The excitement surrounding China belies the reality of the significant challenges ahead. Marcus Alcock likens the enthusiasm to the Californian gold rush of 1848.
It seems that we have to go back to 1848 to find a comparable level of excited interest from investors in a new territory as we are now witnessing in China.
For that was the year that San Franciscan merchant Sam Brannan’s cry of “Gold! Gold! Gold from the American River!” heralded the arrival of hundreds of thousands of prospectors as part of the great California Gold Rush.
Back then, only the lucky few were able to line their pockets with wealth.
For the great majority the gold trail only ended in tears and poverty. But is much of the reinsurance industry, currently rushing in droves to grab a slice of the action in newly liberalised China, heading for a similar fate?
Well at least the economic indicators are wonderful. While the rest of the world struggles to come to terms with the current US-led liquidity crisis and its far-reaching implications, at least the prospects for China look solid in purely economic terms. Although real GDP growth is expected to slow from 11.4% in 2007 to 9.8% in 2008 and further to 9% in 2009 as export growth slows, according to the Economist Intelligence Unit, such figures are still hugely impressive.
And with such rapid economic development fuelling a burgeoning consumer class, there is little doubt that China, currently the world’s 11th largest insurance market and third-largest in the region, has the potential to become one of the world’s most significant reinsurance markets.
Every man for himself
The reinsurance industry certainly seems to think so. Ever since the market was opened up to foreign reinsurers in 2004, brokers and underwriters alike have been falling over themselves to do business in China.
Lloyd’s chairman Lord Levene even tagged onto a prime ministerial delegation to the country, so desperate was he to ensure Lloyd’s was not left behind once the likes of Munich Re and Swiss Re had established offices. And nowadays there is hardly a major player left who isn’t already in China or thinking of being in China.
“It's not all wine and roses, with most commentators agreeing that this is one of the most cutthroat environments around
Yet it’s not all wine and roses, with most commentators agreeing that this is one of the most cutthroat environments around.
Indeed, there have already been some indications that the almost unbridled enthusiasm with which reinsurers first went into China is now more measured.
Munich Re made headlines last year with its decision to withdraw from its lead position in PICC’s property treaty in 2007. There is little doubt that making profit in 2008 is going to be an extremely difficult prospect.
According to Jose Ribeiro, director of international markets and business development at Lloyd’s, the recent renewal of primary policies in January has seen a further drop of around 10% on rates, coupled with a widening of coverage.
And the situation hasn’t been better on the reinsurance side of the fence, either, according to Benfield’s Reinsurance Market Review. Property and marine excess of loss rates have slipped by some 20% as a result of a benign claims environment and the overabundant capacity available at present.
Educating the market
Despite such depressing figures, foreign firms remain very positive about China. After all, it’s hardly as if such figures are markedly different from some of the softening rates being experienced elsewhere at the moment. Yet there is no doubt they are realistic as to what can be achieved in the medium term, as Malcolm Payton, the recently appointed Asia head for broker JLT Re, makes clear.
“For the time being we will do a lot of our business in China through Hong Kong, and over the past 18 months we’ve invested heavily directly in China.
But reinsurance is difficult because I’m not sure they really understand it yet. They’re looking at catastrophe insurance, which they’ve never looked at before, and facultative insurance is playing a much bigger role than treaty at the moment. But we’ve got to educate the local market, which is getting much bigger with the likes of AIG and others going in. In the past the reinsurance sector has been too focused on state-owned companies, but is now expanding.”
“The market remains dominated by the state-sponsored China Re and is heavily bureaucratic
So how come it hasn’t followed its competitors and set up an office in China itself? “The main thing is to have locals,” he answers. “You can’t just put a load of expats in there… What will be key in China is not just to have a direct broker or a reinsurance broker but rather someone who is going in with a connection. We will not just stick an office in a territory for the sake of it.”
It is clear that anyone serious about China has to stick around for some time. It may have massive potential, but it isn’t there yet in reinsurance terms.
The market remains dominated by the state-sponsored China Re and is heavily bureaucratic, with complex and quasi-protectionist arrangements where foreign players are concerned. Still, there are classes that are expected to grow this year, according to Payton.
“Catastrophe classes will be the critical play for 2008/2009, and as every other territory is reducing rates so new opportunities present themselves,” he predicts. “Facultative reinsurance is an easy play for anyone in the world. Hardcore fac is disappearing in the rest of the world, but it can be an alternative to treaties and can give you the quick fix to support the local market.
And from there you can think about cat bonds and other more sophisticated products. But you need the right connections from the ceding companies and brokers will have to show how they add value from getting business.”
Perhaps the really exciting opportunity in the region in near future is not so much China as Singapore, increasingly described as the “new London Market”.
Here the regulatory and legal framework is already world-class. It is home from home for many insurers and reinsurers. Indeed Lloyd’s has specifically developed a strategy of opening up local operations that are more than a mere Lloyd’s representative office.
With all eyes on Asia as one of the most exciting growth areas for the reinsurance market, it is clear that profitability will have to be sacrificed somewhat in the clamour for market position, whether that be in China or Singapore.
Still, at least approaches to doing business seem to be somewhat different to historical “father knows best” tactics, with a local presence and partnership key. As one industry expert mused: “The London Market now understands that only way you understand the local market is by having people on the ground – you can’t just run the operation from London and have 15 people board a plane every few months to the Asia office.”
Marcus Alcock is a freelance journalist.
Asia: China exposed
As insured values grow in Chinaâ€™s big cities â€“ Shanghai, Beijing and Guangzhou â€“ the countryâ€™s exposure to natural catastrophes has become more evident.
Typhoons, flooding, earthquakes and even snowstorms have the potential to cause significant losses. Catastrophe modellers have made it a priority to better map and price these risks.
The most devastating catastrophes generally occur during the summer months. In fact, in the last 30 years, nine of Chinaâ€™s ten most devastating natural catastrophes occurred during the June-August period.
Last year, super typhoon Wipha â€“ the most destructive storm in a decade â€“ made landfall worryingly close to Shanghai. Two million people were evacuated but insured losses only amounted to $250m.
Domenico del Re, Asia Pacific model manager at Risk Management Solutions, commented: â€œDespite its vulnerability to natural catastrophes like typhoons, Chinaâ€™s insurance market is still in its infancy and property insurance penetration is generally low.
However, large cities are the exception and coverage is becoming more widespread, with over 25% of property insurance in Shanghai now written by foreign companies.â€
The first two months of 2008 saw the worst snowstorms in 50 years. While the snowstorms are expected to be among the costliest catastrophes in Chinaâ€™s recent history in terms of economic loss, the insured loss has been very low.
Chinaâ€™s industrial production growth slowed as ferocious snowstorms hit factory output, cut power supply and destroyed crops.
â€œAs a result of the snowstorms, insurersâ€™ profitability will deteriorate this year, but the degree will depend on whether more severe catastrophes will occur over the coming months,â€ warned Daniel Wong, a Moodyâ€™s associate analyst.