The reinsurance sector is no stranger to evolution, but in the past few years the changes have been more rapid and profound.

The difference, according to AM Best, is recent changes are structural, not cyclical.

“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 ratings agency says in a report.

Lower interest rates have led to an increased inflow of alternative capital as investors seek higher returns. According to reinsurance broker Guy Carpenter, alternative capital accounts for 18% of total dedicated capital in the global reinsurance market, up from 8% in 2008.

“Reinsurers have come to realise the benefit of having multiple distribution capabilities,” the AM Best report says. “Building or acquiring primary insurance capability is common now, and expanding reinsurance operations globally into emerging markets is gaining speed.”

Recent mergers and acquisitions (M&A) activity reflects the priority placed on greater global scale and diversification of product lines and distribution.

“As the market gets increasingly more competitive and more challenging, companies with the scale and the global footprint to put money to work or shrink a particular offering will have the real advantage going forward,” AM Best says.

“With current market conditions of double-digit price declines, increasing commissions, lower premiums and increased competition, the need for M&A is becoming clearer.”

The “new reality” is a reinsurance industry “where returns are less impressive and underwriting will have to become a larger contributor to profits and returns”, which will prompt conservative risk selection, more product diversification and a wider geographic reach.

Not everyone will emerge unscathed, but AM Best believes it knows what is required.

“The winners will be able to walk away from bad business; will have the capital and expertise to write new, more complex lines of business; will provide the products and services clients want in a global economy; will be able to manage the inflow of third-party capital to their own benefit; and will be able to participate in the new era of consolidation without being left out of the game.”