Convergence capital is sophisticated and here to stay


Industry veteran, Dennis Mahoney--stressing his views are strictly his own personal opinions--believes convergence capital is here for the long haul.

Despite the view in some quarters that convergence capital is 'hot money' that will be quickly spooked following a major loss event, he suggests there are significant reasons to believe this will not be so.

The former chairman of Aon Global points out that far from being naive or unsophisticated, capital markets players are both smart and large enough to take the long term view.

Insurance linked securities have been around for a number of years now and the fact that investors are increasingly prepared to invest via indemnity triggers versus parametric triggers is suggestive of a greater trust in the insurance industry, he said.

Discussing the issue with Bermuda Re, he said that a loss sufficient to obliterate the entire capital and surplus of the insurance industry might be less painful to the capital markets than a fairly modest movement in interest rates. Most of the larger capital markets players have no more than 5 percent of their assets invested in the ILS sector, he explained.

He commented that this year's cat season looks to have been one of most benign from an insured loss standpoint, barring an earthquake, so investors should make substantial profits; adding further impetus to their appetite.

He added that investors are not as afraid of unmodelled risks as many believe, being willing to invest in 10 year sovereign debt in countries that have not yet been truly stable politically or indeed economically for 10 straight years and at very low risk premiums above libor .

"I struggle with the contention that institutional investors are only interested in risks that are modelled. Given some of the 'exotic' instruments they have invested in over recent years; the issue perhaps revolves around the definition of modelled".

Another insurance industry belief is that there will be no longevity to the new capital, and that it is simply a function of ultra low interest rates. Mahoney said that while he is very proud of the track record of his industry, it must be said that insurers do occasionally become insolvent. Underwriters do cease offering certain products or withdraw from some countries if they make the strategic decision to do so and so they should if they are not making a profit, he said.

He went on to point out that there are few signs of interest rates increasing any time soon, with the ECB having just cut it's rate from .5 percent to .25 percent and both the US Fed and BOE publicly linking interest rates to employment rates. The " yearn for return " is here to stay he suggests and so are the new players.

Rather than questioning the viability or longevity of this new capital he suggests the industry should regard it as an opportunity, one that answers the need for additional capacity for extremely volatile and massive risks.

Ironically he suggests that there is " too much capital for risks that insurance underwriters wish to take on and too little capacity for what some clients actually need ". Convergence capital may provide a solution to to unlock risks that presently reside (often uncomfortably) with governments or have no financial risk mitigation remedies at all.

Mahoney sees the new entrants as a complement to the insurance industry, able to deliver additional capacity quickly and efficiently. He notes that traditional players have in the past been constrained by regulatory and rating agency considerations, meaning that they either have too much capital when rates are lower, or not enough when rates increase, leading to huge swings in the market.

The advent of 'rent-a-capital' sidecars, ILS vehicles, and ILWs ought to flatten the peaks and troughs over time, he said. Indeed the efficiencies of the new capital sources may discourage the growing trend to self insure by major clients, he said.

David Mahoney, convergence capital, ILS Bermuda

Bermuda Re