China in our hands?

The listing of the first-ever China catastrophe bond on the Bermuda Stock Exchange (BSX) is good news for Bermuda. With more jurisdictions competing for insurance-linked securities (ILS), many see it as confirmation that the Island is well positioned to remain at the centre of risk transfer globally, even as new and emerging markets increasingly embrace both new and old methods of doing so.

The $50 million Panda Re bond will be used by China Re to transfer earthquake risk into the global capital markets and is a sign of that nation becoming increasingly comfortable with the nuances of sophisticated financial instruments.

“The Chinese government and regulator want to diversify the country’s catastrophe risk and are encouraging use of alternative, cost-effective solutions such as cat bonds and pools. While this initiative is at a nascent stage, China Re and the large global reinsurers are contributing to finding new solutions and the Panda Re bond is a step in the right direction,” says Dennis Sugrue, director of Standard & Poor’s (S&P), which does not rate the Panda Re bond, but does rate the issuer, China Reinsurance, at A+.

The move to list in Bermuda is also seen as a testament to the far-sightedness of those in control of the BSX. Innovation and a forward-looking approach have been the hallmark of an organisation that is determined to press home its advantage in the ILS space.

“It’s a very positive thing for Bermuda. Different areas of the world are looking to the Island as a platform to support their business, and this new deal emanating from mainland China speaks to the level of experience and traction that Bermuda has developed in becoming a centre of excellence,” said Greg Wojciechowski, CEO of the BSX, describing the deal in a previous issue of this magazine.

“Bermuda is the third largest specialty insurance centre in the world and a very important partner to the global market in providing coverage to absorb and assist countries in times of serious need.”

Ross Webber, CEO of the Bermuda Business Development Authority, has called the Panda Re listing “a welcome development” for the Bermuda market and one that “emphasises the fact that our jurisdiction is a hub for innovation”.

It’s this fundamental understanding of the insurance and reinsurance business and Bermuda’s longevity in servicing the market which has resulted in Bermuda’s solid and trusted reputation.

A new era

The key question now is whether the Bermuda listing of Panda Re heralds a new era of earthquake and disaster risk transfer instruments from China being listed on the Island.

The comments of Li Yuanyuan, the general manager of China Re P&C, at the time of the bond’s initial listing in July, certainly promised more potential listings were in the pipeline.

“We are proud to be the sponsor of Panda Re, which is issuing the first cat bond covering Chinese perils. I hope this is a good sign of opening the door to transferring Chinese catastrophe risks to the capital markets,” he said.

Brad Adderley, senior partner at Appleby, Bermuda, sees no reason to believe that Panda Re will become an endangered species and instead suggests that this could be the start of a mutually beneficial relationship.

“China is a big market but it has the potential to be a huge market,” he says. “It is great for Bermuda that the very first transaction chose to launch here as there are other jurisdictions much closer to them.

“Once you use the market and the sponsor receives the cover it wants and feels comfortable about the process then it is easier for the sponsor to go back a second or third time. When people tap into the market they often come back to it and very often return within a year.”

Sugrue from S&P agrees that the bond is an important development for the market and one that could lead to a pipeline of future deals. He is, however, more cautious in his expectations, arguing that much will depend on the development of the Chinese market in a number of ways.

“Bermuda is already a leading domicile for ILS and collateralised re solutions, but future Chinese cat business will depend on Chinese regulations and how they view protection being provided by a special purpose vehicle in Bermuda,” he says.

“We can expect more cat bonds to come from China in the future, but the pace of issuance may be relatively slow as investor appetite may be muted due to lack of data and robust models in the region.

“As the Chinese insurance market develops, Bermuda might be able to help in structuring innovative solutions with Panda Re being the first step, but we don’t expect the reinsurers on the Island to be active issuers for the time being.”

Tony Ursano, the president of the division of broker TigerRisk that handles ILS, believes the activity from Asian players generally and from China in particular in the insurance space will grow as their insurance liabilities increase alongside their economies.

“In a global business you need a global platform and China is seeking to establish this by company formation in the US, London as well as Bermuda. It is looking to diversify away from its home market (with its inherent risks) and invest capital overseas,” he says.

“They are eager to experience best practice and export that to their own insurance companies—underwriting, pricing, actuarial distribution and technology—all the things that we have been working on for a long time.”

There is evidence that China is determined to quickly learn the nuances of the reinsurance industry. China Minsheng Investment Corp made a move into Bermuda last month by purchasing Sirius International Insurance from White Mountains for about $2.24 billion in cash. And Bermuda-based Chinese reinsurance company TOP is poised to launch an innovative risk industry healthcare product under a deal signed in July.

The genesis of Panda Re

In common with many other nations, China continues to feel the effect of a prolonged credit binge. Total debt (including government, household and corporate) has climbed to about 250 percent of GDP, up 100 percentage points since 2008, and while previous governments have simply looked to spend their way out of a crisis, the central bank is now hesitant to ease monetary policy.

This has meant a greater desire to transfer risks. As PwC notes in its latest Broking 2020 research paper: “Governments in state-dominated insurance sectors such as China … simply do not have the desire or the capability to absorb their fast rising insured values (either directly or through state-owned reinsurers).

“Even in mature markets, many governments are unable or unwilling to continue to play the role of ‘insurer of last resort’, especially if a major or multiple loss event occurred.”

This is certainly true in China, which is a market that investors will increasingly have to take note of as the world’s second largest economy looks to shed the cost burden of some of its liabilities stemming mainly from natural catastrophes related to climate change in the international capital markets.

This necessity was hammered home when China’s Office of State Flood Control and Drought Relief reported in July that direct economic losses from typhoon Soudelor that hit the nation’s Zhejiang, Fujian and Jiangxi provinces amounted to at 8.73 billion Chinese yuan ($1.4 billion).

The milestone in China’s desire to transfer risk, that ultimately paved the way for the Panda Re deal, occurred in June this year when agreement was reached on how to bring about the securitisation of catastrophe insurance risks and to accelerate the adoption of catastrophe bonds for risk transfer needs.

The move dates back to a 2013 government call for an issuance of cat bonds and the use of other weather index-based insurance and reinsurance solutions to help China fight climate change.

The move represented a departure from previous strategy. Sugrue from S&P explains that traditionally Chinese insurers have reinsured their catastrophe risk through the international reinsurance markets, with most risk leaving China for London or continental Europe. The likes of Munich Re, Swiss Re, Lloyd’s and SCOR have been in China for years, but Bermudians aren’t as active in that market yet.

“While cat bonds might be a way to gain some exposure to China for the Bermudians, I wouldn’t think that they would be the key players in this market for a few years,” Sugrue says.

He adds that the price of the risk will also impact the level of issuance from Bermudians, or others.

“Diversification of risk is desirable for reinsurers and investors but there’s no reason to think the Bermudians will rush in for less than a fair return,” he says.

“It’s been mentioned before, however, that some reinsurers take lower rates than anticipated for providing coverage in Japan in order to diversify their exposures—which is one reason you don’t see as much cat bond issuance of Japan risk. This situation could eventually occur in China as well.”

The logic behind a move into ILS, however, is that as well as helping China access the huge capital base of its own investment markets, securitisations could also be marketed to international investors helping to diversify risk globally. And Panda Re does represent the first time that cat bond investors have gained exposure to Chinese perils.

The placement, through GC Securities, was of Series 2015-1 Class A Principal At-Risk Variable Rate Notes due July 9, 2018, with notional principal of $50 million. China Re, which is 15 percent owned by the Ministry of Finance, took advantage of many latest cat bond features for indemnity-triggered catastrophe bonds with Panda Re’s limit to China Re based on US dollars and positioned alongside certain layers of China Re’s traditional retrocession programme to provide per-occurrence protection from earthquakes on an indemnity trigger basis.

Chi Hum, the global head of ILS distribution at GC Securities, said at the time of the deal: “The strong investor support for Panda Re bonds underscores the appetite of capital markets investors for accepting new risks and regions of the global insurance markets. The investors seized upon this unique opportunity to partner with a world class reinsurer to best access and support the Chinese marketplace.”

Asia in general has the potential to be a huge marketplace for anyone in reinsurance and this move could open the door to new markets and new investors in that region.

“The 21st century belongs to Asia in terms of economic development. The most powerful engine of that development is China. That is why we elected to start our Asian presence here,” says Rod Fox, CEO of TigerRisk.

“The market is so large that it is easy to see China Re or other entities in that region using the ILS/cat bond market for larger transactions (than the $50 million Panda Re)—that’s just a natural process,” adds Adderley.

But Bermuda cannot afford to rest on its laurels and firms must innovate in order to maintain its advantage. It’s a point that Wojciechowski recognises.

He says: “Innovation is key to commercial success. Bermuda is an excellent example of a jurisdiction that has an innovative and forward-looking approach in respect of servicing its clients and creating business solutions for its global clientele.”