Reinsurance executives gathering for their annualget-together in Monte Carlo this weekend will be considering theirresponse to increasingly popular alternative insurance-linkedinvestments that are driving down prices in the industry.

Investment funds looking for higher yields in a low-interestrate environment have funnelled billions of dollars in recent yearsinto so-called “catastrophe bonds”, which are sold by insurers toshare the risk they take on for natural disasters.

Reinsurers, whose business is to help shoulder the risks facedby insurers in exchange for part of the profit, have seen theirpricing power diminish and their relevance threatened.

The competition is blamed for pushing reinsurance prices down bymore than a fifth in the lucrative market for hurricane coverage inthe United States when contracts there were renewed in June andJuly.

That downward pressure may spill over into other lines ofbusiness when reinsurers and their insurance company clients renewa further round of contracts on January 1, brokers said.

James Vickers, chairman of broker Willis Re International, saidprice pressures will lead some reinsurers to shift their attentionto speciality areas like marine or aerospace insurance, whileothers may opt to return excess cash to shareholders if prices aretoo low.

“The redeployment of capital that may not be used in U.S.catastrophe business is the most interesting conundrum,” Vickerssaid.

The world's biggest reinsurer, Munich Re, has already said it isconsidering buying back its own shares, while No. 2 player Swiss Rehas said its “first priority” is growing its dividend.

Credit rating agency Standard & Poor's calculates that thereinsurance sector held $34 billion in excess capital lastyear.

ALTERNATIVE THREAT

As long as interest rates stay low, investors in alternativeinsurance products like catastrophe bonds look set to keep gnawingaway at the profitability of traditional reinsurers.

Around $10 billion of new capital flowed into insurance-relatedinvestment structures over the last 18 months, with the totalmarket now worth around $45 billion, reinsurance broker GuyCarpenter estimates.

New issues of catastrophe bonds may reach $7 billion this year,matching a record set in 2007 before the financial crisis, industryobservers say.

Despite the challenges, credit rating agency Moody's gave anupbeat assessment of reinsurers at a briefing in London, arguingthat most firms have embraced the new environment.

“While a continued inflow of alternative capital has thepotential to alter the core business model of reinsurers, manyfirms in the sector have been preparing for this eventuality foryears,” said James Eck, a senior credit officer at Moody's

But rival S&P, also in a London briefing ahead of the MonteCarlo gathering, said there was a risk to the long-term survival ofmany reinsurers.

“Reinsurers who aren't willing to adapt or try and stay ahead ofthe curve are going to be pushed to the sidelines or pushed out,”said Dennis Sugrue, a reinsurance specialist at S&P.

There could be a wave of consolidations in the industry,particularly among smaller operators, Sugrue said.

On Wednesday the chairman of insurance market Lloyds ofLondonwarned the rush of money into alternative insurance products coulddestabilise the industry, potentially leading to a new financialcrisis.

Lloyds boss John Nelson said the industry must avoid capitalbecoming detached from risk, a mistake which he said caused thebanking industry's “systemic problems” from 2007.

But many reinsurers are clearly trying to ride the wave ofalternative insurance investing, taking advantage of their ownspecialist understanding of risk to not only buy the bonds fortheir own portfolios but to advise others, too.

In Europe, reinsurers Swiss Re, Munich Re and Hannover Re areactive issuers of cat bonds to protect their own reinsurance bookand on behalf of insurance clients. U.S. players such as AllstateCorp and Chubb Corp are also regular issuers.

“Most reinsurers need and are beginning to develop some sort ofthird-party fund management capability,” said Willis Re'sVickers.

“Everybody is dabbling in the alternative capital area.”