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Advances in Social Sciences Research Journal – Vol. 10, No. 3
Publication Date: March 25, 2023
DOI:10.14738/assrj.103.14208.
Wei, W., & Ming, L. (2023). Analysis of Systemic Risk in the Chinese Insurance Market Based on Reinsurance Networks. Advances
in Social Sciences Research Journal, 10(3). 155-171.
Services for Science and Education – United Kingdom
Analysis of Systemic Risk in the Chinese Insurance Market Based
on Reinsurance Networks
Wang Wei
School of Insurance, University of Finance and Economics, Beijing, China.
Liu Ming
School of Insurance, University of Finance and Economics, Beijing, China.
Abstracts
Since the financial crisis in 2008, regulators around the world have been committed
to understanding and mitigating the potential systemic risks brought by the
insurance industry, focusing on the risk transmission field within the insurance
industry. This paper focuses on the possible transmission relationship of systemic
risk in China's insurance market through the reinsurance network from the
perspective of macro-prudential, discusses the accumulation and contagion effect
of systemic risk over time, and puts forward suggestions on the macro-prudential
supervision of China's insurance industry.
Keywords:insurance, systemic risks, network perspective
INTRODUCTION
Since the financial crisis in 2008, the insurance industry, as the main business of risk
management, had received a great deal of attention. Regulators around the world had been
working to understand and mitigate the potential systemic risks posed by the insurance
industry, with a focus on areas of risk transmission within the insurance industry. Most scholars
have analyzed the potential sources and transmission channels of systemic risk in the insurance
industry, with the most likely channel for spillover systemic risk from the insurance industry
being reinsurance business.
This paper focuses on the possible systemic risk transmission relationships in the Chinese
insurance market through the reinsurance network under a macro-prudential perspective,
explores the accumulation and contagion effects of systemic risk over time, analyzes the impact
of systemic risk contagion through the reinsurance channel in Chinese insurance market, and
provides some suggestions for the macro-prudential regulation of insurance in China.
This paper is organized as follows:section 2 provides a literature review; section 3 explains
the importance of reinsurance network; section 4 describes the current situation of the Chinese
reinsurance market; section 5 analyzes the network topology characteristics of the reinsurance
market, and reveals how systemic risk propagates and accumulates through the reinsurance
network; section 6 simulates the propagation of risk through the reinsurance network in the
insurance market when a shock occurs, based on the Ising model; section 7 discusses the policy
recommendations.
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LITERATURE REVIEW
Reinsurance is an important tool used by the insurance industry to transfer risk. The
reinsurance market has strengthened the linkages between financial institutions and further
amplified the systemic risk in the financial market. Acharya et al. (2009) proposed that
reinsurance strengthened the linkages among financial institutions and further amplified the
systemic risk in financial markets. Cummins et al. (2014) argued that the financial crisis or
bankruptcy of reinsurers would lead to the destabilization of the entire property insurance
market, causing insurance market failure, which in turn would bring damage to the entire
financial system and even the real economy. Park and Xie (2014) confirmed that centrally
located reinsurers had higher systemic risk. Kanno (2016) constructed an insurance network
model based on the maximum entropy principle and analyzed the structure of the insurance
network. Wang L. (2017) showed that from the perspective of risk contagion in insurance
business, domestic and foreign reinsurers were systemically important; small direct insurers
and some reinsurers with a higher share of ceded premiums had systemic vulnerability;
however, for Chinese insurance industry, the possibility of systemic risk occurring due to
reinsurance underwriting business was not high. Niu X. and Wu X. (2019) pointed out that in
recent years, due to their close ties with other insurance companies, some of the larger and
more complex domestic insurance institutions were in the central position in the reinsurance
network species and played a pivotal role in the stability and stability of Chinese overall
financial system and its ability to serve the real economy.Li F. et al.(2022)developed a network- based contagion model to investigate reinsurance strategy from a macro-prudential
perspective, showing a U-shaped relation with economic losses caused by risk spillovers.Other
influential works include Berdin et al.(2017),Chen H. et al(2020),Jourde T(2022).
THE IMPORTANCE OF REINSURANCE IN INSURANCE INDUSTRY
Reinsurance, as an important risk transfer instrument and risk management mechanism,
serves the following functions: (1) it disperses and transfers part of the risks underwritten by
the reinsurance institution, thus realizing the apportionment of sub-risk; (2) it helps control
the risk liability and uses the financial compensation function of insurance to compensate for
the losses incurred by the reinsurance institution due to insurance risks; (3) it enables the
reinsurance institution to expand its underwriting capacity; fourthly, it reduce the operating
costs of the sub-insurance agency. However, this process of business and activity can also lead
to increased interconnectedness among insurance institutions and an increasing aggregation
of risks among reinsurers, which can easily create systemic risks within the insurance market
through reinsurance business if a crisis occurs in any one or more institutions. Risk
diversification and restructuring mechanisms based on reinsurance contracts have become a
global network that transcends national borders. The risk transfer mechanism of reinsurance
also exists to provide a quick route of contagion for potential risk shocks and the consequences
of magnifying potential insurance risks. Such internal risk transmission channels and
modalities have become an important concern for global regulators.
Reinsurance stands on the top of the insurance network. Risk spillovers from the reinsurance
can lead to financial instability due to risk contagion within the wider insurance industry, and
may even have spillover effects and negative externalities on the economy as a whole. When
the International Association of Insurance Supervisors (IAIS) conducts systemic importance
assessments, reinsurance is considered as an important factor in assessing risk transmission
among insurance institutions. As Acharya et al. (2009) argued, "reinsurance markets increase
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Wei, W., & Ming, L. (2023). Analysis of Systemic Risk in the Chinese Insurance Market Based on Reinsurance Networks. Advances in Social Sciences
Research Journal, 10(3). 155-171.
URL: http://dx.doi.org/10.14738/assrj.103.14208
the interconnectedness of the system in an exponential manner and may therefore increase
systemic risk across the market". Indeed, credit risk from counterparties in reinsurance
transactions has been an important issue in their risk diversification and transmission, and
ceding companies are increasingly using special termination clauses with rating triggers in
their reinsurance contracts for risk mitigation purposes. This practice may actually exacerbate
the problem of “Reinsurance Spiral”. If a reinsurer's rating is lower below a certain threshold,
the clause will allow the major players to cancel the reinsurance policy, thus weakening an
already weak reinsurer and triggering a "reinsurance spiral", leading to a greater likelihood of
systemic risk.
Research has shown that reinsurance can generate systemic risk by increasing the
interconnectedness of risks through leverage and increasing contagion between insurance
institutions. Therefor, the study of systemic risk in insurance is crucial to the study of
reinsurance business linkage networks.
CURRENT SITUATION OF REINSURANCE BUSINESS IN CHINA
In order to analyze the impact of risk shocks on the reinsurance market, it is critical to
understanding the current situation of China's insurance reinsurance business. This section will
analyse Chinese current situation in the insurance industry market from the following
perspectives: the reinsurance institutions 、 the structure of ceded premium, and the
reinsurance payout ratio.
Information of Reinsurance Institutions
Prior to China's accession to WTO, there was only one reinsurance company in China, China Re.
Since 2003, with the continuous opening up of Chinese insurance industry, it has been
developing with great potential, attracting major professional reinsurance institutions all
around the world to set up branches in China, such as Munich Re and Swiss Re, etc. These
foreign reinsurance institutions entered the Chinese reinsurance market and undertook a large
amount of ceded reinsurance business. After the financial crisis in 2008, China accelerated the
establishment of Chinese reinsurance institutions in view of the growing demand for risk
diversification in the domestic insurance industry, and established PICC Re, Qianhai Re and
China Agricultural Re. Up to now, there are 15 reinsurance institutions in the Chinese insurance
market, including 8 foreign professional reinsurance institutions and 7 Chinese professional
reinsurance institutions1.
Structure of Ceded and Ceding Premium
The data shows that by the end of 2020, the total scale of premiums ceded from the original
insurance market in China was 244.183 billion, accounting for 5.68% of the original insurance
premium, rising up 2.12% from the previous year. The scale of ceded premium from property
and casualty (non-life) insurers remained stable relatively (as shown in Figure 1). The life
insurance industry's ceded premium rate was slightly 2% above the global life insurance
1 Although China Re Group has established China Life Reinsurance and China Property Reinsurance to operate life
insurance and non-life insurance reinsurance business respectively, according to the data in the China Insurance
Yearbook, China Re Group still handles reinsurance business separately and is therefore also considered a reinsurance
agency.
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average, while the non-life insurance industry's average ceded premium rate was 8.4% above
the global average2 .
Figure 1 Comparison of ceded premium ratio between life and non-life industry in China
Data source: the Yearbook of China’s Insurance (2015-2021), compiled and mapped by the author3
From the perspective of premium structure, the scale of reinsurance premium has increased
from about RMB 120 billion in 2013 to more than RMB 320 billion in 2020, increasing by more
than 2.69 times and with an annual average growth rate of 13.16% within 8 years in domestic
reinsurance market. In terms of ceded-out business, the ceded-out premium of original
insurance companies accounted for 75.69%, and that of professional reinsurance companies
accounted for 24.31%. By 2020, the ceded premium of professional reinsurance companies was
297.377-billion-yuan, accounting for 87.76% of the ceded business. The ceded premium of
original insurance companies was 41.495-billion-yuan, accounting for 12.24% of the ceded
premium (see Figure 2). It can be seen that China's reinsurance business is mainly underwritten
by domestic professional insurance institutions, with a relatively low level of
internationalization, far behind the world average. From the perspective of change trend, the
proportion of premium ceded by Chinese-funded professional reinsurance institutions had
been descending year by year since 2017, and slightly increased in 2020 (see Figure 3). The
reason may be that as China continued to promote economic globalization, the insurance
industry had always played a leading role in the opening up of the financial industry. With the
comprehensive opening up of the insurance industry, international reinsurance institutions
had accelerated their deployment in China, bringing more abundant funds and advanced
management experience to the reinsurance market in China.
2 Data source: Compiled from "Swiss Re sigma: Global Market Trends".
3 As the insurance industry started to implement the new accounting standards in 2012, they were fully implemented
in 2014. This led to inconsistencies in the calibre of reinsurance statistics prior to 2014, so only data from 2014 onwards
was selected for comparable analysis in this paper. In the modelling, the current year data was used for modelling and
therefore the comparability of the results is not affected.
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Wei, W., & Ming, L. (2023). Analysis of Systemic Risk in the Chinese Insurance Market Based on Reinsurance Networks. Advances in Social Sciences
Research Journal, 10(3). 155-171.
URL: http://dx.doi.org/10.14738/assrj.103.14208
Figure 2 the ratio of premium underwritten by original insurance company and professional
reinsurance company
Data source: the Yearbook of China’s Insurance (2015-2021), compiled and mapped by the author.
Figure 3 the ratio of premium underwritten by foreign and domestic reinsurance company
Data source: the Yearbook of China’s Insurance (2015-2021), compiled and mapped by the author.
Reinsurance Payout in the Chinese Insurance Industry
The reinsurance payout ratio has always been an important indicator of the stability of the
reinsurance system (as shown in Figure 4). Reinsurance payout ratio was generally stable
except for 2016 when it was extremely high. The data shows that non-life reinsurance payout
ratio is higher than life insurance. There was an abnormal payout from Hannover Re in 2015
and 2016, which led to higher payout ratio of life reinsurance market as a whole. The life
reinsurance payout ratio remained at around 50% and the property reinsurance payout ratio
remained at around 55%, excluding the Hanover accident.