Bank of England debates impact of insurance-linked investments

In a much-anticipated address earlier this week, the Bank of England’s head of insurance discussed the growing impact of alternative capital on Britain’s insurance industry. Julian Adams, executive director of Insurance at the UK’s central bank, wasted little time in trying to place the recent surge of market capital into its proper context, advising the audience not to “overstate these developments.” Still, Adams acknowledged the potentially wide-ranging effects of swelling interest in catastrophe bonds and other instruments of alternative capital.

Analysts of the insurance-linked securities (ILS) market have been speculating on how the influx of capital from fresh investors could reshape the insurance industry. Adams reaffirmed the importance of investor education in this space—particularly in the face of limited regulation—but also noted that his impression was of a primarily informed and professional investor base.

Investment capital is increasingly coming from such sources as hedge and pension funds, which see the cat bond market as an attractive destination. Persistently low interest rates and a desire to diversify investment portfolios have served as a catalyst, and commentators expect these conditions to persist for the foreseeable future.

In September, Lloyd’s chairman John Nelson voiced his concern about new investors driving a wedge a wedge between capital and risk. Nelson suggested that a lack of regulation could compromise stability in the reinsurance space. For his part, Adams made it clear that as head of the bank’s Prudential Regulation Authority he was taking his new supervisory role seriously, but that current trends should not be cause for protectionist measures.

Adams noted how the majority of cat bonds have been issued in the name of North America-based events, and it is in this market that the effects of alternative capital are currently concentrated. He also questioned how investor appetite might evolve in the face of an expanded cat bond system, which could accommodate a diverse range of perils and open more investment opportunities for traditional reinsurers.

Aon Benfield recently suggested that as much as $100 billion could enter the reinsurance market over the next five years, precipitating a significant transformation and likely turning up the pressure on industry overseers such as the Bank of England’s Prudential Regulation Authority.

Posted: Monday, October 7th, 2013