Sovereign wealth funds (SWFs) could be a terrific alternative source of capital for primary insurers and reinsurers around the globe.

At least that was the hypothesis we here at Deloitte offered about four years ago in a June 2008 special report on this potential new supplier of financing for insurance carriers, titled “Insurance Firms: The Missing Link in the Sovereign Wealth Fund Acquisition Spree.”

But when a reporter for a British publication called recently to check up on how that theory was panning out, we had to admit that we weren't aware of much investment from SWFs in the insurance sector since our report came out.

However, that's not to say we were wrong in our hypothesis. Indeed, I believe the issue is one of timing, not substance, and that the problem is on the demand side, not the supply side.

First of all, our report came out in June 2008. A few months later, the financial system was in turmoil as millions of people lost their jobs, credit tightened, the housing market collapsed, businesses closed and plans for expansion were put on the back burner. The crisis reverberated globally, affecting banks and national economies around the world.

That meant P&C carriers had far fewer exposures to cover—and too much capacity with which to insure them. A soft market became the rule rather than the exception, which remained the case until just recently as prices have begun to rise at last, prompted primarily by larger-than-normal catastrophe losses.

Basically, an industry that is overcapitalized, with too much surplus chasing a shrinking number of insurable exposures, is probably not on the lookout for new capital—particularly from alternative sources.

P&C insurers are generally more inclined these days to cash out excess funds through dividend payments or stock buybacks rather than to seek out additional capital. Only during hard markets and capacity crunches would the P&C market look to approach alternative-capital sources such as SWFs—and we aren't at that scenario yet.

But we could be on the cusp of a change in that situation, as massive disaster losses last year burned off a good deal of excess capacity and delivered a big hit to insurance-company bottom lines.

In addition, with the economy on the rebound thanks to falling unemployment—and with consumer spending poised to rise—insurers are seeing growth in insurable exposures for the first time in years. Prices are likely to head higher in response to the greater demand for coverage, and insurer returns on equity might go up in kind, making the industry a more attractive investment target for SWFs.

Perhaps the best market for SWF investment in insurance companies would be in emerging markets, where economic growth is more robust than in the United States and Western Europe but insurance markets remain relatively underdeveloped. Middle-class populations and consumer spending are expanding at a fast clip in these emerging markets, while massive infrastructure and business-development projects are underway, resulting in a rising tide of insurable exposures.

Thus, SWFs may yet play a major role in the financing of insurance companies down the road. It's all a matter of supply and demand, as well as timing.

In any case, isn't it enviable that some countries have such a surplus of funds that they don't quite know what to do with all that extra money? If only the U.S. and Eurozone nations had such a problem, instead of having to worry about which budgets and benefits to slash and which taxes to hike.

Insurers here and in Europe would certainly see a lot more growth, rather than having to worry about the threat of long-term stagnation or even a contracting economy.

Special Reports /

Sovereign Wealth Funds and Insurance: A Matter of Timing

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