As China’s economy continues on its path of steady and diversified growth, the country will further invest in its infrastructure as more roads, ports, power plants, hospitals and schools are needed to sustain the expansion of its economy. In particular large construction and infrastructure projects associated with the “One Belt One Road” (OBOR) initiative require additional insurance protection. In 2015, the Insurance Law was amended to also allow insurers to cover surety risk, previously a prerogative of banks. With the recent opening of the market, insurers can now position themselves and benefit from a first-mover advantage. Peak Re will support them with its expertise, underwriting capacity and training capabilities in grasping this new market opportunity.
China’s GDP is expected to have grown by 6.5% in 2016, driven by strong public investments. For 2017 growth might decelerate to a still strong 6.3%, compared to the forecast global average of 2.7%, according to the World Bank. Infrastructure investments, one of the key drivers of the country’s GDP growth, are expected to remain high. According to China’s Ministry of Transport and National Development and Reform Commission (NDRC), from 2016 to 2018 alone the country will invest US$ 724 billion in infrastructure projects. But even this huge amount is eclipsed by the enormous investments needed to turn China’s OBOR initiative, launched in March 2015, into a reality.
In line with its ambition of further promoting China’s integration into the world economy infrastructure investments to revive the ancient Silk Road and to establish a direct access to the Indian Ocean will be gigantic. According to market research, projects already announced as of July 2016 for the countries along the route amount to up to US$ 1.2 trillion with a potential insurance premium volume in the magnitude of USD 7 billion. A further US$ 27 billion in premiums could result until 2030 from future construction projects.
Some of this premium potential will emanate from underwriting surety risk, protecting bondholders, namely the government and private investors, against the financial risk and potential loss in case of a default of the contractor. Given the enormous amounts of infrastructure cover needed, it was quite logical for the government to open up the country’s surety bond market, allowing insurers to write surety risk for the first time.
Surety bonds have already been issued since the Guarantee Law came into force in 1995. However, it had been the exclusive right of banks to provide guarantees. In April 2015 the Insurance Law was amended. Ever since, Chinese primary insurers have commenced writing surety risk. These carriers provide a range of performance bonds that include undertaking, license, rental, credit and supply bonds.
Fundamentally, a surety bond is defined as a contract, in which an insurer or bank provides a guarantee to a beneficiary or obligee that the principal will meet its contractual obligations or that a monetary compensation is paid to the obligee, if the principal fails to deliver on its promise. Typically, these guarantees are found in large industrial construction projects, where the investor is the obligee and the contractor is the principal. The insurer or bank guarantees that the contractor will fulfil its contractual obligations towards the investor – in large infrastructure projects this is frequently the government.
It is noticed that there may be confusion among corporate bonds, financial guarantee and surety bond. While the former two refer to financial obligations to repay the debts or loans, the latter is about the performance or delivery obligations to complete the insured project.
Since 2016 these guarantees or surety bonds are either issued by banks or insurers in China. In the first instance the bank provides its guarantee to the obligee against a collateral – the project sum insured – that the principal or contractor has to deposit with the bank. In the second case, the insurer provides a guarantee to the obligee against a premium paid by the principal. Typically, in China the principal will not have to deposit a collateral with the insurer. Although in the interest of proper risk management, it might be advisable that the principal deposits a certain percentage of the sum insured with the insurer as well. However, clearly insurance has the advantage of not putting any strain on the liquidity of the principal.
In large construction or infrastructure projects a surety bond or bank guarantee is frequently a contractual requirement or precondition of the project owner for awarding an order to the contractor. In case the contract is not honoured, the insurance company is called upon to pay the bond or otherwise assure the finalization of the contractual obligation. In general, performance bonds issued in China usually cover up to 10-20% of the project sum, which is far below the level of cover in the US, for example, where surety bonds sometimes guarantee 100% of the project value.
Surety bonds have been promoted by China’s Ministry of Construction since the late 1990s to reduce financial risks but also to rectify illegal behaviour associated with construction projects, delayed payments and defaults. The guarantees contribute to a more reliable, smooth operation as well as improved quality controls in the execution of large construction projects. Overall, they help ensure their successful completion. Due to their current regulatory and rating challenges, banks prefer to shift surety risks to insurers in order to focus on their core banking business.
Surety insurance is still a fairly new insurance line of business in China. However, it is expected that with OBOR’s progress demand will increase rapidly. Those primary insurers which add the cover to their portfolio can benefit from a first mover advantage, building up expertise and luring experienced underwriters from the banks. Currently most insurers focus on clients, which apply for publicly tendered construction projects. Make Contract Bonds and Commerical Bonds as sub-point under Surety bond, which attract larger, more stable and reliable contractors and where a surety bond is legal requirement. Depending on the size and complexity of the project, contracts may run for three to five years.
Peak Re is keen to explore opportunities to support its clients in China, if they choose to underwrite surety risk. Typically, the risk is ceded as both a stand-alone treaty or facultative, not bundled with other non-life risks such as property.
