As insurance and reinsurance companies in the Asia Pacific region look to strengthen resilience to disasters, there is an expectation that the catastrophe bond will increasingly feature as regional re/insurers leverage alternative sources of risk capital.
The high levels of catastrophe exposure and significant gap between insured and economic losses in Asia Pacific show that the region is in need of a more robust catastrophe management strategy and access to reinsurance or risk capital for protection against losses, according to Fitch Ratings.
Catastrophe prone markets such as China and Japan are expected to increasingly look to instruments such as catastrophe bonds, or other insurance-linked securities (ILS) and collateralized reinsurance products, as alternative sources of risk funding are sought to reduce the reliance on traditional reinsurers.
In a report published today, Fitch Ratings discusses the developing Asia Pacific reinsurance market and the need for greater protection and capacity to support catastrophe and disaster risk transfer in the region.
In recent days we’ve written about the evident protection gap (between economic and insured losses) due to typhoons and floss due to flooding in China. We also wrote yesterday that the world’s hotspots for windstorm insured exposures are set to shift east from the U.S. to Asia over the coming decades.
All of this demonstrates the requirement for more risk transfer capacity and disaster reinsurance capital to support the provision of insurance products. Some of that capital will come from the alternative capital market of ILS funds, institutional investors and collateralized reinsurers, with the catastrophe bond expected to play a strong role as Asia Pacific builds its financial resilience to disasters.
Management of catastrophe exposure and risks in Asia Pacific is a priority both for insurers and reinsurers in the region, as well as for sovereign governments and organisations. Fitch notes that data scarcity remains a problem, but collaborations between industry and governments should help to provide better access to catastrophe data over time.
As this data availability increases, there will be an enhanced ability to use risk transfer options such as traditional reinsurance and alternative reinsurance capital or ILS. Alongside the increase in risk data availability the levels of education on risk transfer and ILS options will grow, all helping to stimulate use of instruments such as cat bonds in the Asia Pacific region.
Fitch says that it expects “a gradual rise in catastrophe bond issuance as an alternative source of direct funding for insurers.”
While traditional reinsurance plays an “irreplaceable role in the insurance risk transfer mechanism, and they are unlikely to be eliminated,” Fitch notes that the use of catastrophe bonds and alternative capital will help to reduce the reliance on reinsurers.
This diversification of risk capital, to make use of the capital markets and third-party or institutional investors who back cat bonds and ILS transactions, would benefit re/insurers in the region and also could prove positive under evolving regions regulatory regimes risk-based capital requirements.
Fitch notes that three cat bonds were issued in Japan in 2014 and one in 2015, demonstrating continued and perhaps growing interest from that market, however Artemis has actually recorded more.
In March 2014 Tokio Marine sponsored the $245m Kizuna Re II Ltd. Japan earthquake cat bond. In May 2014 Sompo Japan and Nipponkoa sponsored a $100m Japan typhoon cat bond Aozora Re Ltd. (Series 2014-1). Zenkyoren sponsored the $300m Nakama Re Ltd. (Series 2014-1) quake bond in May 2014 as well and a $375m Japan quake cat bond in December 2014, Nakama Re Ltd. (Series 2014-2).
In 2015 Artemis recorded Kizuna Re II Ltd. (Series 2015-1), a $290m Japan earthquake cat bond from Tokio Marine & Nichido Fire in March. April saw a non-Japanese insurer, AXA, covering Japanese mortality risk with Benu Capital Limited, which could stimulate Japanese life insurers to look at doing the same in future. Finally a private Japan quake cat bond from Tokio Millennium Re AG, Hotaru, was issued in July.
So activity in Japan is clearly established, with typhoon and earthquake risks the most common to be transferred to the capital markets.
Another breakthrough in the Asia Pacific region was seen in 2015, with the first ever China catastrophe bond Panda Re Ltd. (Series 2015-1), covering China Re for $50m of its earthquake risks. This first development may herald a growing awareness of the catastrophe bond structure in China, which with the extent of the exposures in that country and the rapid rate they are growing at should result in more Chinese cat bonds in the future.
Japanese and Chinese risks make up just over 7% of the outstanding catastrophe bond market, or around $1.838 billion of the $24.98 billion total cat bond and ILS market. So these Asia Pacific risks are now a meaningful part of the diversification available to ILS funds and investors and with this set to grow they will become increasingly important to the market.
As the regulatory landscape in Asia evolves and insurance penetration picks up, the use of catastrophe bonds and other ILS instruments is destined to increase. The gradual rise in cat bond issuance from Asia sponsors and featuring Asian risks that Fitch predicts, will be welcomed by ILS investors searching for more chances for diversification.