A new regulation on credit and guarantee insurance, issued by the CBIRC on 19 May, tightens requirements on insurers’ capital and operations, which would help reduce the risk of significant losses from default to insurers in the global economic downturn amid the coronavirus pandemic, says Moody’s Investors Service.
Moody’s says that the new rules are credit positive in an article in its 26 May 2020 issue of “Moody’s Issuer Comment”.
The new regulation defines financing credit and guarantee insurance (Insurance policies protecting credit risks on loan, financing leases and other financing contracts) and covers risks in consumer finance and loan guarantees for individuals and small and medium-sized enterprises (SMEs). It supersedes previous interim measures published in 2017.
Higher solvency requirements raise the entry barrier to financing credit and guarantee insurance, ensuring that only those insurers with stable capital profiles can underwrite risks, which also reduces pricing competition. A lower cap on retained exposure prevents excessive risk underwriting relative to an insurer’s capitalisation and limits the concentration risk to a single borrower for financing credit and guarantee insurance.
However, the new regulation is in line with government efforts to facilitate SME financing and it relaxes retained exposure requirements. Encouraging exposure to SMEs will potentially raise insurers’ capital erosion risk because SMEs usually have a weaker capital base and are more vulnerable in the current environment because of lower consumer spending and weaker economic activities.
In recent years, credit and guarantee insurance has grown rapidly because of strong demand for financing and easy accessibility for customers. At year-end 2019, credit and guarantee insurance premiums were CNY84bn ($11.8bn), or 6.5% of total property and casualty (P&C) premium income in China, compared with CNY40bn, or 4.8% at year-end 2015.
However, credit and guarantee insurance is highly susceptible to macroeconomic conditions compared with other P&C products and loss ratios rise in an economic slowdown. According to the CBIRC, claims from credit and guarantee insurance increased 50% to CNY16bn in the first quarter of this year from first-quarter 2019, exacerbated by credit deterioration in consumer finance amid the coronavirus-related economic downturn.
Because credit and guarantee insurance is a relatively recent product in the Chinese insurance market and has not been fully tested in a credit downturn, insurers are exposed to mispricing and reserving risk.
The new regulation’s ban on products such as credit and guarantee insurance on debt schemes with a changed underlying obligor, securitisations originated by non-bank institutions and derivatives will help insurers avoid products with higher default risk. Also, required enhancements in risk management systems will improve risk assessment and control.