Reinsurers are adapting to the threat posed by alternative capital by expanding their presence in the capital markets themselves, especially with sidecars and insurance-linked securities, according to two recent reports.

In its “Global Reinsurance Outlook,” Moody's Investors Service outlines the new reality for reinsurers, stating, “Capital markets convergence has finally arrived in the reinsurance market. What began with a trickle of capacity more than 15 years ago has turned into a flood of capital entering the reinsurance market from institutional investors in the form of catastrophe bonds, collateralized reinsurance vehicles and industry loss warranty contracts.”

The report says an estimated $10 billion in new alternative capital entered the industry over the past year, bringing the total amount to an estimated $44 billion—roughly 15 percent of the global property cat reinsurance limit placed.

The impact on the traditional reinsurance market is already being seen. Moody's says June/July renewals in the U.S. were down by between 10 percent and 20 percent, and some Florida accounts decreased by as much as 25 percent. And the competitive pricing is expected to continue into the Jan. 1 renewals, barring meaningful catastrophe losses.

Additionally, Moody's points out that after an event like Superstorm Sandy—which caused between $20 billion and $25 billion in private-sector insured losses—the normal debate would have been over how much reinsurance pricing will increase. Instead, with competition from alternative capital, particularly in the property-catastrophe market, reinsurers are focusing on minimizing pricing declines.

In its wrap-up of 2013 first-half results for a group of 31 companies in the reinsurance market, Aon Benfield states, “Earnings were already under pressure from below-average premium gearing and low interest rates. Now new vehicles operating at a lower cost of capital are making in-roads into higher-margin areas that remain a key driver of profits.”

But reinsurers are adapting to the changing marketplace. Aon Benfield says, “Over time, it is expected that less reinsurance business will be written on rated balance sheets and more through 'satellite' structures backed by third-party capital.”

The firm points out that RenaissanceRe has operated this model for years and others are now pursuing similar strategies.

Several companies among the 31 it follows are “already involved in the management of third-party funds, including Amlin (Leadenhall), Montpelier Re (Blue Water), SCOR (Atropos) and Validus (AlphaCat).

“New capital markets divisions were established by Aspen, Axis, Lancashire, Montpelier Re, Sirius and XL in 2013, while Hannover Re (Leine) and RenaissanceRe (Medici) recently opened existing internal funds to third parties. An alternative route, pursued by Alleghany/Transatlantic (Pillar), Allied World (Aeolus) and Hiscox (Third Point Re), is to invest in strategic partnerships with established independent specialist-fund managers.”

Moody's, too, suggests that many reinsurance firms have for years prepared for this new market reality. “Thorugh their participation as sidecar managers and as sturcurers/placement agents, traders, investors and use of insurance-linked securities to shape their risk-return profile, reinsurers have been essential participants in the evolution of reinsurance convergence with the capital markets,” the ratings agency says.

Moody's believes sidecars in particular present a key opportunity for incumbent reinsurers, explaining, “Instead of being largely cut out of the value chain, reinsurers are integral to the risk-selection process and ongoing management of sidecar vehicles.”

Furthermore, Moody's says sidecars also allow reinsurers to leverage third-party capital to write risks that might not ordinarily fit within underwriting and return parameters of the firms' rated balance sheets.

“Sidecars also allow reinsurers to trade volatile underwriting income for a stable stram of management fee income and the potential for profit overrides,” Moody's adds.

However, the ratings agency cautions that sidecars could pressure pricing or even cannibalize reinsurers' core business by adding lower-cost capacity.

As for how the reinsurance market has performed so far this year, Aon Benfield says the 31 reinsurers in its aggregate report net income attributable to common shareholders of $16 billion, an increase of 6 percent over 2012's first half.

Pre-tax profit for the companies was unchanged at $18.9 billion, while underwriting profit rose by 26 percent to $8.9 billion, which includes an increased contribution of $3.7 billion from prior year reserve releases.

Moody's, meanwhile, says it has a stable outlook on the market, reflecting the industry's “resilience in the face of a challenging operating environment, continued underwriting discipline and improvements in risk management, as well as firmer pricing in some primary insurance markets.