Insurance to be integrated into social governance for solving economic and livelihood problems

The "New Normal" in China has ended the inertia of the conventional thinking and behaviour fostered in the long path of high growth. In turn, it is inevitably the time for people to think about how to safeguard what has been achieved and to explore new ways of development. The most struggling and imminent issue is how to solve those chronic problems caused or left over after the long path of high economic growth, such as poverty, agricultural issues, and debts, which are fundamentally challenging to economic foundation, state governance, public interests, and fiscal governance. Such a context allows people feel seemingly back in the early years of reform, when the priority was given to studying, thinking and exploring ways of development. 

The key issues in the phase of post high growth development are largely reflected in the imbalance of quantity and quality of economic development derived in the high growth speed, which is exactly the phenomenon of the "New Normal". As such, the key tasks of adjusting the economic structure in the "New Normal" refer to fixing the imbalance between the quantity and quality of development. The most obvious characteristic of the imbalance of economic structure is the hysteresis of financial sectors in the economic structure. Thus, the in-depth integration of financial sectors in the economic structure has become a critical issue of adjustment and development in the "New Normal". The core issue for such an integration is about dealing with such fundamental structural problems as poverty, agricultural issues, and debts.    

Climate change and natural disasters are the main cause of impeding economic development and of generating poverty, particularly of sending people back to poverty, according to research made by some prominent think tanks including the World Bank. Recent research reports reveal that natural disasters may cause as much as 70% of the population who have left poverty back to poverty, largely because various natural disasters are widely spread, seriously severe and highly frequent with an obvious upward trend in China. However, the overall resilience against natural disasters remains weak in three dimensions. The infrastructures of disaster prevention and reduction are not yet well developed. The awareness and consciousness of the society remain behind what they should be. The disaster insurance system as the core element of the financial and fiscal resilience system against natural disasters and secondary disasters to social, financial economic and fiscal sectors is seriously absent in China. Thus, the upward trend of frequency and severity of natural disasters in the context of serious absence of disaster insurance system in social financial and government fiscal structures has become the major issue of solving economic and livelihood problems in the "New Normal".

Natural disasters are reflected in some forms of natural force dynamics, such as flooding, drought, frost, hailstone, typhoons, heavy rainfalls and earthquakes. Their consequential economic harm is reflected in a way that one event may result in massive losses to agricultural crops, vehicles, properties, commercial and industrial facilities, infrastructures and bodily injuries of related population. However, the losses would not stop with the damaged parties, but would further cause exponentially expanded losses resulted from contractual default, business interruption, civil liabilities, and legal disputes to mortgage banks, suppliers on credit terms, contractors, and contract principals. In addition, the loss context would inevitably expand into the public sector incurring substantial off budget fiscal expenses in disaster relief and post disaster reconstructions, and in turn would cause significant damage to fiscal balance and resilience. Thus, given the economic relationships, social relationships, legal relationships, financial relationships, and public policy relationships, natural disasters may result in exponentially derived secondary disasters, such as family disasters, business disasters, social disasters, environmental disasters, economic crisis, fiscal crisis and problems of political stability. For example, the significant change of agricultural production relationships[1] resulted from the agricultural land transformation scheme[2]would give rise to significant financial leverage risks[3] in addition to risks of natural disasters for farms. It is nearly impossible for institutional farms to carry on large scale agricultural productions without insurances as contingent capital to offset the contingent liabilities arising out of natural disasters and related financial leverage risks, not mentioning the purpose of agricultural land transformation scheme for increased agricultural productivity.

Given so, the disaster insurance system is mandated in the resolution on deepening the reforms at the third plenary session of the 18th CCPC[4].  It is the first time that insurance is mentioned at such a significant high political level, manifesting significant strategic requirement for insurance to be deeply integrated into economic structure and social governance, aiming to solve those systematic risk issues which impede economic development so as to solve those difficult problems in relation to economy and livelihood. The basic concept of the mandate is understood to be folded in three dimensions. Firstly, quantification of financial contingent liabilities for individual and businesses as well as fiscal contingent liabilities for governments arising out of natural disasters. Secondly, quantification of the gaps between such contingent liabilities and the existing fiscal resilience capacity, and the significance of the derivative or secondary disasters arising out of such gaps. Thirdly, establishment of disaster insurance system for insurance to be institutionally applied as the most efficient and effective contingent capital to hedge against the contingent liabilities so as to prevent derivative and secondary financial disasters.

Most of the capital instruments in the financial market are of debt nature with high liquidity and less limitation to purpose of use although very costly. It is obvious that excessive use of debt capital may result in negative impact to macro economy and financial market. In the event of massive and severe disasters, individuals and businesses would not be able to secure debt capital to salvage themselves. Governments may have access to debt capital for disaster relief and post-disaster reconstructions. However, any immense government debt raised on top of exiting huge fiscal debt base could result in chronic inflation and financial market volatility, which in turn are inevitably harmful to social stability. In contrast, insurance, as one of the mainstream monetary instruments, stand out in such a context with three unique characteristics being stringently budgets specific, highly liquid, and least costly.  A disaster insurance system is set to quantify and qualify disaster related contingent financial liabilities for individuals and businesses as well as contingent fiscal liabilities of governments, and in turn to institutionally place insurance as contingent capital to hedge against the contingent financial and fiscal liabilities. Such reform effort would lead to scientifically relevant and institutionally reliable social and fiscal governance at the lowest costs. In similarity with clean energy, insurance is about transformation of natural force dynamics into profit making assets.

As costly results of the imbalance of quantity and quality of rapid economic growth, insurance is massively absent in the social and economic structures, although it is nominally treated as a derivative commodity for alternative selection in the social environment, not as one of the mainstream capital instruments. From the perspectives of social governance and fiscal governance for financial and fiscal resilience against natural disasters, the costs of the imbalance are reflected on the massively exposed financial contingent liabilities and fiscal contingent liabilities in relation to exposures to natural disasters and related secondary financial disasters. In such a context where massive absence of financial resilience of individuals and businesses against natural disasters, governments are left as the force of resilience against natural disasters, without which the consequence would be rather political. Thus, establishment of insurance oriented fiscal resilience against natural disasters is a reflection of state governance capability, with which governments would be able to undertake disaster reliefs and post disaster reconstructions without sacrifice to fiscal budget regime and in turn to prevent natural disasters from spreading into secondary financial disasters to individuals, businesses and public sectors, so that such chronic systematic risks as disaster related poverty, agricultural hysteresis and debt problems would be able to be confined and solved.

The China Development and Research Foundation (CDRF), the Research Institute for Fiscal Science under the Ministry of Finance, the Policy Research Office of the China Insurance Regulatory Commission, Beijing Normal University, and Swiss Re have jointly undertaken public policy research on the necessity and feasibility of applying parametric insurance solutions in the reform of the natural disaster relief system. Based on this research, Swiss Re has worked closely with some provincial and municipal governments on pilots of integrating parametric insurance solutions in government fiscal regime for the purpose of enhancing fiscal capacity for disaster reliefs and post disaster reconstructions. This allows pilot governments understand and quantify their disaster-related contingent fiscal liabilities, and hedge such fiscal liabilities with disaster parametric insurance as fiscal contingent capital aiming for sustained balance and resilience of fiscal budgetary regime in both normal years and disaster years. This will institutionally enhance fiscal governance level and result in effective adjustment of the social and economic structures.

[1] Individual farmers vs. large institutional farms in relationships with suppliers, contractors and principals.

[2] Individual farmers are encouraged to lease their individual land to large institutional farms or to form cooperatives for the benefits of large scale specialized farming operations.

[3] farming loans and supply on credit

[4] The 18th Congress of the Communist Party of China.

Published July 2016