What are the prospects for the use of catastrophe bonds as a tool for insurance and reinsurance risk transfer in China? Broker Willis Group provides some thoughts on what could be an ideal tool for transferring the nation’s massive natural disaster and weather risk.
China’s insurance and reinsurance sector regulator, the Chinese Insurance Regulatory Committee (CIRC), initiated discussions on the potential use of catastrophe bonds in the country back in 2010/11. The regulator has been looking at the best risk transfer tools to provide a way to reduce State support for a number of insurance initiatives.
There are cultural issues surrounding the uptake of insurance products in China, as in many countries in Asia, which have hindered the penetration of insurance products at the ground-level resulting in much slower uptake than had initially been expected.
Now, however, insurance uptake is beginning to accelerate and therefore discussions of sources of reinsurance and risk capital are gaining in importance. The capital markets is a natural piece of that discussion, which has reached the highest levels in China in recent months, with insurance-linked securities (ILS) and particularly catastrophe bonds looked on favourably.
Insurance and reinsurance broker Willis has provided some thoughts on how a catastrophe bond market in China could develop over the coming years.
Firstly, Willis believes that catastrophe bonds could be used to provide risk transfer for state-owned insurers in China. The CIRC has already expressed an intention to develop catastrophe risk funds and pools, as a way to aggregate risks before potentially using cat bonds to offset them.
Willis believes that this approach could result in catastrophe bonds being issued in multiple tranches, to suit different layers of pooled catastrophe risk and different investor appetites.
It’s also noteworthy that China has a number of agricultural funds, which provide financing to provinces after disaster events. Historically, these funds have been drained year after year, but the Chinese government has repeatedly topped them up as they are so needed. Catastrophe bonds could be a welcome solution to enable these agricultural emergency funds to become more self-sustained and less draining on government money.
A second potential use case for cat bonds could follow the CIRC’s push for greater use of captive insurers in China. By encouraging large, often formerly state-owned, entities to explore alternative routes to risk transfer, an awareness of cat bonds is growing.
Willis says that its clients are increasingly looking at catastrophic risk transfer options, for exposures including; “Massive-scale mortality risk from farming and agriculture, pandemic disease risk from large transportation companies, and depopulation risks from utilities in areas impacted by earthquakes.”
Willis executives note some specific use cases for catastrophe bonds, which could solve some real-world issues affecting China. Of particular note is the potential for parametric triggers in these solutions. In a country where so much risk is uninsured the potential for parametrics is huge, given the absence of basis risk and the need for rapid payout capital.
Willis believes that a parametric catastrophe bond could suit the risk transfer needs of Chinese regional banks with large project and SME loan book exposure to disaster such as earthquakes. A cat bond could provide a solvency backstop to a regional bank in the event of a massive catastrophic event.
Similarly, Willis believes a cat bond triggered by declining occupancy rates at a national hotel chain, could provide effective insurance risk transfer. The triggering event could be due to public declaration of a health pandemic by the local or national government, or an increase in mortality combined with a decline in occupancy rate. An interesting idea, that could have application outside China as a parametric insurance solution for large hotel chains.
Willis also believes that large national or regional Chinese power plants with exposure to earthquakes, or other natural disasters, could find catastrophe bonds a useful tool. Again, a parametric trigger could provide a valuable source of contingent capital relief.
As the CIRC and Chinese government continues to discuss potential solutions for catastrophe risk transfer and at the same time Chinese investors become more comfortable with higher yielding corporate bonds and gain an appreciation for risk models, a Chinese ILS and catastrophe bond market could flourish.
While an ILS market could be three to five years away, notes Willis, the signs of its development are beginning to show already.