Mass flood of capital ‘could tip insurers into bank-like crisis’

Lloyd’s of London bosses have warned that floods of capital from investors such as hedge funds and pension funds could cause a crisis in the insurance industry similar to that suffered by the banks.

Billions of pounds of funds have been poured into the sector 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.

John Nelson,  Lloyd’s chairman and a former investment banker, last night urged insurers not to repeat the mistakes made by the banking industry in the lead-up to the 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 piling into 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,” he added.

“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 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, yes, it could get out of hand.”