Three of the industry’s most respected leaders have voiced concerns over the potential of so-called alternative capital to damage the industry’s reputation due to instability caused by a delinking occurring between the risk and the source of the capital.
John Nelson, chairman of Lloyd’s, and Mike McGavick, chief executive of XL Group, and Frank Majors, co-founder and principal, Nephila Capital, all voiced similar concerns at the Bermuda Monetary Authority’s 2014 insurance seminar.
“I think the likelihood of it (alternative capital) evolving into something less stable or abusive is real and this is the thing we really all ought to be thinking about because that drives to the heart of trust in the system and we don’t need distrust in our system,” McGavick said.
“There’s opportunity for there to be new clashes in exposure that are unrecognised and when they come due are un-payable. And in essence this is the story of the real estate crisis and that is the risk here because the risk is being removed from those that took the risk. The advantage of the integrated model is you’re betting with your money. That changes how you feel about it.”
Nelson voiced similar concerns. “It’s going to be a continuous challenge, that as the alternative capital market develops, the temptation to detach the risk from the capital becomes ever greater and there will be kinds of securities where the returns look really alluring but if we do that we will destabilize the whole thing exactly as happened in sub-prime mortgages.”
Majors stressed that so-called alternative capital is no problematic at the moment but admitted there could be concerns if its use was abused.
“This development of alternative capital does have the possibility for concern, or abuse, or misuse, or being taken too far in the future. Right now I would just like to make the point that the effect of the alternative capital is to actually de-lever the industry significantly. So it’s very different right now, in this stage of development, very different from the mortgage securitization which was a process of adding leverage. What it really is, is taking a risk off of levered balance sheets onto unlevered balance sheets.”
He added that he did not think of alternative capital as “a new group of people showing up at the party”, but rather as a technological channel to more pools of capital. “If you have access to deeper pools of capital that should add stability, unless it’s abused in some way,” Majors said.
John Nelson, Bermuda, Reinsurance, Mike McGavick, Frank Majors, Bermuda Monetary Authority, Insurance