Chinese insurers could use cat bonds as a capital tool: Moody’s

Introduction of a new risk-based capital system in China could increase the chances that insurers and reinsurers from the country elect to utilise catastrophe bonds as a tool which could help them to replenish or boost their capital adequacy.

Moody’s Investor Services notes in an update that China’s upcoming regulatory move towards a risk-based capital regime, called the China Risk-Oriented Solvency System (C-ROSS), a new regime requiring insurance companies to maintain capital commensurate with their risks Moody’s believes that the system is credit positive for the Chinese insurance market.

The new risk-based capital regime comes into effect at a time when these Chinese insurers are growing strongly, as premium penetration increases and the cost of the cover they sell rises with inflation. As a result, because of premium growth and the impending regulatory capital regime under C-ROSS, Moody’s says that it finds it likely that Chinese insurers will need to replenish their capital over the next few years.

Moody’s notes that the Chinese insurance regulator, the CIRC, has proposed a number of new potential funding channels for insurers that need to recapitalise or to boost capital levels. These new avenues for securing capital and funding include the use of catastrophe bonds as a way to offload risk, replenish or boost their capital adequacy and change their capital structure under the C-ROSS regime.

Fitch Ratings agrees that Chinese non-life insurers may need additional capital injections as their expanding portfolios put a strain on their solvency ratios. Net retained premiums continue to outpace the generation of internal capital surplus at Chinese non-life insurers, meaning that they will continue to need new infusions of capital, the rating agency says.

Most major non-life insurers in China have already reported declining solvency levels, with most insurers solvency ratios remaining below 200% at the end of the first-half of this year. Fitch notes that net premium leverage remains high, which indicates that Chinese insurers have a weak capacity to withstand financial shocks.

As well as the solvency and capital adequacy issues that a regime like C-ROSS could bring to the fore for certain insurers in China, the sectors major source of underwriting volatility is claims resulting from natural disasters although the sector does leverage catastrophe modelling and reinsurance appropriately, according to Fitch.

Perhaps that suggests that catastrophe bonds as a way to transfer some of these natural disaster or extreme weather risk to the capital markets, while also improving their solvency or capital adequacy, might one day become an increasingly attractive prospect for Chinese insurance companies. Allowing Chinese insurers to benefit from both the risk transfer and capital benefits that ILS can provide.