Reinsurers are adapting to the threat posed by alternativecapital by expanding their presence in the capital marketsthemselves, especially with sidecars and insurance-linkedsecurities, according to two recent reports.

In its “Global Reinsurance Outlook,” Moody's Investors Serviceoutlines the new reality for reinsurers, stating, “Capital marketsconvergence has finally arrived in the reinsurance market. Whatbegan with a trickle of capacity more than 15 years ago has turnedinto a flood of capital entering the reinsurance market frominstitutional investors in the form of catastrophe bonds,collateralized reinsurance vehicles and industry loss warrantycontracts.”

The report says an estimated $10 billion in new alternativecapital entered the industry over the past year, bringing the totalamount to an estimated $44 billion—roughly 15 percent of the globalproperty cat reinsurance limit placed.

The impact on the traditional reinsurance market is alreadybeing seen. Moody's says June/July renewals in the U.S. were downby between 10 percent and 20 percent, and some Florida accountsdecreased by as much as 25 percent. And the competitive pricing isexpected to continue into the Jan. 1 renewals, barring meaningfulcatastrophe losses.

Additionally, Moody's points out that after an event likeSuperstorm Sandy—which caused between $20 billion and $25 billionin private-sector insured losses—the normal debate would have beenover how much reinsurance pricing will increase. Instead, withcompetition from alternative capital, particularly in theproperty-catastrophe market, reinsurers are focusing on minimizingpricing declines.

In its wrap-up of 2013 first-half results for a group of 31companies in the reinsurance market, Aon Benfield states, “Earningswere already under pressure from below-average premium gearing andlow interest rates. Now new vehicles operating at a lower cost ofcapital are making in-roads into higher-margin areas that remain akey driver of profits.”

But reinsurers are adapting to the changing marketplace. AonBenfield says, “Over time, it is expected that less reinsurancebusiness will be written on rated balance sheets and more through'satellite' structures backed by third-party capital.”

The firm points out that RenaissanceRe has operated this modelfor years and others are now pursuing similar strategies.

Several companies among the 31 it follows are “already involvedin the management of third-party funds, including Amlin(Leadenhall), Montpelier Re (Blue Water), SCOR (Atropos) andValidus (AlphaCat).

“New capital markets divisions were established by Aspen, Axis,Lancashire, Montpelier Re, Sirius and XL in 2013, while Hannover Re(Leine) and RenaissanceRe (Medici) recently opened existinginternal funds to third parties. An alternative route, pursued byAlleghany/Transatlantic (Pillar), Allied World (Aeolus) and Hiscox(Third Point Re), is to invest in strategic partnerships withestablished independent specialist-fund managers.”

Moody's, too, suggests that many reinsurance firms have foryears prepared for this new market reality. “Thorugh theirparticipation as sidecar managers and as sturcurers/placementagents, traders, investors and use of insurance-linked securitiesto shape their risk-return profile, reinsurers have been essentialparticipants in the evolution of reinsurance convergence with thecapital markets,” the ratings agency says.

Moody's believes sidecars in particular present a keyopportunity for incumbent reinsurers, explaining, “Instead ofbeing largely cut out of the value chain, reinsurers are integralto the risk-selection process and ongoing management of sidecarvehicles.”

Furthermore, Moody's says sidecars also allow reinsurers toleverage third-party capital to write risks that might notordinarily fit within underwriting and return parameters of thefirms' rated balance sheets.

“Sidecars also allow reinsurers to trade volatile underwritingincome for a stable stram of management fee income and thepotential for profit overrides,” Moody's adds.

However, the ratings agency cautions that sidecars couldpressure pricing or even cannibalize reinsurers' core business byadding lower-cost capacity.

As for how the reinsurance market has performed so far thisyear, Aon Benfield says the 31 reinsurers in its aggregate reportnet income attributable to common shareholders of $16 billion, anincrease of 6 percent over 2012's first half.

Pre-tax profit for the companies was unchanged at $18.9 billion,while underwriting profit rose by 26 percent to $8.9 billion, whichincludes an increased contribution of $3.7 billion from prior yearreserve releases.

Moody's, meanwhile, says it has a stable outlook on the market,reflecting the industry's “resilience in the face of a challengingoperating environment, continued underwriting discipline andimprovements in risk management, as well as firmer pricing in someprimary insurance markets.