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XL CEO highlights alternative capital risks

Array of experts: Pictured (from left) at the BMA Insurance Seminar are Fiona Luck, member of the BMA board; John Nelson, chairman, Lloyd’s of London; Mike McGavick, CEO, XL Group; Frank Majors, co-founder and principal, Nephila Capital; Dennis Mahoney, director, Ironshore; Brian Duperreault, CEO, Hamilton Insurance Group; Andrew Bailey, Deputy Governor, Bank of England.

A flood of alternative capital into reinsurance could cause instability and put the industry’s reputation at risk.

And XL Group CEO Mike McGavick called for a renewed focus to enhance “trust in the system”.

Mr McGavick said at a conference in Bermuda: “I think the likelihood of 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 the system.”

And he warned: “There’s opportunity for there to be new clashes in exposure that are unrecognised and when they come due are unpayable.”

Mr McGavick likened the potential risk to reinsurance to the sub-prime mortgage boom that led to bank collapses and triggered the economic crisis.

“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.”

Mr McGavick was speaking at the recent 2014 Bermuda Monetary Authority insurance seminar, which also featured Lloyd’s of London chairman John Nelson and Bank of England deputy governor Andrew Bailey, who is also CEO of the UK Prudential Regulation Authority.

Mr Nelson said: “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 destabilise the whole thing exactly as happened in sub-prime mortgages.”

Frank Majors, co-founder and principal of Nephila Capital, said: “This development of alternative capital does have the possibility for concern, or abuse, or misuse, or being taken too far into the future.

“Right now, I’d just like to make the point that the effect of the alternative capital is actually to de-leverage the industry significantly.

“So it’s very different right now, in this stage of development, very different from the mortgage securitisation which was a process of adding leverage.

“What it really is, is taking a risk off of levered balance sheets and on to unlevered balance sheets.”

And he added that alternative capital should be seen a channel to more pools of capital.

Mr Majors said: “If you have access to deeper pools of capital, that should add stability, unless it’s abused in some way.”