Catastrophe bonds in China, some discussion on their feasibility

Our regular readers will know that we try to keep abreast of discussions, news and announcements involving the potential use of catastrophe bonds, insurance-linked securities and innovative risk transfer instruments in new markets around the world. China is one of the markets where catastrophe bonds have been discussed both in relation to the countries domestic re/insurers needs for risk transfer and the governments needs to provide a disaster backstop for the fast growing economy.

An article from China Insurance News (available here translated by Google) discusses catastrophe bonds and asks whether the Chinese re/insurance market and economy are ready for their introduction and use as risk transfer tools. The article contains a few interesting insights into the potential for a catastrophe bond market in China, both with respect to their domestic re/insurers and governments potential use.

One key issue at the moment that the article highlights is that reinsurance coverage is relatively cheap for Chinese re/insurers meaning that for catastrophe bonds to be adopted they will need to price comparably to other global sources of reinsurance. However, the pricing could still be attractive to the Chinese government if they were looking to provide natural disaster coverage across provinces or territories. In this case the capacity is harder to come by meaning that prices for traditional reinsurance either rise or aren’t available. So this is one area that catastrophe bonds could prove attractive.

Shanghai has been slated as the location for an insurance exchange which it is said will include offerings of cat bonds, derivatives and other risk transfer instruments. Establishment of such a market within China could see usage of capital markets tools become much cheaper and more accessible to Chinese domestic insurers and reinsurers.

The article goes on to discuss cat bonds in some detail, explaining the types of triggers and contracts which can be use. It’s positive to see this kind of educational material published in China as it can only help raise the profile of the risk transfer tools in a potentially huge market for them.

Another issue that the article discusses is risk models which cover China. Typhoon and earthquake models are available from some of the major risk modelling firms, but coverage is not complete and there can be gaps. Lack of coverage, historical event and loss data are issues as these are nowhere near as complete as in other countries where cat bonds are already issued. For the Chinese, the lack of models for other risks that they have significant exposure to is also a worry, including thunderstorm, snowfall and flood. The article also suggests that risk models need to calibrated to take into account Chinese construction practices and also the rate of development and change in the country. The author of the article see’s modelling as the biggest obstacle to cat bonds in China.

On the topic of the legislative and regulatory environment in China, there is some concern that Chinese securities, tax and accounting standards may not currently allow domestic companies to issue cat bonds without some amendments. That’s to be expected though as China has historically been inward looking with respects to its economic and financial institutions and legislation, there are signs that the country is keen to modernise now.

The article concludes by suggesting that catastrophe bonds and alternative risk financing/transfer techniques be put on the agenda and undergo a feasibility study for use in China as soon as possible.

Once again, it’s encouraging to see this ongoing discussion as to how risk transfer can be best effected in China. The market could be enormous and the opportunity for established re/insurers to participate and investors to access any deals in a new geographic location will be very attractive.

You can read some of our previous articles and discussion on the prospects for a catastrophe bond market in China here.