BOE’s Carney warns on low rates driving capital into reinsurance

The Governor of the Bank of England Mark Carney has spoken out on capital inflows into reinsurance, saying that a ‘soft cycle’ in the financial markets (referring to interest rates) is driving capital into reinsurance and causing a soft cycle there.

Carney speaking today at the Institute and Faculty of Actuaries General Insurance Conference in Wales, discussed interest rates and how the record low rate environment can put insurers at risk. He discussed investment risk, volatility and mispricing before turning to reinsurance.

Carney said; “Low rates are encouraging inflows of external capital into sectors like reinsurance. In effect, a “soft cycle” in financial markets is reinforcing a “soft cycle” in insurance – a particularly problematic combination.”

This is one of the perrenial headlines, that investors classed as ‘yield hunters’ are desperately throwing capital at the reinsurance sector to avoid the low interest rate environment. Granted this is a reason that insurance-linked securities (ILS) have benefitted from a higher profile in recent years, but to cite it as the reason investors allocate money to an asset class such as this is, in our view, missing the point.

We’ve written before about the qualities of the ILS asset class and investor motivations for entering the ILS and reinsurance space. Yes, there will always be some capital trying to escape low yields elsewhere in the financial market, but to tar an entire asset class with the same brush seems a little hasty.

Carney also showed that he has spotted the structural change that is occurring in the reinsurance market, saying; “More capital boosts market capacity, but can also test underwriting discipline.”

That’s an accurate statement, one we write about a lot. But, as most know, what is really testing discipline is the competition for signings, the attempts to save market share and the expansion of terms. This is not being driven by the capital, it is an effect of new capital, new players, new and more efficient business models and also a trait of the traditional reinsurers.

Indeed, if you were to analyse the $60 billion or so of alternative reinsurance capital, the vast majority is from major institutional investors, with long-term investment horizons, such as pension funds. Much of this capital was already in the reinsurance space as an equity investor, however it has now found a way to minimise the credit risk, decrease the correlation and more directly active the return of risk.

It is a constant concern that regulators have a habit to over-simplify structural issues about the market down to a single statement about low interest rates encouraging capital into the space. It completely understates the fact that reinsurance has only really emerged as a more directly accessible asset class in the last decade or two and the changes this is now creating across the market.

Carney promises tougher scrutiny for top officials in the insurance and reinsurance sector. The BOE may find that scrutiny is welcomed, as only then can the Bank of England really get under the hood of this market and truly understand the deeper convergence dynamics which are taking place.

You can read Mark Carney’s speech from today here.