New reinsurance capital, a challenge to Lloyd’s or an opportunity?

John Nelson, Chairman of the Lloyd’s insurance and reinsurance market in London, said in an interview that the changing reinsurance market dynamic, caused by capital from new sources flowing into the sector, is a major challenge to Lloyd’s.

In an interview published on the Lloyd’s website, John Nelson was questioned about the changing reinsurance landscape and his vision for the future of the Lloyd’s insurance and reinsurance market.

Nelson said that the noticeable softening of rates in the reinsurance market, exacerbated by the low-level of catastrophes in 2013, has put an emphasis on strong underwriting.

Part of the pressure on premiums, Nelson said, has been caused by capital coming into the reinsurance market from new sources. This new capital, largely referred to as third-party or alternative reinsurance capital which comes from institutional investors such as pension funds and dedicated specialist managers, is changing the dynamics of how reinsurance is distributed, said Nelson.

Nelson has commented on the influx of new capital into the reinsurance market before. Most famously with his comments made during a speech in early September, when Nelson warned against the systemic risk that he felt third-party backed non-traditional reinsurance capital could bring to the sector.

Nelson followed this at the Monte Carlo reinsurance Rendezvous later that month, where he expanded on his thoughts on alternative reinsurance capital, saying that new forms of capital could help the commercial insurance market grow from $600bn to $2tn by 2025.

In his interview for the Lloyd’s website Nelson said that the changing reinsurance market dynamic created by the influx of new capital from non-traditional sources will be a major challenge for the Lloyd’s market, but he remains optimistic about the future.

Artemis would suggest that perhaps Nelson should be a little more optimistic about all this new capital, which is entering the reinsurance market and is willing to display its efficiency through its lower cost of capital and ability to underwrite certain business at lower prices.

Lloyd’s, as a reinsurance market built on external capital, should be looking at the growing interest from investors, in allocating capital to reinsurance as an asset class, as an opportunity. Rather than fearing third-party reinsurance capital and seeing it as a threat or challenge, Lloyd’s needs to embrace it and should perhaps evolve itself into a platform which welcomes new capital from third-parties.

The Lloyd’s market contains a huge amount of underwriting talent. That talent is extremely attractive to large institutional investors looking for new ways to access the returns of the insurance and reinsurance market. As a specialist market, Lloyd’s could offer investors such as pension funds access to a diverse portfolio of re/insurance business were it to focus on channeling this capital into itself.

Alternative or third-party reinsurance capital has already entered the Lloyd’s market, helping to boost the overall underwriting capacity of Lloyd’s and also bringing new products to its offering as well.

Special purpose syndicates have pulled institutional capital into Lloyd’s and a number of managing agency projects have made pools of capital available to Lloyd’s underwriters, some of which has been sourced from very similar investors to those interested in insurance-linked securities and the wider reinsurance space.

Another example of alternative sources of reinsurance capital entering the Lloyd’s market has been the high-profile establishment of a syndicate by the largest ILS asset manager in the space, Nephila Capital. Nephila Syndicate 2357 underwrites non-traditional catastrophe excess of loss business on a fully-collateralized basis with the backing of Nephila Capital and its investors. It underwrites CWIL business (Nephila’s County Weighted Industry Loss product) which has brought a new and unique offering into Lloyd’s as well.

The use of new capital at Lloyd’s has helped it to grow its capacity, bring in more efficient and lower cost capital to help it to compete and also brought new products into the market which enable it to better meet the needs of cedents who cannot be fully satisfied by the conventional reinsurance market. So it’s certainly not all challenging.

Could we see a day in the future where a mechanism is established which allows large institutional investors, such as global pension funds, to access the returns of the Lloyd’s insurance and reinsurance market in a similar way to the Aon – Berkshire Hathaway facility?

Such a facility would be of great interest to investors, enabling them to access the returns of a diversified portfolio of risk from the Lloyd’s market, with the knowledge that Lloyd’s underwriters and syndicates are applying their underwriting knowledge to the contracts backed.

With the appetite for access to reinsurance as an asset class growing all the time, a facility offering third-party capital access to the Lloyd’s market in this way might be heavily subscribed to by investors seeking diversified returns from reinsurance risk.

Yes such a facility would be another major change for the market, but should it be seen as a challenge or rather as an opportunity?

The new capital flowing into reinsurance is of course competition for the Lloyd’s market and will force it to rethink its business model. Of course any significant entry of third-party capital into Lloyd’s may also be disruptive, upsetting the established status quo, but perhaps it’s time for change.

As risk and capital continue to converge, the world’s oldest reinsurance market stands in a unique position to benefit from this convergence. Some might say that Nelson should be trying to place Lloyd’s at the heart of these trends and that he should see it not as a challenge but rather as one of the biggest opportunities to be presented to Lloyd’s in many years.