Expanding exposure highlights China’s need for catastrophe bonds

Rapidly expanding insured catastrophe and severe weather exposure in mainland China highlights the need for risk transfer instruments such as catastrophe bonds, which also presents an opportunity for Hong Kong’s ambitions to become a marketplace for insurance-linked securities (ILS).

China’s rapidly expanding economy, growing infrastructure and increasing urbanisation in regions exposed to natural catastrophe perils as well as severe weather risks such as rainfall and flooding, means that insured exposure in the country is growing rapidly.

While the Chinese domestic insurance and reinsurance market has coped with this rapid growth well to-date, alongside assistance from a handful of major global reinsurance players, the expansion of insured exposure, as well as the growing value-at-risk that is not insured in infrastructure and government owned developments, suggests a conduit to reinsurance capacity could be extremely valuable for the country as this rapid development continues.

Already, China’s insurance market made up roughly 9% of global premiums as of 2017, according to reinsurance firm Swiss Re.

Swiss Re forecasts that this figure will grow rapidly, with China expected to contribute a massive 16% of global insurance premiums by 2028.

That makes China both a target for the insurance and reinsurance industry establishment who would like to participate in that growth, as well as an ideal test bed for new ways to route risk to capital, we would suggest.

Hong Kong stands in the perfect position to act as a facilitator and conduit for risk from inside China to reach capital from the global markets, so its ambitions to develop insurance-linked securities (ILS) regulations are seen as a significant opportunity and highlighted in the Chinese press today.

The South China Morning Post discusses the opportunity for Hong Kong to act as a hub for catastrophe bond issuance transferring risks from China to the broader global capital markets, importantly helping to diversify the catastrophe risk exposure outside of China’s own re/insurance market and into the deepest and most liquid pool of risk capital available.

The article discusses the increasing urbanisation in regions of China that are exposed to major catastrophe risks such as typhoons, which will require increasing amounts of risk capital to support them and reinsurance market access to ensure the exposure is well-diversified outside of China itself.

China is well-positioned to develop a forward-thinking insurance market based on efficiency and risk diversification, promoting the active transfer of peak catastrophe and weather exposures through conduits to the wider capital markets, in order to help its own domestic insurers take on increasing insured exposure within the countries borders.

While China could take a protectionist approach to insurance and reinsurance, internalising the risk within its own corporates and only making use of retrocession to shave off the peak exposures, the country would be better advised to work to leverage the efficiency of the capital markets to enable its primary insurers to do more, which is where the opportunity for Hong Kong lies.

Given the cross border approach to finance currently being embraced, where some Hong Kong and Chinese financial institutions are setting up cross border flows that effectively enable them to trade in instruments as if in a single market, the local insurance and reinsurance industry can benefit from this and could use Hong Kong as a conduit to the wider capital markets.

China’s policies of inventing, manufacturing and constructing at home rather than importing, means a growing need for insurance and risk capital as well, presenting opportunities to its home-grown insurance industry and those that have access from outside.

But again, the capital markets present perhaps the best access to efficient risk capacity to support Chinese domestic market growth.

While global re/insurers often discuss protectionism related trends as an issue in their access to Chinese risk, it seems really more a case of China wanting to deliver as much as it can for itself, seeking to learn and develop its own internal markets, which given its size, population, massive economic growth and ability to innovate, is no real surprise.

Which makes it seem natural that China would also look to the insurance-linked securities (ILS) market and capital market in general, as a way to tap into efficient risk capital that can back the risk transfer needs of its growing risk pools.

The news article discusses Hong Kong’s potential opportunity to rapidly expand its reinsurance market in support of Chinese economic and industrial growth, particularly given the urban expansion in typhoon exposed coastal areas, to which we’d also add the growing flood risks given the changing landscape in regions exposed to heavy rains and earthquake exposure in certain regions as well.

As a result, catastrophe bonds may have a significant role in China, in helping its burgeoning domestic insurance market access efficient reinsurance capital, and also in allowing municipal or sovereign risks to be transferred and diversified outside of the country.

Hong Kong’s efforts to develop the necessary legislation to support ILS market activity could provide the mechanisms to support access to the wider capital markets here, to the benefit of the entire region.

ILS legislation and a regulatory regime to support catastrophe bonds and other capital markets backed reinsurance instruments is seen as a priority in Hong Kong, having been included in its budget this year.

The aim is to place legislation to support ILS vehicle domiciling and transactions into Hong Kong’s 2019-20 legislative session, meaning it could be operational soon after.

The South China Morning Post reports that talks between the Insurance Authority and lawmakers are now underway.

The opportunity to establish a conduit to the capital markets for sourcing reinsurance capacity to support the Chinese domestic insurance market’s underwriting of catastrophe risks could prove significant, both for Hong Kong and China itself.

China could differentiate the prospects of its insurers by leaning heavily on the capital markets for reinsurance capacity, both for private market and government sources of catastrophe or severe weather risk.

That would enable China’s domestic insurance market to open diversifying risk transfer channels to support its own efficiency and continued growth.

While Hong Kong could cement itself a key role as an ILS hub in supporting the development of efficient risk markets in China and their connections to the wider world of capital.

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