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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.
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Figure 4 reinsurance payout ratio between life and non-life insurance in China
Data source: the Yearbook of China’s Insurance (2015-2021), compiled and mapped by the author.
It is obvious that most of reinsurance contracts in the Chinese insurance industry originates
from domestic primary insurance institutions, while the international business is mainly
completed or ceded by international (professional) insurance institutions. In terms of ceded- out premium, primary insurance companies are mainly the risk ceded-out party and
professional reinsurance companies are mainly the ceded-in party. Foreign reinsurers are
gradually becoming the main ceded-in agents in the market, and China's original insurers are
also actively involved in the reinsurance industry, with relatively small premium sizes making
the correlation between the businesses relatively weak.
The predominant relationship between professional reinsurers and direct insurance
companies is unidirectional and vertical, i.e. professional reinsurers generally do not purchase
reinsurance sold by the original insurer or have relatively small volumes of this business, and
there is little correlation between professional reinsurers and the few horizontal
interconnectedness that may exist between reinsurers. To some extent, such a network
structure limits the potential impact of unexpected risks on the insurance industry as a whole,
and the likelihood that traditional reinsurance activities will have a negative and potentially
systemic impact on the industry as a whole is low. Even if it does, it is likely to be limited in the
insurance industry.
ANALYSIS OF THE STRUCTURE OF CHINESE REINSURANCE NETWORK BASED ON THE
PRINCIPLE OF MAXIMUM ENTROPY
As it is difficult to obtain accurate data on reinsurance contracts directly, this paper uses the
principle of maximum entropy and simulates Chinese network connections in the insurance
market through complex network, analyzing the network structure characteristics related to
reinsurance network at two levels: life insurance and non-life insurance (property and casualty
insurance) respectively.
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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
Given that reinsurance premiums are divided into ceded and ceded-out premiums, a
reinsurance directed network was constructed based on the reinsurance bilateral connection
matrix. The results of the model show that professional reinsurers are more likely to take in
risk from the original insurer than to cede risk. They also show that professional reinsurers
rarely share risk with each other, which is generally consistent with the results discussed in the
existing literature 5 . In addition, life insurers are more likely to take in risk than non-life
insurers, and non-life insurers are more likely to take out risk. This is mainly reflected in the
fact that life insurers are more likely to take in than non-life insurers, and the opposite is true
in terms of taking out. This finding is consistent with the structure of the reinsurance market in
practice, where professional reinsurers generally choose to underwrite reinsurance sold by the
original insurer due to the relatively vertical network of the reinsurance market, with the
possibility of a few horizontal linkages between professional reinsurers, but these are very
weak. In terms of the time dimension, the number of reinsurers receiving facultative business
has been relatively stable, with a sudden drop between 2015 and 2016 mainly due to the
increment of the reinsurers.
Network Centrality:
The centrality indicator captures the importance of insurance (reinsurance) institutions in the
market. In this paper, we select eigenvector centrality and betweenness centrality to analyze
the importance of the insurers(reinsurers).
The eigenvector centrality is used as an important indicator of the influence of the node in the
overall network. Based on the previous ideas of network construction, a reinsurance network
for the life and non-life insurance was established and analyzed for eigenvector centrality and
betweenness centrality as well as temporal changes (see Figure 7 and 8 for details).
Figure 7 the eigenvector centrality of the life insurers in the insurance market (2015-2020)
Figure 7 shows the change in the eigenvector centrality of the life reinsurance market from
2015 to 2020.the first row shows 2015, 2016 and 2017 respectively, and the second row shows
2018, 2019 and 2020 respectively. 0-97 are the original insurer codes and 98-111 are the
5
International Association of Insurance Supervisors (IAIS), Reinsurance and financial stability[R], Basel: International
Association of Insurance Supervisors, 2012: 10.
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reinsurer codes. As can be seen from Figure 7, over time, the risk concentration of the life
insurance reinsurance market presents a process from concentration to relative dispersion.
From the perspective of space, concentration means that in the life insurance reinsurance
market, after risk exchanges, market risk is mainly shared by several large insurance companies
and professional reinsurance companies; Diversification refers to that, compared with the
situation in which the market risks were mainly concentrated in professional reinsurance
institutions in 2015, after five years of development, the main market risk pattern has changed
into multiple large insurance companies and professional reinsurance companies sharing
market risks. In terms of time, with the development of the market, the risks assumed by each
risk-bearing entity are increasing, and the number of risk-bearing entities has also increased,
and the degree of risk concentration has decreased, showing a certain trend of diversification.
Figure 8 the eigenvector centrality of the non-life insurers in the insurance market (2015-
2020)
It is slightly different from the situation of life insurance companies, as shown in Figure 8. The
horizontal axis 0 to 76 in the figure is the code of non-life insurance institutions, and 77 to 89
is the code of reinsurance institutions. From the perspective of space, in the reinsurance
network of non-life insurance, the risk concentration showed a trend of gradually sharing to
the whole market from 2015 to 2020, and the relative scores between nodes were relatively
close. Although a large number of risks are still concentrated in professional reinsurance
companies, their risk allocation is more average than that of life insurance reinsurance
networks. This indicates that the non-life insurance reinsurance network is more likely to have
the risk caused by the default of the reinsurance contract than the life insurance reinsurance
network, thus inducing the systemic risk, which spreads in a waterfall manner in the whole
non-life insurance market.
In terms of betweenness centrality, the betweenness centrality of the reinsurance network is
shown in Figure 9. As with the eigenvector centrality, the betweenness centrality of the
reinsurance network in the life insurance market is also concentrated in several large original
insurance companies and professional reinsurance companies. Such results show that if the
crisis occurs in small life insurance institutions, as long as there is no fatal impact on these large
insurance institutions and professional reinsurance institutions, there is a great chance that
large insurance institutions and professional reinsurance institutions will become effective risk
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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
blocking points and isolate risks from other institutions. However, just like the two sides of the
coin, if the crisis occurs in these large insurance institutions and professional reinsurance
institutions, its intermediary effect will amplify the impact of the crisis, make the crisis spread
quickly to the entire network, and bring fatal damage to the entire insurance market. This also
confirms that IMF, BIS and FSB (2009), Geneva Association (2010) and IAIS (2010) put forward
the characteristics of measuring the scale and interrelation of systemic risk.
Figure 9 the betweenness centrality of the life insurers in the insurance market (2015-2020)
Analysis of the intermediary centrality of the reinsurance network in the non-life insurance
market (shown in Figure 10) is compared to the reinsurance network in the life insurance
market. While specialist reinsurers take on some intermediary functions, the main network
intermediaries are concentrated in the non-life primary insurers. This suggests, on the one
hand, that risk sharing in the non-life network is more balanced and that when a crisis arises in
one institution, the entire network can assume the risk in a balanced manner. But on the other
hand, it also indicates that non-life market networks have fewer risk-blocking points compared
to life market networks, and that in the event of a large-scale risk outbreak, most institutions
in the network would be affected by the shock and thus have a higher likelihood of systemic
risk. This is closely related to the business activities engaged in by non-life insurance
institutions. Some credit guarantee businesses could be potential triggers of systemic risk.
Figure 10 the betweenness centrality of the non-life insurers in the insurance market (2015-
2020)