LLOYD’S of London chairman John Nelson last night issued a stark warning about the potential for a new financial crisis if the flow of investment funds into the insurance industry is left unchecked.
Low yields on traditional bonds has led investors to seek new locations for their money such as catastrophe bonds, which are eating into the market for traditional reinsurance.
Nelson warned that the change could “undermine some of the qualities of the insurance model” by splitting capital from risk.
Insurers sell catastrophe bonds to cover major losses. If no catastrophe occurs then the holders receive a healthy annual payout – but if a disaster happens then investors can expect to lose part of their original payment.
Andrew Horton, the chief executive of Lloyd’s insurer Beazley, recently told City A.M. that pension funds were only just starting to realise the potential of catastrophe bonds: “It’s getter cheaper to invest so it’s not going away.”