Lloyd’s warns of risks, opportunities for transfer chain from new capital

Lloyd’s Chairman, John Nelson has warned of risks associated with inflows of alternative capital into the insurance and reinsurance industry. However, if used appropriately, he believes the capital could help fund expansion into new lines of business and territories.

Speaking at the PricewaterhouseCoopers breakfast in Monte Carlo, Nelson said that alternative capital entering the sector from pension and hedge funds does carry risks. In particular he warned of the potential for ‘passive’ capital that is detached from the underlying risks.

Other commentators at event also warned of the risks associated with leveraging, whereby investors borrow funds to invest in insurance risk in a bid to increase their returns. Both passive capital and the use of leverage were features of mortgage securitisations at the heart of the banking crisis in 2008.

The influx of cheap capital may also encourage insurers to invest in other markets, such as index linked securities, or to use their risk expertise to earn fees by acting as fund managers for alternative capital providers, said Nelson. He also noted that brokers, in search of new sources of revenue, are looking to act as intermediaries for third party capital providers. Others at Monte Carlo noted that brokers and insurers compete directly to provide third party capital providers with underwriting, analytics and fund management.

“Brokers are at the vanguard of developing business,” said Nelson. “I hope that brokers remain focused on their core role and do not become reliant on fees from third party capital,” he said. He also expressed concern over how new structures that involve reinsurers, insurers, brokers and alternative capital providers could affect insureds. “There is a danger that the role of the insured could be diminished,” he said, questioning whether in such circumstances the investment fund or the insured is the broker’s number one priority.