal and economic conditions in China;

 

   

no major changes in tax law in China or the tax rates applicable to our subsidiaries and consolidated affiliated entities in China;

 

   

no material changes in the exchange rates and interest rates from the presently prevailing rates;

 

   

availability of finance not a constraint on our future growth;

 

   

our ability to retain competent management, key personnel and technical staff to support our ongoing operations; and

 

   

no material deviation in market conditions from economic forecasts.

 

These assumptions are inherently uncertain. If we had used different assumptions and judgments, the valuation results would have been different and the amount of share-based compensation would also have been different because the fair value of the underlying ordinary shares for the options granted would have been different.

 

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The following table sets forth the options granted to certain directors, officers and employees in 2004, 2006 and 2007, after giving effect to the 10,000-for-one share exchange in July 2007:

 

Grant Date


  

Number of 

Ordinary Shares
Underlying Options
Granted


   Option Exercise
Price Per Share


   Fair Value of
Ordinary Share


   Intrinsic Value
Per Option


   Type of
Valuation


July 2004

   123,570,000    RMB0.00001    RMB0.88327    RMB0.88326    Retrospective

January 2006

   34,210,000    RMB0.87413    RMB0.80275    RMB0               Retrospective

February 2007

   5,473,684    RMB2.3214    RMB2.3214    RMB0               Contemporaneous

October 2007

   42,000,000    See Note (1)    See Note (1)    RMB0               See Note (1)

(1)   The Option Exercise Price Per Share will be set at the price per ordinary share in this offering, which will be equal to the Fair Value of Ordinary Share at that time.

 

On January 8, 2005, we issued (after giving effect to the 10,000-for-one share exchange in July 2007) 66,550,000 ordinary shares to Kingsford Resources Limited at the par value of RMB0.00001 per share. AAC estimates the fair value of our shares (after giving effect to the 10,000-for-one share exchange in July 2007) to have been RMB0.86021 per share as of that date.

 

The fair values of our ordinary shares are affected by the equity value of our company and the number of shares outstanding. The equity value of our company, which measures the value of all the equity interests in our company, increased by approximately 13.2%, from RMB364 million in July 2004 to RMB412 million in January 2005. This is primarily attributable to the growth of our business. In addition, the rapid and substantial growth of our business during the period proved the viability of our business model. Specifically, the increase in the total equity value from July 2004 to January 2005 was primarily attributable to the increase in net revenue in the fourth quarter over the third quarter of 2004 and the increase in the number of affiliated insurance agencies and brokerages from four in July 2004 to seven in January 2005.

 

However, the total number of ordinary shares increased by 16% from July 2004 to January 2005. The dilution effect more than offset the increase in our equity value, thereby reducing the per share value of our ordinary shares from RMB0.88327 in July 2004 to RMB0.86021 in January 2005.

 

Our equity value increased by approximately 67.7% from RMB412 million in January 2005 to RMB691 million in January 2006. This is primarily attributable to our actual performance in 2005 exceeding our projections for 2005 and the actual results of 2004. This gave us a better visibility for 2006 and enabled us to increase our projections for 2006. In addition, the investment by a private equity investor in December 2005 provided the funding we needed to rapidly expand our business.

 

Specifically, the increase in the equity value from January 2005 to January 2006 was primarily attributable to the following developments during the period:

 

   

In 2005, we earned a net revenue of RMB143.7 million, which exceeded our net revenue projection of RMB105 million for 2005 as well as the net revenue of RMB34.0 million we earned in 2004.

 

   

Compared to a net loss of RMB92.7 million in 2004, the net loss in 2005 was only RMB6.7 million, representing a significant improvement.

 

   

In December 2005, a private equity investor made a RMB150 million investment in our company.

 

Because under the shareholders agreement entered into in December 2005, two of our shareholders, Cathay Capital Group and CDH, had certain preferential rights with respect to liquidation, we treated the shares held by Cathay Capital Group and CDH as preference shares for the purpose of allocating our equity value, using the option-pricing method. As a result, value of our ordinary shares decreased by approximately 7% from RMB0.86021 in January 2005 to RMB0.80275 in January 2006.

 

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Our equity value increased by approximately 154.8% from RMB691 million in January 2006 to RMB1,761 million in January 2007. This is primarily attributable to the following factors:

 

   

the increase in our total net revenue, which reached RMB246.5 million for 2006 as compared to RMB143.7 million for 2005, an increase of 71.5%;

 

   

our transition to a net profit of RMB57.4 million for 2006 from a net loss of RMB6.7 million for 2005; and

 

   

the significant expansion of our distribution network, including (1) our establishment of four new insurance agencies and acquisition of majority interests in three insurance agencies in 2006, (2) the increase in the number of our sales and service outlets to 144 at the end of 2006 from 19 at the end of 2005 and (3) the increase in the total number of sales agents and in-house sales representatives from approximately 2,730 and 380, respectively, at the end of 2005 to approximately 8,170 and 540, respectively, at the end of 2006.

 

As a result of the foregoing factors, and after having given effect to the dilutive effect of the options granted in January 2006, we believe the fair value of our ordinary shares increased by approximately 189% from RMB0.80275 in January 2006 to RMB2.3214 in January 2007.

 

The increase in our equity value from January 2007 to the time of this prospectus is primarily attributable to the following factors:

   

The increase in our total net revenue, which reached RMB172.6 million for the first six months of 2007 as compared to RMB106.8 million for the first six months of 2006;

 

   

The increase in our net profit, which reached RMB58.7 million for the first six months of 2007 as compared to RMB24.2 million for the first six months of 2006;

 

   

Our success in increasing the proportion of our revenues attributable to life insurance products, which is an important component of our strategy going forward;

 

   

The addition of a new Chief Financial Officer, Mr. David Tang, a new director of training department, Mr. Mingli Liang, a new chief operating officer with over 30 years of life insurance industry experience, Dr. En Ming Tseng, and a new internal control team;

 

   

The continued growth of the insurance industry in China, from which we derive our revenue as insurance intermediaries;

 

   

A more favorable regulatory environment with government support for consolidations and establishment of nation-wide service networks in the Chinese insurance intermediaries industry, which we expect will help insurance intermediaries, like us, to further expand operations and grow into stronger nation-wide service providers; and

 

   

The imminent launch of our initial public offering, which will provide us with additional capital and will enhance our ability to access capital markets to grow our business, raise our profile in China and provide our shareholders with greater liquidity.

 

AAC used the discounted cash flow method of the income approach to assess the fair value of our ordinary shares in 2004, 2005, 2006 and 2007. The major assumptions considered in calculating the fair values are as follows:

 

   

Weighted average cost of capital of between 17.0% and 22.0% was used.

 

   

Discount for lack of marketability of between 5% and 15% was used. AAC quantified the discount for lack of volatility by the Black-Scholes option-pricing model. This model treats the right to sell the company shares freely before a liquidity event as a put option. The farther the valuation date is from a liquidation event, the higher the put option value and thus the higher the implied discount for lack of

 

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volatility. The option-pricing method is one of the methods commonly used in estimating discount for lack of marketability as it can take into consideration factors like timing of liquidity events, risk free interest rate and estimated volatility of our shares.

 

   

Comparable companies: In deriving the discount rate, eight public companies with businesses similar to ours were selected for reference. These companies, which obtain a significant proportion of their revenues from the insurance brokerage business, are Marsh & McLennan Co. Inc., Aon Corporation, Willis Group Holdings Ltd., Brown & Brown Inc., Arthur J Gallagher & Co., Hilb Rogal and Hobbs Co., U.S.I. Holdings Corporation and Benfield Group Plc.

 

The major assumptions considered as at each grant date are summarized below:

 

Grant Date


   Weighted Average
Cost of Capital


    Discount for
Lack of
Marketability


    Three-Year Revenue
Compound Annual
Growth Rate


    Three-Year Average
Earnings Before
Interest and Tax


 

July 2004

   22.0 %   15 %   62 %   33 %

January 2005

   22.0 %   12 %   62 %   32 %

January 2006

   18.5 %   11 %   49 %   32 %

January 2007

   17.5 %   6 %   68 %   26 %

 

We determined the fair value of the options granted at each option grant date using the Black-Scholes option pricing model with the following assumptions:

 

     Options Granted 2004

    Options Granted 2006

    Options Granted 2007

 

Risk-free interest rate range

   3.2 %   1.9 %   2.7 %

Expected life range (years)

   1.50     2.21     5.60  

Expected dividends

   0.0 %   0.0 %   0.0 %

Expected volatility

   25.1 %   24.8 %   28.5 %

 

For the purpose of determining the estimated fair value of our share options, we believe expected volatility and estimated share price of our ordinary shares are the most sensitive assumptions since we were a privately held company at the date we granted our options. Changes in the volatility assumption and the estimated share price of our ordinary shares could significantly impact the estimated fair values of the options calculated by the Black-Scholes option pricing model. Expected volatility is estimated based upon the average stock price volatility of the comparable companies listed above over a period commensurate with the expected term of the options. According to paragraph 23 of SFAS 123(R), when estimating expected volatility of the share price of nonpublic entity, historical volatility of an “appropriate industry sector index” should be considered. As there is no sector index for the insurance brokerage business in the stock exchanges in the United States, the market where the company is applying for a listing, the pool of selected companies, with significant amount of their revenues obtained from the insurance brokerage business, is considered as a proxy for the industry sector and average volatility of the pool was used in the valuations. AAC believes that the average share price volatility of the guideline companies is a reasonable benchmark in estimating the expected volatility of our ordinary shares.

 

Determining the value of our share-based compensation expense in future periods requires the input of highly subjective assumptions, including estimated forfeitures and the price volatility of the underlying shares. We estimate our forfeitures of our shares based on past employee retention rates and our expectations of future retention rates, and we will prospectively revise our forfeiture rates based on actual history. Our share compensation charges may change based on changes to our actual forfeitures. Our actual share-based compensation expenses may be materially different from our current expectations.

 

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Impairment of Goodwill and Long-lived Assets

 

We are required to review our amortizable intangible assets for impairment when events or changes in circumstances indicate that the carrying value of such assets may not be recoverable. Goodwill and intangible assets with indefinite lives are required to be tested for impairment at least annually or more frequently if events or changes in circumstances indicate that these assets might be impaired. If we determine that the carrying value of our goodwill or acquired intangible assets have been impaired, the carrying value will be written down.

 

To assess potential impairment of goodwill, we perform an assessment of the carrying value of our reporting units at least on an annual basis or when events and changes in circumstances occur that would more likely than not reduce the fair value of our reporting units below their carrying value. If the carrying value of a reporting unit exceeds its fair value, we would perform the second step in our assessment process and record an impairment loss to earnings to the extent the carrying amount of the reporting unit’s goodwill exceeds its implied fair value. We estimate the fair value of our reporting units through internal analysis and external valuations, which utilize income and market valuation approaches through the application of capitalized earnings and discounted cash flow. These valuation techniques are based on a number of estimates and assumptions, including the projected future operating results of the reporting unit, appropriate discount rates and long-term growth rates.

 

The fair value of each reporting unit is determined by analysis of discounted cash flows. The significant assumptions regarding our future operating performance are revenue growth rates, discount rates and terminal values. If any of these assumptions changes, the estimated fair value of our reporting units will change, which could affect the amount of goodwill impairment charges, if any.

 

We have not recognized any impairment charge on goodwill and intangibles for the three-year period ended December 31, 2006. We are currently not aware of any impairment charge of the goodwill and intangibles.

 

Income Taxes

 

We recognize deferred income taxes for temporary differences between the tax basis of assets and liabilities and their reported amounts in the financial statements, net operating loss carryforwards and credits by applying enacted statutory tax rates applicable to future years. Deferred tax assets are reduced by a valuation allowance when, in our opinion, it is more likely than not that some portion or all of the deferred tax assets will not be realized. We record a valuation allowance to reduce our deferred income tax assets to an amount that we believe will more likely than not be realized. We have considered future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need and amount for the valuation allowance. In the event we were to determine that we would be able to realize our deferred income tax assets in the future in excess of our net recorded amount, an adjustment to our deferred income tax assets would increase income in the period such determination was made. Alternatively, should we determine that we would not be able to realize all or part of our net deferred income tax assets in the future, an adjustment to our deferred income tax assets would decrease income in the period such determination was made. Current income taxes are provided for in accordance with the laws of the relevant taxing authorities. The components of the deferred tax assets and liabilities are individually classified as current and non-current based on their characteristics.

 

In June 2006, the FASB issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes—An Interpretation of FASB Statement No. 109” (“FIN 48”). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in any entity’s financial statements in accordance with FASB Statement No. 109, “Accounting for Income Taxes” and prescribes a recognition threshold and measurement attributes for financial statement disclosure of tax positions taken or expected to be taken on a tax return. Under FIN 48, the impact of an uncertain income tax position on the income tax return must be recognized at the largest amount that is more-likely-than-not to be sustained upon audit by the relevant taxing authority. An uncertain income tax position will not be recognized if it has less than a 50% likelihood of being sustained. Additionally, FIN 48 provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006.

 

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We have adopted the provisions of FIN 48 on January 1, 2007. The total amount of unrecognized tax benefits as of the date of adoption was RMB305,000. As a result of the implementation of FIN 48, we recognized a RMB305,000 increase in the liability for unrecognized tax benefits which was accounted for as an increase to the January 1, 2007, balance of accumulated deficit. As of June 30, 2007, we recognized liabilities for unrecognized tax benefits totaled RMB994,000 (US$130,583).

 

Allocation of Expenses

 

Expenses incurred from January 1, 2004 until June 9, 2004, the date of reorganization, relating to general corporate functions have been allocated between the entities retained by China United Financial Services and our company based on a pro-rata percentage of total net revenues. General corporate overhead expenses primarily related to centralized corporate functions, including treasury, tax, accounting and administrative functions. We believe the assumptions and methodologies underlying the allocation of general corporate overhead expenses from China United Financial Services are reasonable. However, such expenses may not be indicative of the actual level of expenses that would have been incurred by our company if we had operated as an independent, stand-alone entity for that period. As such, the financial information herein for the year ended December 31, 2004 may not necessarily reflect the combined financial position, results of operations and cash flows of our company if we had been an independent, stand-alone entity during the entire year of 2004.

 

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Selected Quarterly Results of Operations

 

The following table presents our selected unaudited quarterly results of operations for the eight quarters in the period from July 1, 2005 to June 30, 2007. The information should be read in conjunction with our consolidated financial statements and related notes included elsewhere in this prospectus. We have prepared the unaudited consolidated quarterly financial information on the same basis as our audited consolidated financial statements. The unaudited financial information includes all adjustments, consisting only of normal and recurring adjustments, that we consider necessary for a fair presentation of our financial position and operating results for the periods presented. Results for the quarters are not necessarily indicative of results that may be expected for the full year. We believe that the quarter-to-quarter comparison of our operating results should not be relied upon as being indicative of our results for any future quarters or for a full year.

 

    For the three months ended

 
   

September 30,

2005


   

December 31,

2005


   

March 31,

2006


   

June 30,

2006


   

September 30,

2006


   

December 31,

2006


   

March 31,

2007


   

June 30,

2007


 
    (in RMB thousands)  

Net revenues:

                                               

Commissions and fees

  42,758     56,905     41,232     65,311     51,700     87,409     70,594     101,729  

Other service fees

  627     393     97     151     305     344     121     117  
   

 

 

 

 

 

 

 

Total net revenues

  43,385     57,298     41,329     65,462     52,005     87,753     70,715     101,846  

Operating costs and expenses:

                                               

Commissions and fees

  (22,658 )   (29,533 )   (21,243 )   (32,078 )   (31,315 )   (48,440 )   (32,979 )   (54,296 )

Selling expenses

  (1,379 )   (1,654 )   (2,235 )   (3,053 )   (2,973 )   (3,027 )   (2,198 )   (1,998 )

General and administrative expenses

  (5,524 )   (10,054 )   (15,338 )   (10,455 )   (13,585 )   (12,741 )   (11,338 )   (14,577 )
   

 

 

 

 

 

 

 

Total operating costs and expenses

  (29,561 )   (41,241 )   (38,816 )   (45,586 )   (47,873 )   (64,208 )   (46,515 )   (70,871 )

Income from operations

  13,824     16,057     2,513     19,876     4,132     23,545     24,200     30,975  

Other income (expenses), net:

                                               

Interest income

  20     384     898     698     1,964     1,804     1,027     953  

Interest expense

  (6 )   (4 )   (26 )   (2 )   (2 )   (4 )   (22 )   (44 )

Others, net

  2     (19 )   8     2     (5 )       11     4  
   

 

 

 

 

 

 

 

Income before income taxes

  13,840     16,418     3,393     20,574     6,089     25,345     25,216     31,888  

Net Income tax benefit (expense)

  (194 )   (271 )   (275 )   317     70     461     (362 )   186  
   

 

 

 

 

 

 

 

Net income before minority interest

  13,646     16,147     3,118     20,891     6,159     25,806     24,854     32,074  

Minority interest

  2     25     1     159     822     439     914     848  
   

 

 

 

 

 

 

 

Net income

  13,648     16,172     3,119     21,050     6,981     26,245     25,768     32,922  
   

 

 

 

 

 

 

 

 

Our quarterly results of operations are affected by seasonal variations caused by insurance companies’ business practices and consumer demand. Historically, insurance companies, under pressure to meet their annual sales targets, would increase their sales efforts during the fourth quarter of a year by, for example, offering more incentives for insurance intermediaries to increase sales. As a result, our commission and fee income for the fourth quarter of a year has generally been the highest among all four quarters. Business activities, including buying and selling insurance, usually slow down during the Chinese New Year festivities, which occur during the first quarter of each year. As a result, our commission and fee income for the first quarter of a year has generally been the lowest among all four quarters.

 

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The temporary decline in revenues from the second quarter to the third quarter of 2006 was due to the introduction of mandatory third party automobile liability insurance by the PRC government. This change in government policy did not negatively affect our sales volume, but the commission rate for the mandatory insurance was initially set by the insurance companies at a rate lower than the previous rate for optional insurance, which caused a decline in our related revenues. Because our commissions and fees and operating expenses were not proportionately reduced by this change, our net profit and net profit margin declined for that quarter. The commission rates for third party automobile liability insurance increased again over time as a result of competition among insurance companies, such that in later quarters this change no longer had a material impact on our overall financial results.

 

Results of Operations

 

    For the Year Ended December 31,

    For the Six Months Ended June 30,

 
    2004

    04 to 05
Percentage
Change


    2005

    05 to 06
Percentage
Change


    2006

    2006

    06 to 07
Percentage
Change


    2007

 
    RMB     %     RMB     %     RMB     US$     RMB     %     RMB     US$  
    (in thousands, except percentage data)  

Consolidated Statement of Operations Data

                                                           

Net revenues:

                                                           

Commissions and fees

  33,401     326.7     142,520     72.4     245,652     32,271     106,543     61.7     172,323     22,638  

Other service fees

  564     109.0     1,179     (23.9 )   897     118     248     (4.0 )   238     31  
   

 

 

 

 

 

 

 

 

 

Total net revenues

  33,965     323.1     143,699     71.6     246,549     32,389     106,791     61.6     172,561     22,669  
   

 

 

 

 

 

 

 

 

 

Operating costs and expenses:

                                                           

Commissions and fees

  (4,256 )   1,444.9     (65,752 )   102.4     (133,076 )   (17,482 )   (53,321 )   63.7     (87,275 )   (11,465 )

Selling expenses

  (2,432 )   127.3     (5,527 )   104.2     (11,288 )   (1,483 )   (5,288 )   (20.7 )   (4,196 )   (551 )

General and administrative expenses

  (120,576 )   (34.6 )   (78,879 )   (33.9 )   (52,119 )   (6,847 )   (25,793 )   0.5     (25,915 )   (3,404 )
   

 

 

 

 

 

 

 

 

 

Total operating costs and expenses

  (127,264 )   18.0     (150,158 )   30.9     (196,483 )   (25,812 )   (84,402 )   39.1     (117,386 )   (15,420 )
   

 

 

 

 

 

 

 

 

 

Income (loss) from operations

  (93,299 )   (93.1 )   (6,459 )   *     50,066     6,577     22,389     146.4     55,175     7,249  

Other income (expenses), net:

                                                           

Interest income

  49     808.2     445     1,105.4     5,364     705     1,596     24.1     1,980     260  

Interest expense

  (15 )   26.7     (19 )   78.9     (34 )   (5 )   (28 )   135.7     (66 )   (9 )

Others, net

  158     (109.5 )   (15 )   *     5     1     10     50.0     15     2  
   

 

 

 

 

 

 

 

 

 

Net income (loss) before income taxes

  (93,107 )   (93.5 )   (6,048 )   *     55,401     7,278     23,967     138.3     57,104     7,502  

Net income tax benefit (expense)

  396     *     (672 )   *     573     75     42     519.0     (176 )   (23 )
   

 

 

 

 

 

 

 

 

 

Net income (loss) before minority interest

  (92,711 )   (92.8 )   (6,720 )   *     55,974     7,353     24,009     137.1     56,928     7,479  

Minority interest

      *     27     5,163.0     1,421     187     160     1,001.3     1,762     231  
   

 

 

 

 

 

 

 

 

 

Net income (loss)

  (92,711 )   (92.8 )   (6,693 )   *     57,395     7,540     24,169     142.8     58,690     7,710  
   

 

 

 

 

 

 

 

 

 


*   Not meaningful for analysis because the percentage change is mathematically undeterminable or involves a change from income or benefit to loss or expense, or vice versa.

 

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Six Months Ended June 30, 2007 Compared to Six Months Ended June 30, 2006

 

Net Revenues.    Our total net revenues increased by 61.6% from RMB106.8 million for the six months ended June 30, 2006 to RMB172.6 million (US$22.7 million) for the six months ended June 30, 2007 primarily as result of:

 

   

a 50.8% increase in commissions and fees derived from the distributions of property and casualty insurance products, from RMB101.4 million for the six months ended June 30, 2006 to RMB152.8 million (US$20.1 million) for the six months ended June 30, 2007; and

 

   

a 276.5% increase in commissions and fees derived from the distributions of life insurance products, from RMB5.2 million for the six months ended June 30, 2006 to RMB19.5 million (US$2.6 million) for the six months ended June 30, 2007.

 

The increase in commissions and fees was mainly attributable to a significant increase in the number of sales agents in our distribution network, slightly higher commission and fee rates and the establishment of four new affiliated insurance intermediary companies and the acquisitions of majority interests in three affiliated insurance agencies in 2006. The financial results of those newly established or acquired companies were more fully reflected in the first half of 2007. The total number of sales agents in our distribution network increased from approximately 5,800 as of June 30, 2006 to approximately 10,200 as of June 30, 2007. Since we only started distributing life insurance products in January 2006 and had only limited resources to commit to selling life insurance products in the first half of 2006, the percentage increase of our commissions and fees from life insurance products was much larger than that from property and casualty insurance products.

 

Our other service fees, which accounted for 0.1% of our total net revenues in the first half of 2007, decreased by 4.0% primarily because we reduced or waived services fees for services provided to some long-term customers as an incentive for their policy renewals.

 

Operating Costs and Expenses

 

Commissions and Fees.    Commissions and fees we incurred increased 63.7% from RMB53.3 million for the six months ended June 30, 2006 to RMB87.3 million (US$11.5 million) for the six months ended June 30, 2007 primarily due to the increase in the distributions of insurance products. The percentage increase of our commissions and fees incurred slightly outpaced that of our commission and fee revenue primarily because individual sales agents, who generally earn a higher commission than our in-house sales representatives, constituted a slightly higher percentage of our sales force in the first half of 2007 than in the first half of 2006. Individual sales agents as a percentage of our sales force increased from 93.6% as of June 30, 2006 to 94.7% as of June 30, 2007.

 

Selling Expenses.    Our selling expenses decreased by 20.7% from RMB5.3 million for the six months ended June 30, 2006 to RMB4.2 million (US$0.6 million) for the six months ended June 30, 2007 primarily due to decreases in office expenses following further centralization of management functions as well as decreases in advertising fees after the completion of our Beijing advertising campaign.

 

General and Administrative Expenses.    Our general and administrative expenses for the six months ended June 30, 2007 remained stable compared to those expenses for the same period in 2006. Sharp reductions in share-based compensation expenses from RMB13.0 million to RMB0.8 million were offset by increases in most other general and administrative expenses that were primarily due to the overall expansion of our operations.

 

 

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Income from Operations.    As a result of the foregoing factors, our income from operations increased by 146.4% from RMB22.4 million for the six months ended June 30, 2006 to RMB55.2 million (US$7.2 million) for the six months ended June 30, 2007.

 

Other Income, Net.    Our other income, net, increased primarily due to an increase in interest income as a result of an increase in cash and cash equivalents arising from overall positive cash flows.

 

Net Income before Income Taxes.    As a result of the foregoing factors, our net income before income taxes increased by 138.3% from RMB24.0 million for the six months ended June 30, 2006 to RMB57.1 million (US$7.5 million) for the six months ended June 30, 2007.

 

Income Tax Benefit (Expense).    Our income tax benefit for the six months ended June 30, 2007 was primarily due to current tax expenses of RMB1.0 million and other tax expenses of RMB689,000 attributable to an increase in unrecognized tax benefits, offset by a deferred tax credit of RMB1.5 million attributable to an increase in operating loss carryforwards.

 

Minority Interest.    The substantial increase in minority interest was primarily due to our acquisitions of a majority interest in two insurance agencies and the establishment of four new insurance agencies and one limited liability company, in which we hold majority interests, in the second half of 2006 and also the establishment of two new insurance agencies and brokerages and one new investment holding company in the first half of 2007. An increase in the aggregate losses of companies in which we only hold majority interests also contributed to the increase in the loss shared by minority shareholders for the six months ended June 30, 2007.

 

Net Income (Loss).    As a result of the foregoing, our net income increased by 142.8% from RMB24.2 million for the six months ended June 30, 2006 to RMB58.7 million (US$7.7 million) for the six months ended June 30, 2007.

 

Year Ended December 31, 2006 Compared to Year Ended December 31, 2005

 

Net Revenues.    Our total net revenues increased by 71.6% from RMB143.7 million in 2005 to RMB246.5 million (US$32.4 million) in 2006 primarily as result of:

 

   

a 57.9% increase in commissions and fees derived from the distributions of property and casualty insurance products, from RMB142.5 million in 2005 to RMB225.0 million (US$29.6 million) in 2006; and

 

   

commissions and fees of RMB20.6 million (US$2.7 million) in 2006 derived from the distributions of life insurance products.

 

The increase in commissions and fees derived from the distributions of property and casualty insurance products was mainly attributable to a significant increase in the number of sales agents and in-house sales representatives in our distribution network and the establishment of five new affiliated insurance intermediary companies in 2005, whose financial results were more fully reflected in 2006. We only started distributing individual life insurance products in 2006, and our commissions and fees from the distributions of life insurance products accounted for 8.4% of our total commissions and fees in 2006 and 11.3% in the first half of 2007. The total number of sales agents and in-house sales representatives in our distribution network increased from approximately 2,730 and 380, respectively, as of December 31, 2005 to approximately 8,170 and 540, respectively, as of December 31, 2006.

 

Our other service fees decreased primarily because an insurance company cancelled the collection of certain premiums payable from us in 2005 that resulted in a corresponding recognition of other service fees in 2005. There were otherwise no significant changes in the fees generated from providing settlement-related services.

 

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Operating Costs and Expenses

 

Commissions and Fees.    Commissions and fees we incurred increased 102.4% from RMB65.8 million in 2005 to RMB133.1 million (US$17.5 million) in 2006 primarily due to the increase in the distributions of property and casualty insurance products and the commencement of our life insurance business in 2006. We did not engage in individual life insurance business in 2005 and therefore did not incur any commission or fee expenses for the distributions of life insurance products. The percentage increase of our commissions and fees incurred outpaced that of our commission and fee revenue primarily because individual sales agents, who generally earn a higher commission than our in-house sales representatives, constituted a higher percentage of our sales force in 2006 than in 2005. Individual sales agents as a percentage of our sales force increased from 87.9% at the end of 2005 to 93.9% at the end of 2006. In addition, the commencement of our life insurance business in 2006 also contributed to the faster increase in commissions and fees incurred, because the sale agents’ commission rates for selling life insurance products are generally higher than for selling property and casualty products.

 

Selling Expenses.    Our selling expenses increased by 104.2% from RMB5.5 million in 2005 to RMB11.3 million (US$1.5 million) in 2006 primarily due to rapid sales growth and expansion of our distribution network. We established four new insurance agencies in 2006 and increased the number of distribution outlets from 19 at the end of 2005 to 144 at the end of 2006. The percentage increase of our selling expenses was more than the percentage increase of our net revenues primarily because we incurred significant initial expenses in connection with the establishment of new insurance agencies and distribution outlets.

 

General and Administrative Expenses.    Our general and administrative expenses decreased by 33.9% from RMB78.9 million in 2005 to RMB52.1 million (US$6.8 million) in 2006 primarily as a result of a decrease of RMB32.4 million in share-based compensation expenses, partially offset by an increase of approximately RMB5.6 million in other general and administrative expenses due to the overall growth of our business. For a detailed description of our share-based compensation expenses in 2006 and 2005, see “—Key Performance Indicators—Operating Costs and Expenses—Share-based Compensation Expenses.”

 

Income (Loss) from Operations.    As a result of the foregoing factors, we achieved income from operations of RMB50.1 million (US$6.6 million) in 2006, compared with a loss from operations of RMB6.5 million in 2005.

 

Other Income, Net.    Our other income, net, increased significantly primarily due to an increase in interest income from RMB0.4 million in 2005 to RMB5.4 million (US$0.7 million) in 2006. The increase in interest income was mainly attributable to the additional cash from the private placement with CDH completed in December 2005.

 

Net Income (Loss) before Income Taxes.    As a result of the foregoing factors, we achieved net income before income taxes of RMB55.4 million (US$7.3 million) in 2006, compared with a net loss before income taxes of RMB6.0 million in 2005.

 

Income Tax Benefit (Expense).    Our income tax benefit in 2006 was primarily due to deferred tax credits of RMB1.5 million (US$0.2 million), offset by current tax expenses of RMB0.9 million (US$0.1 million).

 

Minority Interest.    Minority interest of RMB1.4 million (US$0.2 million) in 2006 was primarily due to our acquisitions of a majority interest in three insurance agencies and the establishment of three new insurance agencies and one limited liability company, in which we hold majority interests, in 2006.

 

Net Income (Loss).    As a result of the foregoing, we had a net income of RMB57.4 million (US$7.5 million) and a net margin of 23.3% in 2006, compared with a net loss of RMB6.7 million in 2005.

 

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Year Ended December 31, 2005 Compared to Year Ended December 31, 2004

 

Net Revenues.    Our total net revenues increased significantly from RMB34.0 million in 2004 to RMB143.7 million in 2005 primarily as a result of the increase in our commissions and fees, which increased from RMB33.4 million in 2004 to RMB142.5 million in 2005, due primarily to a significant expansion of our distribution network in 2005. The total number of our sales agents and in-house sales representatives increased from zero and approximately 170, respectively, as of December 31, 2004 to approximately 2,730 and 380, respectively, as of December 31, 2005. In addition, we established three insurance agencies in the second half of 2004, and their financial results were more fully reflected in 2005. Our other service fees increased primarily due to increases in demand for our settlement-related services and because an insurance company cancelled the collection of certain premiums payable from us in 2005 that resulted in a corresponding recognition of other service fees in 2005.

 

Operating Costs and Expenses

 

Commissions and Fees.    We incurred substantially higher commissions and fees of RMB65.8 million in 2005 compared to RMB4.3 million in 2004 primarily due to increase in the distributions of property and casualty insurance products. The percentage increase of our commissions and fees incurred outpaced that of our commission and fee revenue because we started the transition in 2005 from relying exclusively on in-house sales representatives to replying principally on sales agents for the distribution of insurance products. Individual sales agents as a percentage of our sales force increased from zero at the end of 2004 to 87.9% at the end of 2005.

 

Selling Expenses.    Our selling expenses increased by 127.3% from RMB2.4 million in 2004 to RMB5.5 million in 2005 primarily due to sales growth and expansion of our distribution network. We established five new insurance intermediary companies in 2005 and increased the number of distribution outlets from nine at the end of 2004 to 29 at the end of 2005. The percentage increase of our selling expenses was less than the percentage increase of our net revenues because of the transition in 2005 to a sales model that rely principally on sales agents instead of in-house sales representatives.

 

General and Administrative Expenses.    Our general and administrative expenses decreased by 34.6% from RMB120.6 million in 2004 to RMB78.9 million in 2005 primarily as a result of a decrease of RMB52.8 million in share-based compensation expenses, partially offset by an RMB11.1 million increase in other general and administrative expenses due to the overall growth of our business. For a detailed description of our share-based compensation expenses in 2005 and 2004, see “—Key Performance Indicators—Operating Costs and Expenses—Share-based Compensation Expenses.”

 

Loss from Operations.    As a result of the foregoing factors, our loss from operations decreased by 93.1% from RMB93.3 million in 2004 to RMB6.5 million in 2005.

 

Other Income, Net.    Our other income, net increased primarily due to an increase in interest income. The increase in interest income was mainly attributable to an increase in cash generated from operating activities.

 

Net Loss before Income Taxes.    As a result of the foregoing factors, our net loss before income taxes decreased by 93.5% from RMB93.1 million in 2004 to RMB6.0 million in 2005.

 

Income Tax Benefit (Expense).    Our income tax benefit in 2004 was primarily due to an increase in deferred tax assets of RMB0.6 million, offset by current tax expenses of RMB0.2 million.

 

Minority Interest.    We did not have minority interest in 2004 because all of our affiliated insurance agencies and brokerages were wholly owned by our consolidated affiliated entities.

 

Net Income (Loss).    As a result of the foregoing, our net loss decreased by 92.8% from RMB 92.7 million in 2004 to RMB6.7 million in 2005.

 

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Liquidity and Capital Resources

 

Our principal sources of liquidity have been cash generated from our operating activities and our sales of ordinary shares through private placements. See “Related Party Transactions—Private Placements.” As of December 31, 2006 and June 30, 2007, we had RMB223.9 million (US$29.4 million) and RMB363.4 million (US$47.7 million) in cash, respectively. Our cash consists of cash on hand and bank deposits with terms of 90 days or less. Our principal uses of cash have been to fund our working capital requirements, rental deposit, office renovation, purchases of automobiles and office equipment and acquisitions. Although we consolidate the results of our PRC affiliated entities, we do not have direct access to their cash and cash equivalents or future earnings. But we can direct the use of their cash through agreements that provide us with effective control of these entities. Moreover, we receive annual or monthly fees from some of these affiliated entities in exchange for certain technology consulting and other services provided by us and the use of trademark owned by us. See “Corporate Structure—Our Corporate Structure and Contractual Arrangements.” We expect to require cash to fund our ongoing business needs, particularly the further expansion of our distribution network through acquisitions and establishment of new insurance agencies and brokerages.

 

We believe that our current cash and cash equivalents, anticipated cash flow from operations and net proceeds from this offering will be sufficient to meet our anticipated cash needs, including our cash needs for working capital and capital expenditures for at least the next 12 months. We may, however, require additional cash due to changing business conditions or other future developments, including any investments or acquisitions we may decide to pursue. If our existing cash is insufficient to meet our requirements, we may seek to sell additional equity securities, debt securities or borrow from lending institutions. Financing may be unavailable in the amounts we need or on terms acceptable to us, if at all. The sale of additional equity securities, including convertible debt securities, would dilute our earnings per share. The incurrence of debt would divert cash for working capital and capital expenditures to service debt obligations and could result in operating and financial covenants that restrict our operations and our ability to pay dividends to our shareholders. If we are unable to obtain additional equity or debt financing as required, our business operations and prospects may suffer.

 

The following table sets forth a summary of our cash flows for the periods indicated:

 

    Year Ended December 31,

   

For the Six Months

Ended June 30,

 
    2004

    2005

    2006

    2007

 
    RMB     RMB     RMB     US$     RMB     US$  
   

(in thousands)

 

Net cash generated from operating activities

  10,686     71,961     53,936     7,085     76,208     10,011  

Net cash (used in) generated from investing activities

  (7,581 )   (85,954 )   (2,411 )   (317 )   64,139     8,426  

Net cash generated from (used in) financing activities

  14,094     159,599     (2,149 )   (282 )   (985 )   (129 )

Net increase in cash and cash equivalents

  17,199     145,606     49,376     6,486     139,362     18,308  

Cash and cash equivalents at the beginning of the year

  11,924     29,123     174,634     22,942     223,926     29,417  

Cash and cash equivalents at the end of the year

  29,123     174,634     223,926     29,417     363,406     47,741  

 

Operating Activities

 

Net cash generated from operating activities amounted to RMB76.2 million (US$10.0 million) for the six months ended June 30, 2007, primarily attributable to (1) a net income of RMB58.7 million (US$7.7 million), (2) an increase of RMB17.8 million (US$2.3 million) in accounts payable primarily as a result of sales growth, (3) an increase of RMB11.6 million (US$1.5 million) in insurance premium payable primarily as a result of sales growth and less stringent premium collection practices by the insurance companies in the middle of the year as compared to the year end, and (4) an increase of RMB11.4 million (US$1.5 million) in other receivables, which negatively affected operating cash flow, primarily as a result of advances extended to entrepreneurial agents to help them establish sales teams.

 

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Net cash generated from operating activities amounted to RMB53.9 million (US$7.1 million) in 2006, primarily attributable to (1) a net income of RMB57.4 million (US$7.5 million), (2) share-based compensation expenses of RMB24.1 million (US$3.2 million), which did not affect our operating cash flow, (3) an increase of RMB16.5 million (US$2.2 million) in accounts receivable as a result of an increase in sales, particularly sales in the fourth quarter for which payment had not been received by the end of 2006, which negatively affected operating cash flow, and (4) an increase in other receivables of RMB11.0 million (US$1.4 million), primarily representing advances extended to entrepreneurial agents to help them establish sales teams, which negatively affected operating cash flow.

 

Net cash generated from operating activities in 2005 was RMB72.0 million, primarily attributable to (1) a net loss of RMB6.7 million, (2) share-based compensation expenses of RMB56.5 million, which did not affect our operating cash flow, (3) an increase of RMB12.8 million in accounts payable, as a result of a growth in sales generated by increased number of sales agents compensated by commissions payable only when we receive payments from insurance companies, (4) a decrease of RMB6.3 million in other receivables, primarily due to repayment of working-capital advances to regional managers used to fund the development of agent distribution networks, and (5) an increase of RMB5.4 million in accounts receivable, which increase negatively affected cash flow, in line with a growth in sales.

 

Net cash generated from operating activities in 2004 was RMB10.7 million, primarily attributable to (1) a net loss of RMB92.7 million, (2) share-based compensation expenses of RMB109.3 million, which did not affect our operating cash flow, (3) an increase of RMB5.3 million in other payables, primarily representing insurance compensation received from insurance companies that have not yet been disbursed and funds held on behalf of unrelated third parties, (4) an increase of RMB4.2 million in insurance premium payable in line with an increase in sales, and (5) an increase of RMB11.8 million in other receivables, primarily due to the making of working capital advances to regional managers used to fund the development of agent distribution networks and advances to employees for daily operations.

 

Investing Activities

 

Net cash generated from investing activities for the six months ended June 30, 2007 was RMB 64.1 million (US$8.4 million), primarily attributable to repayments, net of advances, totaling RMB77.5 million (US$10.2 million) of advances previously made to certain subsidiaries of China United Financial Services and personal loans previously made to two executive officers of our company, partially offset by an increase of RMB11.6 million (US$1.5 million) restricted cash set aside for settling the insurance premium payable.

 

Net cash used in investing activities in 2006 was RMB2.4 million (US$0.3 million), primarily attributable to (1) payment of the purchase price for the acquisition of majority interests in three insurance agencies totaling RMB8.1 million (US$1.1 million), (2) the purchase of automobiles and office equipment and leasehold improvement in an amount of RMB6.3 million (US$0.8 million) and (3) advances, net of repayments, amounting to RMB7.7 million (US$1.0 million) primarily to certain subsidiaries of China United Financial Services and an entity controlled by our chief executive officer and our president, partially offset by a refund of RMB20.0 million (US$2.6 million) in deposit paid in connection with a proposed acquisition that was subsequently abandoned.

 

Net cash used in investing activities was RMB86.0 million in 2005, resulting primarily from (1) advances, net of repayments, totaling RMB59.3 million to certain subsidiaries of China United Financial Services and to our chief executive officer and our president and (2) the deposit of RMB20.0 million paid in connection with a proposed acquisition that was subsequently abandoned.

 

Net cash used in investing activities in 2004 amounted to RMB7.6 million, primarily attributable to advances, net of advances, totaling RMB5.8 million, to subsidiaries of China United Financial Services.

 

Financing Activities

 

Net cash used in financing activities was RMB1.0 million (US$0.1 million) for the six months ended June 30, 2007, primarily attributable to (1) a dividend payment of RMB11.5 million (US$1.5 million) and (2) an

 

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advance of RMB7.5 million (US$0.1 million) by an executive officer as part of the purchase price for the subsequent exercise of his options in July 2007, partially offset by (1) repayments of RMB3.3 million (US$0.4 million) from certain subsidiaries of China United Financial Services of earlier advances for working capital purposes and (2) an increase of RMB6.5 million (US$0.9 million) in minority interests, primarily due to the establishments of three new majority-owned subsidiaries in the first half of 2007.

 

Net cash used in financing activities was RMB2.1 million (US$0.3 million) in 2006, primarily attributable to (1) RMB5.0 million (US$0.7 million) repayment of a loan from an unrelated third party and (2) net repayments totaling RMB4.2 million (US$0.6 million) to certain subsidiaries of China United Financial Services for working capital purposes, partially offset by an increase of RMB6.2 million (US$0.8 million) in minority interest due to establishment of four new majority-owned insurance agencies and one limited liability company and acquisitions of majority interests in three insurance agencies.

 

Net cash generated from financing activities amounted to RMB159.6 million in 2005, primarily as a result of the proceeds from the private placement of CISG’s ordinary shares to CDH. Net cash generated from financing activities amounted to RMB14.1 million in 2004, primarily attributable to (1) RMB35.0 million proceeds from share issuances to Cathay Auto Services Limited and China United Financial Services and (2) advances, net of repayments, of RMB12.5 million from related parties, partially offset by cash distributions totaling RMB32.0 million in connection with our restructuring pursuant to which we acquired our insurance intermediary business.

 

Capital Expenditures

 

We incurred capital expenditures of RMB1.6 million, RMB2.8 million, RMB6.3 million (US$0.8 million) and RMB1.7 million (US$0.2 million) for the years ended December 31, 2004, 2005, 2006 and the six months ended June 30, 2007, respectively. Our capital expenditures have been used primarily to purchase automobiles and office equipment. We estimate that our capital expenditures will increase significantly in 2007 and 2008 as we further expand our distribution network and improve our unified operating platform.

 

Contractual Obligations

 

The following table sets forth our contractual obligations and commercial commitments as of December 31, 2006:

 

     Payment Due by Period

     Total

   Less than
1 year


   1-3 years

   3-5 years

   More than
5 years


     (in thousands of RMB)

Long-term debt obligations(1)

   555    318    237      

Operating lease obligations

   13,254    5,664    7,263    220    107

Purchase Obligations(2)

   860    860         
    
  
  
  
  

Total

   14,669    6,842    7,500    220    107
    
  
  
  
  

(1)   Excludes accrued interest.
(2)   Represents remaining payment commitment in connection with our new IT system.

 

Other than the contractual obligations and commercial commitments set forth above, we did not have any other material long-term debt obligations, operating lease obligations, purchase obligations or other material long-term liabilities as of December 31, 2006.

 

Holding Company Structure

 

We are a holding company with no material operations of our own. We conduct our operations primarily through our wholly owned subsidiaries in China and our affiliated entities, Meidiya Investment and Yihe

 

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Investment, and their subsidiaries. As a result, our ability to pay dividends and to finance any debt we may incur depends upon dividends paid by our wholly owned subsidiaries and trademark license and service fees paid by some of the subsidiaries of Meidiya Investment and Yihe Investment. If our wholly owned subsidiaries or any newly formed subsidiaries incur debt on their own behalf in the future, the instruments governing their debt may restrict their ability to pay dividends to us. Our wholly owned subsidiaries are permitted to pay dividends to us only out of their retained earnings, if any, as determined in accordance with PRC accounting standards and regulations. Under PRC law, each of our subsidiaries and affiliated entities in China is required to set aside at least 10% of its after-tax profits as reported in the PRC statutory financial statements each year, if any, to fund a statutory reserve until such reserve reach 50% of its registered capital, and to further set aside a portion of its after-tax profits to fund the employee welfare fund at the discretion of its board. Although the statutory reserves can be used, among other ways, to increase the registered capital and eliminate future losses in excess of retained earnings of the respective companies, the reserve funds are not distributable as cash dividends except in the event of liquidation of the companies. Furthermore, the new tax law enacted by the People’s Congress to take effect on January 1, 2008 may eliminate the current exemption of enterprise income tax on dividend derived by foreign investors from foreign invested enterprises and may impose on foreign invested enterprises an obligation to withhold tax on dividend distributed by such foreign invested enterprises. At December 31, 2006, our restricted net asset was RMB313.5 million (US$41.2 million), which is not eligible for distribution. This amount is composed of the registered equity of the our PRC subsidiaries and affiliated entities and the statutory reserves described above.

 

Off-Balance Sheet Commitments and Arrangements

 

We have not entered into any financial guarantees or other commitments to guarantee the payment obligations of third parties. We have not entered into any derivative contracts that are indexed to our shares and classified as shareholder’s equity, or that are not reflected in our consolidated financial statements. Furthermore, we do not have any retained or contingent interest in assets transferred to an unconsolidated entity that serves as credit, liquidity or market risk support to such entity. We do not have any variable interest in any unconsolidated entity that provides financing, liquidity, market risk or credit support to us or that engages in leasing, hedging or research and development services with us.

 

Inflation

 

Since our inception, inflation in China has not materially impacted our results of operations. According to the National Bureau of Statistics of China, the change of consumer price index in China was 3.9%, 1.8% and 1.5% in 2004, 2005 and 2006, respectively.

 

Quantitative and Qualitative Disclosure About Market Risk

 

Foreign Exchange Risk

 

Substantially all of our revenues and expenses are denominated in RMB. Our exposure to foreign exchange risk primarily relates to cash and cash equivalent denominated in U.S. dollars through a private placement completed in December 2005 and proceeds from this offering. We do not believe that we currently have any significant direct foreign exchange risk and have not hedged exposures denominated in foreign currencies or any other derivative financial instruments. Although in general, our exposure to foreign exchange risks should be limited, the value of your investment in our ADSs will be affected by the foreign exchange rate between U.S. dollars and RMB because the value of our business is effectively denominated in RMB, while the ADSs will be traded in U.S. dollars.

 

The value of the RMB against the U.S. dollar and other currencies may fluctuate and is affected by, among other things, changes in China’s political and economic conditions. The conversion of RMB into foreign currencies, including U.S. dollars, has been based on rates set by the People’s Bank of China. On July 21, 2005, the PRC government changed its decade-old policy of pegging the value of the RMB to the U.S. dollar. Under

 

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the new policy, the RMB is permitted to fluctuate within a narrow and managed band against a basket of certain foreign currencies. This change in policy has resulted in an approximately 9.5% appreciation of the RMB against the U.S. dollar by September 30, 2007. There remains significant international pressure on the PRC government to adopt an even more flexible currency policy, which could result in a further and more significant appreciation of the RMB against the U.S. dollar. To the extent that we need to convert U.S. dollars we receive from this offering into RMB for our operations, appreciation of the RMB against the U.S. dollar would have an adverse effect on the RMB amount we receive from the conversion. Conversely, if we decide to convert our RMB denominated cash amounts into U.S. dollars amounts for the purpose of making payments for dividends on our ordinary shares or ADSs or for other business purposes, appreciation of the U.S. dollar against the RMB would have a negative effect on the U.S. dollar amount available to us. We have not used any forward contracts or currency borrowings to hedge our exposure to foreign currency exchange risk.

 

Interest Rate Risk

 

Our exposure to interest rate risk primarily relates to the interest rates for our outstanding debt and the interest income generated by excess cash invested in liquid investments with original maturities of three months or less. As of December 31, 2006, our total outstanding loans amounted to RMB555,000 (US$73,000) with interest rates varying from 4.185% to 6.3%. The loans are long-term automobile bank loans with fixed interest rates. Assuming the principal amount of the outstanding loans remains unchanged in 2007, a 1% increase in each applicable interest rate would add RMB4,875 (US$640) to our interest expense in 2007. We have not used any derivative financial instruments to manage our interest risk exposure. Interest-earning instruments carry a degree of interest rate risk, and our future interest income may be lower than expected. We have not been exposed nor do we anticipate being exposed to material risks due to changes in interest rates, because most of our borrowings bear fixed interest rates. However, our future interest expense may increase due to changes in market interest rates.

 

Recent Accounting Pronouncements

 

In March 2006, the Emerging Issues Task Force reached a consensus on Issue No. 06-3, How Taxes Collected from Customers and Remitted to Government Authorities Should Be Presented in the Income Statement (That Is, Gross versus Net Presentation), or EITF No. 06-3. We are required to adopt the provisions of EITF No. 06-3 beginning in fiscal year 2007. We do not expect the provisions of EITF No. 06-3 to have a material impact on our consolidated financial position, results of operations or cash flows.

 

In June 2006, the FASB issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109,” or FIN 48, which clarifies the accounting for uncertainty in tax positions in the income tax positions in FASB Statement No. 109, “Accounting for Income Taxes.” FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. FIN48 is effective for us beginning in fiscal year 2007. We have adopted the provisions of FIN 48 on January 1, 2007. The total amount of unrecognized tax benefits as of the date of adoption was RMB305,000. As a result of the implementation of FIN 48, we recognized a RMB305,000 increase in the liability for unrecognized tax benefits which was accounted for as an increase to the January 1, 2007, balance of accumulated deficit. As of June 30, 2007, we recognized liabilities for unrecognized tax benefits totaled RMB994,000 (US$130,583).

 

In September 2006, the FASB issued FASB Statement No. 157, “Fair Value Measurement,” or SFAS 157. SFAS 157 addresses standardizing the measurement of fair value for companies that are required to use a fair value measure of recognition for recognition or disclosure purposes. The FASB defines fair value as “the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement dates.” SFAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007 and interim periods within those fiscal years. We are in the process of assessing the impact of the adoption of SFAS 157 on our financial position or results of operations and cash flows.

 

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In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities, or SFAS No. 159, which permits entities to choose to measure many financial instruments and certain other items, which are not currently required to be measured at fair value, at fair value. SFAS No. 159 will be effective on July 1, 2008. We are currently evaluating the impact of adopting SFAS No. 159 on our consolidated financial position, cash flows, and results of operations.

 

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INDUSTRY

 

General Factors Driving the Growth of the Chinese Insurance Industry

 

We believe that certain macroeconomic factors have been and will continue to be the key driving forces behind the growth of the Chinese insurance industry. China’s economy has grown rapidly since 1978, when the PRC government began economic reform and gradually opened the country to the outside world. Rapid economic growth has created substantial wealth in the PRC in recent years, particularly in urban areas, where approximately 43% of the total population, or over 560 million people, now reside. The following table sets forth certain macroeconomic data for the period between 2001 and 2006.

 

    2001

  2002

  2003

  2004

  2005

  2006

  CAGR
(2001 –2006)


    (in billions of RMB except per capita data)   (%)

GDP

  10,965.5   12,033.3   13,582.3   15,987.8   18,386.8   21,087.1   11.5

Savings deposits at end of year

  7,376.2   8,691.1   10,361.7   11,955.5   14,105.1   16,158.7   14.0

Per capita annual disposable income of urban households

  6,859.6   7,702.8   8,472.2   9,421.6   10,493.0   11,759.5   9.4

Source:    China Statistical Yearbook 2007

 

We believe that the continued accumulation of wealth, as illustrated by the significant growth in savings deposits and per capita annual disposable income of urban households, presents substantial opportunities for increasing the sales of life insurance products, especially products with saving or investment features.

 

We believe that demographic factors have also contributed to the growth of the PRC life insurance industry and will continue to drive its future growth. According to the National Bureau of Statistics, the percentage of the population aged 65 and above in the PRC increased from 7.0% in 2000 to 7.7% in 2005. The following chart illustrates the projected growth of China’s aging population from 2007 to 2050, assuming a total fertility rate of 1.7.

 

LOGO


Source:    National Population and Family Planning Commission of China

 

China’s public pension system is still developing and may have difficulty providing adequate coverage for the elderly. Accordingly, the aging trend heightens the need for private pension products, such as endowment and annuity life insurance products.

 

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Rapid economic growth has also created substantial growth opportunities for property and casualty insurance in the PRC. For example, according to the China Statistical Yearbook 2007, the number of privately owned automobiles increased from approximately 6.3 million in 2000 to 23.3 million in 2006 at a CAGR of 24.5%, and the total number of civilian automobiles increased from approximately 16.1 million to approximately 37.0 million at a CAGR of 14.9% during the same period. As a result, sales of automobile insurance increased significantly during the same period. Similarly, we believe that continued growth of investment in fixed assets and freight traffic have contributed to the increased sales of commercial property insurance and cargo insurance, respectively, in recent years.

 

The Chinese Insurance Industry

 

Size and Growth

 

The Chinese insurance industry was the third largest insurance industry in Asia after Japan and South Korea and the 9th largest in the world by premium volume in 2006, according to the Sigma Report No. 4/2007 published by Swiss Reinsurance Company. It is also one of the fastest growing insurance industries among the world’s major economies. Between 2000 and 2005, total insurance premiums increased from RMB160.9 billion to RMB492.8 billion (US$64.7 billion), representing a CAGR of 25.1%, according to data published by the CIRC. The following table sets forth the total insurance premiums received by life insurance companies and property and casualty insurance companies in the PRC from 2000 to 2005 and their respective CAGR.

 

     2000

   2001

   2002

   2003

   2004

   2005

  

CAGR

(2000 – 2005)


     (in billions of RMB)    (%)

Life insurance

   100.3    142.5    227.5    298.3    319.8    364.5    29.44

Property and casualty insurance

   60.6    69.1    77.3    86.6    112.5    128.4    16.20

Source:    China Insurance Yearbook 2006

 

Density and Penetration

 

Despite its rapid growth and achieving substantial scale in recent years, the Chinese insurance industry, measured by insurance density, or per capita premiums, and insurance penetration, or total premiums as a percentage of GDP, remains under-developed as compared with the insurance industries of more developed economies. The following table sets forth insurance density and penetration data of the PRC and selected countries and regions in 2006.

 

     Life Insurance

   Non-life Insurance(1)

     Density(2)

   Penetration(3)

   Density(2)

   Penetration(3)

     (US$)    (%)    (US$)    (%)

China

   34.1    1.7    19.4    1.0

United States

   1,789.5    4.0    2,134.2    4.8

United Kingdom

   5,139.6    13.1    1,327.1    3.4

Germany

   1,136.1    3.1    1,300.7    3.6

France

   2,922.5    7.9    1,152.9    3.1

Japan

   2,829.3    8.3    760.4    2.2

South Korea

   1,480.0    7.9    591.2    3.2

Taiwan

   1,800.0    11.6    450.3    2.9

Australia

   1,389.0    3.8    1,191.9    3.2

  (1)   Accident and health insurance are classified as non-life insurance in Sigma Reports.
  (2)   Premiums per capita
  (3)   Total premiums as a percentage of the GDP

Source:    Sigma Report 04/2007, Swiss Reinsurance Company

 

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The low insurance density and penetration figures in the PRC suggest that the Chinese insurance market has significant growth potential.

 

Geographic Variations

 

Within China, the development of the insurance industry is uneven across different provinces and municipalities. Like the economy as a whole, the insurance industry is more developed in the eastern and southern coastal areas than in the rest of the country. The following table sets forth certain data of the top ten life insurance markets in 2005. In 2006, we distributed life insurance products in six of the top ten life insurance markets, namely, the municipalities of Beijing and Shanghai and the provinces of Guangdong, Shandong, Hebei and Sichuan.

 

     Life Insurance

         

Province/Municipality


   Total Premiums

   Market Share(1)

   Density(2)

   Penetration(3)

   GDP

   Population

    

(in billions

of RMB)

   (%)    (in
RMB)
   (%)   

(in billions

of RMB)

   (in millions)

Beijing(4)

   43.0    11.7    2,795.5    6.3    688.6    15.4

Jiangsu

   34.0    9.2    454.7    1.9    1,830.6    74.8

Guangdong(5)

   27.3    7.4    326.8    1.3    2,236.7    91.9

Shanghai

   24.6    6.7    1,805.0    2.7    915.4    17.8

Shandong

   21.9    6.0    273.4    1.4    1,851.7    92.5

Henan

   17.6    4.8    180.5    1.7    1,058.7    93.8

Zhejiang

   17.3    4.7    409.0    1.6    1,343.8    49.0

Hebei

   16.4    4.5    238.9    1.6    1,009.6    68.5

Sichuan

   14.0    3.8    160.5    1.9    738.5    82.1

Liaoning

   12.8    3.5    352.9    1.9    800.9    42.2

  (1)   As a percentage of the total life insurance premiums in the PRC
  (2)   Premiums per capita
  (3)   Total premiums as a percentage of the province’s or municipality’s GDP
  (4)   Excluding a major group annuity contract, Beijing would have ranked No. 4, with total premiums of approximately RMB23.7 billion.
  (5)   Excludes premium, market share, density and penetration data for the city of Shenzhen.

Sources:  China Insurance Yearbook 2006; China Statistical Yearbook 2006

 

The following table sets forth certain data of the top ten property and casualty insurance markets in 2005. In 2006, we distributed property and casualty insurance products in seven of the top ten property and casualty insurance markets, namely, the municipalities of Shanghai, Beijing and Shenzhen and the provinces of Guangdong, Shandong, Hebei and Sichuan.

 

     Property and Casualty Insurance

         

Province/Municipality


   Total Premiums

   Market Share(1)

   Density(2)

   Penetration(3)

   GDP

   Population

    

(in billions

of RMB)

   (%)    (in
RMB)
   (%)   

(in billions

of RMB)

   (in millions)

Guangdong(4)

   11.8    9.6    141.2    0.5    2,236.7    91.9

Jiangsu

   9.4    7.6    125.1    0.5    1,830.6    74.8

Zhejiang

   8.9    7.2    208.9    0.8    1,343.8    49.0

Shanghai

   8.8    7.2    650.3    1.0    915.4    17.8

Shandong

   7.2    5.8    95.2    0.5    1,851.7    92.5

Beijing

   6.7    5.4    435.4    1.0    688.6    15.4

Hebei

   5.4    4.3    78.3    0.5    1,009.6    68.5

Shenzhen

   5.0    4.1    605.7    1.0    492.7    8.3

Sichuan

   4.9    4.0    55.9    0.7    738.5    82.1

Liaoning

   3.9    3.2    108.8    0.6    800.9    42.2

  (1)   As a percentage of the total property and casualty insurance premiums in the PRC

 

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  (2)   Premiums per capita
  (3)   Total premiums as a percentage of the province’s or municipality’s GDP
  (4)   Excludes premium, market share, density and penetration data for the city of Shenzhen.

Sources:    China Insurance Yearbook 2006; China Statistical Yearbook 2006; Shenzhen Statistics Bureau

 

Competitive Landscape

 

The Chinese insurance industry has been dominated by four insurance companies in recent years:

 

   

China Life Insurance Company Limited, or China Life, a life insurance company;

 

   

PICC Property and Casualty Company Limited, or PICC, a property and casualty insurance company;

 

   

Ping An Insurance (Group) Company of China, Ltd., or Ping An, an insurance holding company that owns both life insurance and property and casualty insurance companies; and

 

   

China Pacific Insurance (Group) Company, Ltd., or China Pacific, another insurance holding company that owns both life insurance and property and casualty insurance companies.

 

As more and more new insurance companies, both domestically owned and foreign invested, have been established in recent years, competition among insurance companies has become increasingly intense, and the combined market share of the four major insurance companies has been decreasing. According to data released by the CIRC, the combined life insurance market share of China Life, Ping An Life Insurance Company of China, Ltd., the life insurance subsidiary of Ping An, and China Pacific Life Insurance Company, Ltd., the life insurance subsidiary of China Pacific, was 70.1% in terms of total premiums in 2005, representing a decrease of 4.7 percentage points from the previous year. Similarly, the combined property and casualty insurance market share of PICC, China Pacific Property, the property and casualty insurance subsidiary of China Pacific, and Ping An Property & Casualty Insurance Company of China, Ltd., the property and casualty insurance subsidiary of Ping An, decreased by 7.3 percentage points from the previous year to 72.6% in 2005.

 

The number of insurance companies operating in the PRC has increased significantly in recent years. According to China Statistical Yearbooks, the number of insurance companies increased from 34 at the end of 2000 to 107 at the end of 2006, representing an increase of 214.7%. In particular, most of the world’s largest insurance companies, such as American International Group, Inc., ING Group, AXA, Assicurazioni Generali, Aviva, Prudential, Allianz, Nippon Life Insurance, MetLife, AEGON and CNP Assurances, have entered the Chinese insurance markets, mostly through joint ventures with local partners. As of June 30, 2007, we maintained business relationships with 16 life insurance companies and 21 property and casualty insurance companies, including all major insurance companies in China.

 

Distribution Channels

 

Insurance companies in the PRC historically have relied primarily on individual sales agents and direct sales force to sell their products. The individual sales agents are not employees of the insurance companies. They generally enter into exclusive agency contracts with one insurance company and market and sell insurance products on behalf of that insurance company. As a result of increased competition in recent years, many insurance companies have gradually expanded their distribution channels to include insurance intermediaries such as commercial banks, postal offices, insurance agencies and insurance brokerages. Moreover, some newly established insurance companies have chosen to focus on product development and rely primarily on insurance agencies and brokerages to distribute their products. The following charts show the percentages of the total premiums by distribution channels for life insurance companies and property and casualty insurance companies, respectively, in 2005.

 

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Life Insurance Companies   Property & Casualty Insurance Companies
LOGO   LOGO

 


  (1)   Ancillary-business agencies refer to entities that distribute insurance products as an ancillary business, such as commercial banks, postal offices, automobile dealerships, airlines and railroad companies.

Source:    China Insurance Yearbook 2006

 

Insurance Intermediaries in the PRC

 

Overview

 

Under the CIRC’s classification, insurance intermediaries in the PRC are classified into the following three types:

 

   

“professional insurance intermediaries,” which refer to independent insurance agencies, brokerages and adjusting companies;

 

   

“ancillary-business insurance agencies,” which refer to entities that distribute insurance products as an ancillary business, such as commercial banks, postal offices, automobile dealerships, airlines and railroad companies; and

 

   

“insurance salespersons,” which refer to individual sales agents who have signed agency contracts with insurance companies to sell insurance products on behalf of the insurance companies.

 

According to the Insurance Intermediary M