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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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Advances in Social Sciences Research Journal (ASSRJ) Vol. 10, Issue 3, March-2023

Services for Science and Education – United Kingdom

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.