Rating agency AM Best said yesterday the outlook for the reinsurance industry next year remained gloomy.

AM Best said it would hold its outlook at “negative” and blamed continuing market challenges which will hit positive rating actions — which could translate into negative rating pressures.

Agency senior director Robert DeRose said: “Recent indications of a market bottoming are slowly emerging, but the overall operating environment remains negative, which is concerning.”

The Best’s briefing said that the strain on profitability is evident in reduced risk-adjusted returns with “market headwinds” — which presented significant longer-term challenges.

AM Best said that negative factors such as low rates, broader terms and conditions, the unsustainable flow of net favourable loss development and low investment yields would continue to hit risk-adjusted returns over the longer term.

And it added that alternative capital was as an additional pressure-bearing front and now comprises approximately 20 per cent of the dedicated global reinsurance market capacity.

This percentage has been steadily growing year over year, underscoring why cycle management has been a key strategy for organisations possessing the capability to move between primary and reinsurance platforms. The agency added that, while rated balance sheets were well-capitalised and able to cope with various stress scenarios, this strength could erode over time for some carriers as earnings come under increased pressure, favourable reserve development wanes, earnings grow more volatile, and the ability to earn back losses following events was prolonged by the inflow of alternative capacity.

Mr DeRose said: “These issues have placed unrelenting pressure on underwriting discipline, forcing insurers to exercise restraint or risk long-term viability.”

The review added that companies with diverse business portfolios, advanced distribution capabilities and broad geographic scope are better positioned to withstand the pressures in this difficult operating environment and would have greater ability to target profitable opportunities.

And it said that the spate of mergers and acquisitions would continue as “an important strategic option to gain greater scale and diversification as companies navigate the market cycle.

But the review said: “However, M&A activity does have potential hazards and can have either a positive or negative rating consequence depending on the quality of the partners, earnings accretion and execution risk.”

The review added: ”Given current weaknesses in rate adequacy, it will take optimal conditions, including benign or near-benign catastrophe years, a continued flow of net favourable loss reserve development and stable financial markets to produce even low double-digit returns.

“Such return measures would have been considered average or perhaps mediocre just a few years ago.

“The reality of the present situation is that a major catastrophe will occur at some point and the mask of redundant reserves will eventually be removed to reveal the true ramifications of current market conditions.”

And the review warned: “If history is a guide, it may be more ominous than some believe.”