Premiums should be rising sharply after all the natural disasters in recent years. But they’re not, thanks to capital flowing into the reinsurance/insurance market, much of it from new investors.

Insurance has never looked so good to investors searching for returns in a low-interest-rate environment. And post-financial crisis, many of those investors appreciate having their money in a security that’s not related to global financial markets.

If an institutional investor such as a super fund buys an earthquake catastrophe bond, it risks having to pay out the entire amount on earthquake losses – but the investment is immune from stock market collapses and European bond crises.

No cat bond paid out last financial year, not even for Superstorm Sandy, another factor encouraging investment in insurance-linked securities (ILS).

The various kinds of insurance-linked securities provide an alternative form of financing to traditional reinsurance and restrict reinsurers’ ability to raise their rates to recoup the losses of recent years.

Reinsurers themselves have got in on the act, with Hannover Re sponsoring a European windstorm catastrophe bond and Swiss Re issuing bonds covering Australian, Canadian and US mortality over the past financial year.

“While a continued inflow of alternative capital has the potential to alter the core business model of reinsurers, many firms in the sector have been preparing for this eventuality for years through their participation in sidecars and the ILS market,” Moody’s VP and Senior Credit Officer James Eck said.

Moody’s latest Global Reinsurance Outlook lists increased competition from alternative markets as one of the industry’s key challenges, along with low interest rates and sluggish economic conditions in North America and Europe.

“Over the past year, an estimated $US10 billion ($10.95 billion) of new alternative capital has entered the industry, raising the total amount to about $US44 billion ($48.2 billion),” it says.

“This influx of capital has had a major impact on current reinsurance market dynamics and pressured property cat pricing, with June/July renewals in the US down 10-20%.”

The $US44 billion compares with an estimated $US510 billion ($558.67 billion) held by reinsurers globally, but the figure is growing.

Aon Benfield says the new investors include super funds, high-net-worth individuals and sovereign wealth funds that typically carry out considerable research, invest a small percentage of their funds as a way of diversifying and seek lower, more stable returns over longer timeframes.

“Much of the new capital is being channelled to specialist fund managers, who then deploy it into the ILS sector via products such as catastrophe bonds and industry loss warranties, or other non-traditional structures such as sidecars and collateralised reinsurance, on their investors’ behalf,” an Aon Benfield review of reinsurer capital says.

Catastrophe funds make up about 43% of ILS investors, with institutional investors accounting for 41%.

US investors put in about 46% of the capital and Bermudans and Swiss 19% each, Aon Benfield says.

Insurance-linked securities include catastrophe bonds, industry loss warranties – where investors pay out on a “trigger” of total industry loss – and collateralised reinsurance, where unrated investors such as hedge and super funds provide capital to cover the potential claim.

Investors have enjoyed a relatively benign loss period, with no catastrophe bond payouts in the year to June 30.

However, bonds have paid out before, with investors in the Muteki catastrophe bond losing their entire $US300 million ($328.6 million) principal in 2011 after the Japan earthquake.

Views are divided on whether insurance-linked alternative capital is here to stay.

Aon Benfield believes the new investors are in the market for the long haul and will stay involved even if returns from other investments start to improve.

But Standard and Poor’s (S&P) analysts say when interest rates on traditional investments start to rise, “some of this capital will retreat to more conventional investments”.

A large loss could also dampen enthusiasm, but so far investor interest is fuelling demand for more of the securities to be issued, which has raised questions about what alternative capital means for traditional reinsurance.

Aon says insurance-linked securities are making inroads into the higher-margin areas of reinsurance that drive reinsurers’ profits, forcing many to “rethink their business models in the pursuit of differentiation and relevance in the market”.

The reinsurers are examining cost structures and client offerings, and using their industry expertise and relationships to set up deals that bring together investors and insurers and reduce their own costs.

S&P says competitive tension in the market will favour reinsurers that have prepared for change, “while others will be subject to marginalisation or consolidation”.

In the meantime, funds continue to pour into alternative capital investments. In the 2007 financial year a record $US8.1 billion ($8.85 billion) was raised in catastrophe bonds, and Aon forecasts $US7 billion to $US8 billion ($7.67 billion to $8.76 billion) this calendar year.