In 2001, not long after I first moved to Bermuda, I published an article in Insurance Day entitled “Welcome to Convergence Island.” That article considered the convergence of the insurance and capital markets, and presaged Bermuda’s emergence as a jurisdiction of choice for innovative Insurance Linked Securities (“ILS”). Events now rapidly evolving on the South China coast may have a comparable seismic impact on the international reinsurance industry. Based on recent announcements by the mainland China and Hong Kong authorities, Hong Kong could be transforming into “China’s Bermuda."
The Bermuda Market
The foundations of Bermuda’s insurance industry were the captive insurance companies established, mainly by large U.S. corporations, from the early 1960s onwards. Legislative changes in the Bahamas at the end of that decade prompted an exodus of captive insurers to Bermuda - a continuing reminder to policy makers of the fungibility of capital. Captives are still a key market for Bermuda, but the island’s position as a reinsurance and ILS hub has primarily been driven by the capacity demands of the U.S. property & casualty insurance market. A major catalyst for Bermuda’s growth was Hurricane Andrew in 1992, which caused an estimated US$15.5 billion (equivalent to US$26.5 billion today) of South Florida insured property damage.
The industry's response to the resulting capacity crunch was the formation of eight new Bermuda property catastrophe reinsurers. These joined ACE and XL Group, previously established in the 1980s in response to capacity constraints in the US casualty market. Today Bermuda is recognised as one of the world's three largest reinsurance markets, complemented by its position as an ILS centre.
China's "Belt & Road Initiative"
On the opposite side of the globe, the ambitious project to re-establish China’s historic land and maritime trade links - the Belt & Road Initiative (“BRI”) - is underway. Estimates vary for the required investment outside of China but US$5 trillion, through to 2030, has been mentioned by the Chairman of Hong Kong's Insurance Authority ("HKIA"), Moses Cheng. Even by China’s standards that is a daunting funding target. BRI involves infrastructure projects in numerous developing countries along its route. Risks as diverse as construction, engineering, delay-in-start up, property, political risk, kidnap and ransom, third party liability, marine and cargo, all require insurance cover. Swiss Re has estimated that BRI related commercial insurance premiums of US$28 billion could be generated by 2030.
At a joint China and U.K. insurance summit held in London on 18 June 2018, China’s official news agency reported that the Chairman of China Re, Yuan Linjiang, commented on the complexity of political, economic, and cultural situations in the countries linked to BRI and stated: “full awareness and prediction of risks are necessary for governments, companies and individuals.” Mr. Yuan observed that the “use of insurance and reinsurance were the best way to divert and minimise risks” and called for a “joint insurance mechanism to deflect major risks.”
Hong Kong's Response
Mr. Yuan’s comments were no doubt met with approval by the London insurance market but there had already been announcements from the HKIA about developing a regional “insurance hub” and “risk management centre" in Hong Kong. In May 2017 the mainland China and Hong Kong regulators had signed a joint framework agreement for an equivalence assessment, to be conducted over a four year period, on their respective solvency regulatory regimes. Hong Kong has also introduced regulatory and tax incentives to encourage mainland Chinese companies to set-up captive insurers.
Expectations locally were that these initiatives would take time to come to fruition, perhaps until 2020 at the earliest. In 2017 the mainland China and Hong Kong regulators had only said they would “consider” each other’s insurance industries for “preferential treatment” under the solvency equivalency framework. Then, on 17 July 2018 (a month after the London insurance summit) the HKIA issued a statement confirming “preferential treatment” would be given under the “China Risk Oriented Solvency System” (“C-ROSS”), for one year commencing from 2 July 2018.
“Preferential treatment” applies to insurance ceded by mainland China insurers to an “Accredited Hong Kong Reinsurer” i.e. authorised and regulated in Hong Kong, with an internationally recognised credit rating of at least A minus (subject to also meeting relevant reporting and solvency requirements). As confirmed by China's insurance regulator, the China Banking & Insurance Regulatory Commission, “preferential treatment” means that the risk capital charge for the mainland China cedant in respect of the reinsurance recoverable is deemed to be reduced to 0.087%. Qualifying Hong Kong reinsurance would therefore effectively be treated under C-ROSS as collateralised on-shore in China.
Hong Kong's ambitions to become a regional risk management hub were further endorsed by the Financial Secretary, Paul Chan, in a speech to local insurance executives on 28 August 2018. In his speech Mr. Chan reportedly announced the government’s intention to introduce tax incentives to support the market for reinsurance, together with marine and speciality insurance, in Hong Kong.
Asia Insurance Linked Securities
Singapore has successfully promoted itself as an Asia insurance hub for a number of years. The Monetary Authority of Singapore (“MAS”) has more recently been proactive in developing a favourable regulatory and tax framework for the issuance of ILS. To encourage ILS sponsors to use Singapore, MAS has also generously introduced a grant system that will contribute to the costs of an ILS transaction. Notwithstanding these inducements the market is still waiting for the first Asia domiciled ILS transaction to be completed in the region.
Hong Kong also recognises the benefits of alternative capital. The government’s Financial Services Development Council previously made observations on the importance of ILS as a driver in the growth of the local reinsurance industry. Despite this, Hong Kong’s current ILS regulatory regime could be viewed as restrictive in comparison with the more established off-shore ILS jurisdictions, and Singapore. Even so, in the context of reinsurance there is a crucial concession available under the current HKIA guidelines. This allows a Hong Kong admitted “professional reinsurance company” to issue ILS through a special purpose vehicle, without any requirement to obtain prior approval from the HKIA.
The Hong Kong Reinsurance Hub
The net effect of all these developments is that a Hong Kong admitted reinsurance company (complying with the required rating, reporting, and solvency conditions) could now be an attractive source of capacity for mainland Chinese insurers looking to optimise their capital. A Hong Kong reinsurance company could also efficiently replenish and diversify its own capital base through issuing ILS from Hong Kong.
Reinsurance capacity is only one element of risk mitigation, and arguably the least essential in the case of well capitalised mainland China primary insurers, but reinsurers also have risk management, underwriting, and pricing expertise, all of which will be in demand for BRI. The development of a reinsurance hub in Hong Kong may therefore provide a valuable service to mainland China, support Hong Kong’s economy, and contribute to the success of BRI.
A number of the conditions that contributed to Bermuda’s exponential growth into a premier international reinsurance market are already present in Hong Kong. The most important of these could be the presence of a vast primary insurance market conveniently located on its doorstep. Unlike Bermuda, Hong Kong also has the advantage of being a Special Administrative Region of the People's Republic of China, and a major world financial centre in its own right. That said, there are other ingredients of Bermuda’s success which may have to be replicated before Hong Kong could justifiably claim to be “China’s Bermuda.” These will be the subject of my next commentary on the fast-moving developments in the Asia reinsurance market.