A global reinsurance industry report has predicted some tough times ahead and said consolidation among Bermuda's newest insurers could be on the cards.

The Standard & Poors report - entitled Global Reinsurance Outlook 2003: Famine in the Midst of Plenty - said the global reinsurance sector faced deepening losses from old policies and poor investments in spite of massive new capital injections.

It said Bermuda had a brighter outlook as it had succeeded in getting the bulk of the new business. But the report said investor pressure might push the Island's newer companies to merge in the future.

"Since September 11, 2001, more than $20 billion has been invested in new and existing reinsurance operations. Nevertheless, the new capital has brought only limited benefit to established rated reinsurers, as more than $8 billion was accounted for by eight new reinsurers.

New operations set up during 2002 included Wellington Reinsurance Ltd., Allied World Assurance (Awac), Arch Capital, Axis Specialty, DaVinci Reinsurance Ltd., Endurance Re, Montpelier Re, and Goshawk Re, these being mainly located in Bermuda. "The ease with which these operations have been set up and capitalised serves to underline the relatively low barriers to entry in the reinsurance industry," the report said.

"The relatively benign regulatory and tax environment in Bermuda and its proximity to the US capital markets makes it an attractive location for start-ups. A number of the investors backing these companies have demanding short-term return expectations, however, and some consolidation among the new companies can be expected in the next few years," it said.

Despite the capital injections and new businesses setting up, the report found there were fundamental problems that could adversely affect the industry: "Like water poured into a sieve, the higher premiums flowing into the reinsurance industry are running away through deepening losses on old policies and soured investments," it said.

Looking at the negative outlook for ratings, the S&P report said that of the top 25 global reinsurance groups ranked by net premiums written 12 were on negative credit watch, indicating the possibility of future credit downgrades.

In addition, this year alone there had been 47 downgrades and only three upgrades among the 150 largest global reinsurers.

But the S&P report said that proportion of downgrades was not expected to continue in 2003, but that downgrades could still outnumber upgrades.

The dire outlook was made despite the rate increases being seen in the current hard market. "To an outside observer, and indeed to some of those within the industry, the prospects for the next few years appear bright. Significant price increases - ranging from ten percent for US property/catastrophe to more than 100 percent for certain long-tail casualty lines - mean that, for most reinsurers, the 2002 underwriting year (as distinct from the financial year) should be significantly more profitable than any in the past five years.

"In addition, and probably more importantly, other policy terms and conditions have been tightened: These include higher attachment points (that is, higher levels of risk retention by the reinsured); more widespread imposition of limits on liability lines for proportional business; and more specific risk definitions and exclusions."

But ultimately Standard & Poor's said its view was that an improved outlook for the reinsurance sector would only be achieved by an end to, or at least a reduction in, pricing cyclicality; the maintenance of the improved terms and conditions currently being imposed; and a further shift in emphasis from reinsurance as a source of capital to reinsurance as a value-added risk management tool.