Lloyd’s of London, the insurance market established in 1688, has warned that the high volume of capital from investors such as hedge funds and pension funds could send the insurance industry into a crisis similar to that suffered by the banks.
The influx of funds into the sector has steadily increased in recent years as investors look to offset the impact of lower interest rates. Although this excess capital has driven down prices across Lloyd’s, it has prompted fears the industry may not be pricing its risks properly.
Lloyd’s chairman, John Nelson, who is a former investment banker, has urged insurers not to repeat the mistakes made by the banking industry in the lead-up to the 2008 financial crisis when “capital became detached from the underlying transaction of risk”.
Speaking at the Lloyd’s annual dinner, he said that although the flows of new capital had helped to fund expansion and keep pace with growing economies and rising demand, “insurance of course can be a dangerous business for those who do not understand it”.
Investors are also favouring insurance-linked financial instrument such as catastrophe bonds, which are sold by insurers and reinsurers to share the risk they take on for natural disasters.
“We all vividly remember the systemic problems which arose in the banking industry,” said Nelson. “Some of the structures being used could undermine some of the qualities of the insurance model, which provides a secure and reliable risk transfer market for specialist risk and indeed the reliable payment of claims.
“All of us in this industry, and dare I say it, the regulators as well, need to be extremely watchful on this we have seen the consequences in other parts of the financial services industry – and the pain that it caused to worldwide markets, to economies, and to the underlying customers.”
Bronek Masojada, chief executive officer (CEO) of Lloyd’s insurer Hiscox, said: “This new form of capital is not going to disappear and we all need to adapt to it. We’re in an early stage of this cycle and done well it could bring benefits to the whole market, but if not regulated properly it could get out of hand.”
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