China catastrophe re/insurance system development a ‘difficult project’

Developing a system for catastrophe insurance, reinsurance and a catastrophe fund, across a country as large, diverse and affected by so many natural catastrophe perils as China, is a “very difficult project” according to the China Insurance Regulatory Commission.

In a press conference held today, Wang Zuji, the vice chairman of the China Insurance Regulatory Commission (CIRC), told reporters that establishing a fully functional catastrophe insurance and reinsurance market in China would take time, but that he was optimistic that the various trials are heading in the right direction.

The development and planning of a catastrophe risk transfer system, which would perhaps be a better name for it, in China has been ongoing for a number of years now. Politicians and State Council leaders have discussed the use of various instruments for hedging or transferring catastrophe risk, including catastrophe bonds, traditional reinsurance, weather derivatives and weather risk transfer tools as well as hedging with other instruments such as commodities.

Catastrophe risk transfer is vital to the ongoing development and growth of the Chinese economy. Catastrophe exposures in China are enormous, with economic losses often into the billions of dollars even though insured losses are typically significantly lower.

It is the economic and fiscal losses that China should focus on for the establishment of a catastrophe risk transfer system, protecting their own governments investment in industries such as agriculture as well as providing a market in catastrophe risk transfer and hedging which could be accessed by other corporations, industries, financiers such as banks and the general public through insurance markets.

The State Council of China has placed a significant amount of importance on establishing the catastrophe insurance system and the CIRC is tasked with making its development one of its top-three priorities. Wang Zuji said that the pilot project implementations, in Shenzhen and Yunnan, are progressing well and helping to develop “enormous support” for the establishment of the full catastrophe risk transfer system.

The catastrophe insurance system will feature multi-level risk sharing, between insurers, reinsurers, central and local governments and others. At this stage Wang did not mention the involvement of the capital markets, but accessing insurance-linked securities (ILS) capital with instruments such as catastrophe bonds and the planned catastrophe fund have been discussed in the past at CIRC and State Council levels.

The first stage of the systems development is at the national level, beginning with earthquake catastrophe insurance regulations, legislation for the insurance system and development of disaster prevention systems. Next the ministry of finance and related departments will develop regulation to implement the system operationally, in line with the national guidance. Third is the need to analyse the perils in China, such as earthquake, floods and landslides, determine rates for each peril and establish co-insurance rules. Finally continue to promote the pilot work to prepare for the establishment of the catastrophe insurance system.

So there is a lot to do for the CIRC and State Council. Wang Zuji would not be drawn on giving a date for the establishment of the catastrophe insurance system, only saying that it is a very difficult project. Given the size of China, the number of people exposed, the fact that economic exposure rises rapidly but insured exposure only slowly at the moment, it is a difficult task to create a system for transferring insured catastrophe risks.

So perhaps the Chinese State Council would be advised to focus on their own exposures to catastrophe risks, such as their subsidies which they pour into industries such as agriculture and construction, or the loans that the Chinese state-owned banks give to corporations developing the country.

These kinds of risks, which are often not insurable interest, could be protected using a system of parametric catastrophe and weather insurance. Given they sit outside of insurable interest perhaps the capital markets would be a better source of risk financing than reinsurers in this case, or at the least co-participants alongside global reinsurers.

By protecting these fiscal or GDP level cash injections with a source of catastrophe contingent risk transfer and financing through parametrics, index-based products, weather derivatives and even catastrophe bonds, the Chinese government might find that its low-level insurance markets receive a buffer which enables them to develop more readily.

In fact, couldn’t the Chinese government adopt the ILS model and establish its catastrophe fund in such a way as it is open to capital markets investors, who would be keen to soak up some of the catastrophe exposure in the country? The traditional insurance to reinsurance risk transfer chain may not be the quickest system to develop. China might find that establishing catastrophe risk transfer to the capital markets, where investors clearly have the appetite to take on these diversifying risks, a quicker initiative to get up and running which could leverage the pilot work undertaken recently on parametric insurance products.

The catastrophe fund is perhaps the opportunity that the State Council needs to inject capital as a contingent source of catastrophe financing. The capital markets would be very interested in accessing such a fund and there are a number of initiatives which could help with the risk modelling needs and creation of parametric or weather index triggers to transfer the risk into the fund.

However China decides to approach the development of its catastrophe insurance system it is a hugely complex task so no surprise that it could take some years to become more widely used. But given the need for catastrophe risk financing and transfer in China, any opportunities to speed up the systems development or to leverage new sources of capital, like ILS, would be advisable and perhaps provide a way to see some immediate benefits, or quick-wins, in advance of the full system being launched.