China-Taiwan: “Astonishing” divergence of views across Lloyd’s

When Lloyd’s syndicates were asked to come up with their exposure to a war between China and Taiwan, an “astonishing” divergence of views was revealed for this nightmarish conflict scenario.

Lloyd’s regularly runs Realistic Disaster Scenarios (RDS) exercises to come up with a view of exposure for its syndicates and on a market-wide exposure.

However, rather than an RDS, the China-Taiwan project was termed a “data collection exercise”, Lloyd’s has clarified in a statement to GR since this article was first published.

Responses to the China-Taiwan exercise, prepared by broking and risk advisory firm CHC, and presented to the market in January 2023, were far from coherent due to the inconsistency of underwriters’ risk perceptions for a conflict between the two Chinas.

“The divergence of views was astonishing. Losses would be significant…into the bad corner of the risk register,” a confidential source familiar with the exercise told GR.

“One entity, a political risk underwriter, said there was only one thing to decide, which was the point at which China would go nuclear,” the source continued.

“At the other end of the spectrum, you had people saying this was never going to happen and that it was a complete waste of time – and everything in-between,” the source added.

“We’re talking about a 5,000% loss ratio,” said a second senior source at a political risk insurer, again choosing to speak anonymously.

“The one thing capital hates is surprises, but this is unthinkable.”

Tensions between China and Taiwan are at their highest in decades, with Chinese military aircraft regularly skirting airspace, and Chinese warships stepping up naval exercises.

Chinese President Xi Jinping has vowed to reunite with the island – by diplomacy or force – repeating the promises by previous Chinese leaders, since China’s civil war ended on the mainland with Communist victory and Taiwan’s estrangement in 1949.

As Chinese power has grown, Beijing has been increasingly unwilling to accept US regional hegemony – Taiwan’s ally and protector. Any conflict could therefore have global implications.

Core to the market’s exposure are two major factors: firstly, Taiwan produces 60% of semiconductors used by the world economy, 90% of the most advanced ones; secondly, the South China Sea just to the south of Taiwan is an artery through which transits $5.3trn of annual global trade.

A war between China and Taiwan would therefore have enormous consequences to global trade and could halt the availability of advanced microchips used in consumer electronics, satellites, aircraft and supercomputers.

The exercise consisted of three scenarios. The first of which was headed “quarantine” and was focused on a naval blockade and disruption of trade, short of outright war. The second was titled “seizure of outlying islands” in a limited military operation by Beijing. The third was “Conflict over Taiwan” – amphibious invasion and outright war of conquest for Taiwan.

“Blockade has been seen as the most likely scenario rather than invasion. The book would be dramatically impacted, capital flows immediately impacted,” said the second source.

“We’re talking about the unthinkable. But then again Germany and Italy have decoupled from Russia in their energy supplies and economically, which was also unthinkable two years ago,” the same source added.

Geopolitical risk perceptions have changed since Russia’s invasion of Ukraine in February 2022. Prior to that geopolitical shock, the market consensus was the economic disruption would make war politically unpalatable.

“What’s changed since then is the sense of a market opportunity in all this. Insurance companies are now thinking more practically about how to make money from this risk – since Ukraine,” the first anonymous source added.

Lloyd’s has provided a statement in response to this article.

“Lloyd’s regularly asks market participants to model for plausible, but hypothetical scenarios to assess their potential impact on our market. This is an important part of protecting our customers against the kind of external shocks seen in recent years and ensuring our market is ready to respond in a range of scenarios.

“As part of this planning, we recently asked a number of participants for exposure data. This is standard practice and was not collected as an exercise to review cover. This exercise is distinct to an RDS in that is does not lead to underwriting or capital implications.

“The planning documents sent to the market were not ‘Realistic Disaster Scenarios’ and instead contained additional data-gathering reports to be filled out by the syndicates.

“We would not take a view on the contents of the modelling in the report, including the likelihood of occurrence.

“Lloyd’s has not issued any guidance related to reviewing cover. As always, it is the responsibility of individual syndicates to review cover based on their risk appetites.”