Industry must ensure cheap capital “doesn’t undermine the integrity of the business”

John Nelson

The opportunities presented by the emerging markets will be an important avenue of growth for the insurance industry through to 2025, explained Lloyd’s chairman John Nelson, speaking to Global Reinsurance at the Rendez-Vous in Monte Carlo.

While the industry will need between $600m and $2trn to service these markets in the future, the growing flood of money coming in from the capital markets is premature, he noted.

“In essence the situation for insurance and reinsurance is pretty clear,” he said. “On the one hand there is a substantial growth opportunity because of the growth in the emerging markets over the next ten to 20 years and also the insurance penetration, which is currently very low. Secondly because the nature of the risk is changing as businesses change, there’s huge opportunity.”

“So capital coming in is fine, it’s just a question of how it comes in,” he continued. “At the moment it’s coming in, in a sense, ahead of demand, so you have to be careful that that doesn’t undermine the integrity of the insurance business model. Part of the job Lloyd’s and the market has is to develop those structures which are robust. I think it’s up to the insurance sector to mobilise the capital in the right way for themselves.”

Speaking earlier in Monte Carlo at the PWC Breakfast Nelson had clarified his concerns surrounding “cheap capital” and the potential for systemic risk, a la mortgage-backed securities in the banking sector. “I do not think that insurance currently stands in the same position as banking – quite the reverse,” he insisted. “One of the key differences is the role of our sector and by reinsurers in particular in absorbing risk not creating risk.”

Speaking to Global Reinsurance he said: “I think the whole insurance space will change and ways of bringing capital in will change. What is absolutely vital is that we keep our structures robust so that capital is nailed pretty firmly to the underlying risk transfer transaction and that we don’t get it completely detached from it, and it’s done in a way so that people are forced to risk-adjust price it in a sophisticated way and there’s got to be the right measurements in place to measure aggregates.”

“If you look back over the last few years that is the reason why insurance has performed pretty well in very difficult circumstances, as oppose dare I say to certain other sections of financial services where the capital became firmly detached… and the rest as they say is history.”

While rising interest rates may provide a bit of a check on the capital coming in from institutional investors, it will not close the floodgates. A further $100bn of alternative capital is set to enter the industry over the next five years, according to Aon Benfield. Nelson said the growing involvement from pension funds and other investors would irreversibly change the face of the industry.

“When interest rates rise – and they will, it’s just a question of when and how much – it will have I suspect an impact on tightening up the capital supply a bit. But I don’t think we should assume it will tighten it up in the way that some people in the industry hope it will because insurance is beginning to establish itself as an asset class.”