The reinsurance market has entered a “new reality,” and underwriting discipline is key to maintaining the sector's profitability, rating agencies said in reports released Wednesday.

The current changes in the reinsurance market may be structural rather than cyclical, Oldwick, New Jersey-based A.M. Best Co. Inc. said in its report, “It is Not Your Father's Reinsurance Market Anymore — The New Reality.”

“The market is operating in a 'new reality' of abundant capacity from traditional and alternative sources, low interest rates and thinner reinsurance margins driven by intense competition against shrinking demand for reinsurance cover,” the report said.

While traditional reinsurance protection historically was the primary source of capacity for cedents, now primary companies are retaining more risk and increasingly using alternative markets to access capacity, the report said.

“At the same time, the old playbook of private equity starting a traditional reinsurance company and then exiting via an initial public offering is becoming less attractive,” the report added.

“Investors would rather put capital to work for a relatively short period of time (typically one to three years) as opposed to creating new companies that require longer-term capital commitments with a less certain exit strategy,” it said.

The ease of entry and exit to reinsurance is, among other things, key to reinsurance functioning as a tradable asset class, the report said.

“Ultimately, that seems to be the end game, conceivably for all reinsurance risks, to be able to wake up in the morning, wait for the market to open, and trade in or out of various pools of reinsurance risk — even if there was an event the night before,” the report said.

Merger and acquisition activity will continue among traditional reinsurance companies, the report predicts, because reinsurers “understand the need to form larger, global, well-diversified operations with broad underwriting capabilities to assess risk and to serve as transformers of risk to the capital markets.”

Underwriting discipline essential

Meanwhile, underwriting discipline is necessary as reinsurers adjust their exposure to natural catastrophe risk after two years of low claims, according to New York-based Standard & Poor's Corp.'s report, “Discipline Is Necessary As Reinsurers Adjust Their Exposure To Catastrophe Risk.”

While many reinsurers have reduced their exposure to catastrophe risk, some this year took on more catastrophe exposure, the rating agency said in the report.

“In our view, an increased focus on catastrophe risk weakens a reinsurer's risk position by increasing volatility in earnings and on the balance sheet,” the report said.

“We consider underwriting profitability in the sector likely to become more vulnerable to natural catastrophes; therefore, we anticipate that operating performance could deteriorate at reinsurers that are more exposed,” it said.

The reinsurers most exposed to extreme catastrophe loss scenarios include several London-based players and some North American reinsurers “that have larger-than-average appetites for catastrophe risk.”

Use of retrocession cover by reinsurers increased at Jan. 1, 2015, according to the report, “reflecting the cheaper retrocession rates available globally and the increased use of third-party vehicles such as catastrophe bonds and sidecars.”