Bermuda’s reinsurance market is facing multiple challenges, but it attractiveness to companies remains strong, says ratings agency AM Best.

In a report on the global reinsurance sector, Best said challenges faced by the island’s flagship industry include US tax reform, a shrinking pool of reinsurers due to mergers, competition from rival jurisdictions and the impact of Brexit.

However, Best pointed out that financial-services regulator the Bermuda Monetary Authority takes a proactive approach to tackle emerging risks.

The report adds: “In a period of increasing regulatory uncertainty, the BMA’s experience and ability to deal with different jurisdictions may even make it a more attractive jurisdiction for re/insurers.

“Bermudian re/insurers have played a critical role in fulfilling their promises and have aided in the recovery of the local economies that they insure.”

Soft catastrophe reinsurance pricing, low interest rates and the continuing influx of competing alternative capital resulted in “anaemic returns” for island reinsurers, Best added.

Mergers and acquisitions became a preferred tactic for reinsurers to diversify, increase their relevance and compete in the market.

“The US tax law provides yet another impetus for M&A activity, resulting in a shrinking pool of reinsurers to regulate,” Best stated. “However, these pressures are partially offset by the larger balance sheets of the reinsurers.”

Looking at the global scene, midyear renewals proved a “tremendous disappointment” to reinsurers as pricing optimism fizzled, the report said.

Best added that alternative capital was having an increasing influence on market pricing as it continues to grow its share of total market capacity.

The report adds that conditions remain ripe for further consolidation within the industry, and it notes an “accelerating trend” of alliances between traditional and alternative capital providers, exemplified by Markel’s proposed takeover of Bermudian ILS manager Nephila Capital.

“To the dismay of many observers, a series of catastrophe losses totaling over $100 billion did not dent the market’s capacity to fill orders at January 1 and the renewal season ended with only modest relief for pricing,” Best commented.

“Nonetheless, optimism prevailed for a rebirth of the underwriting cycle for the June/July US catastrophe renewal. We now know how that ended and while there was some improvement in pricing for loss-affected accounts, overall, the midyear renewal was a tremendous disappointment as any residual optimism fizzled.

“The reinsurance sector continues to skip along the bottom of the market with no clear trigger for a meaningful and widespread hardening. At the same time, the capital markets’ influence on the reinsurance sector continues to expand, replacing capacity lost in 2017 and then some.”

Alternative capital, comprising insurance-linked securities such as catastrophe bonds and collateralised reinsurance products, were having a growing influence on the market, Best added.

“AM Best is concerned that property-catastrophe pricing is somewhat at the mercy of the alternative capital market and is not as heavily influenced by the traditional reinsurance market as historically has been the case,” the report stated.

“This is an important distinction with respect to current market dynamics. Any hope for near-term improvement in the market is directly correlated to the current level of excess capacity in the overall market today.

“This is compounded by the continued inflow of alternative capacity that was seen in the fourth quarter of 2017 and through 2018, which has helped offset the collateralised capacity that is currently trapped until losses from 2017 work their way through the settlement process.”

Best said the “new normal” for reinsurers looks to be one where returns are less impressive and underwriting and fee income become larger contributors to profits. “Better risk selection, greater diversification of product offerings, a wider geographic reach, and conservative loss picks are keys to survival,” the report concluded. “Those factors, combined with the ability to take advantage of the new ‘cheaper’ capital coming into the market by investors that may not have the reinsurance and underwriting expertise, could lead to significant success for some.

“Not everyone will win in the end. The solid players will be the ones that have been conservative in underwriting and in reserving; have been able to develop a book of business that remains relevant for today’s market and allows for quick shifts in and out of lines of business depending on market conditions; and have created expertise in managing third-party capital to their own advantage.”