A traditional soft market is coming, as alternativecapital-driven pricing pressure in the reinsurance market flows tothe primary market, a recent Nomura report contends.

Nomura analysts Clifford Gallant and Mathew Rohrmann say in thereport—titled “The Evolution of Reinsurance: Soft Market to SpurM&A”—that one impact of the growing alternative-capitalpresence will be further price weakening in property/catastrophereinsurance rates, followed by weakening across all reinsurancelines, before finally affecting primary-commercial rates.

“We have already seen a slowdown in primary-commercial rateincreases despite the ongoing pressure of a low-investment-yieldenvironment,” states the report. “Much as we have seen ingenerations of previous cycles, we expect that the availability ofcheap reinsurance will exacerbate the fight for market shares atthe primary level, leading to a traditional soft market.”

Nomura then expects consolidation as the traditional reinsurancebusiness model comes under pressure. “Many [reinsurers] may need tomerge to survive,” Nomura says. “Eventually, companies that we maynot yet think of as buy/sell candidates will take part. Thepressures of a bad soft market cannot be understated, in ourview.”

The report ties this outlook to Endurance Specialty Holdings'attempt to buy Aspen Insurance Holdings, stating the attempt “makesperfect sense, by our view of the world. Endurance is small and, inour opinion, could end up on the selling side to survive unless itacts quickly to grow and diversify.”

According the report, the reinsurance market is not just underpricing pressure, but is experiencing an evolution in themarketplace. “In the evolutionary process,” says the report,“things happen slowly before they happen very fast.”

Nomura notes the first catastrophe bonds were issued in themid-1990s, but only recently has the alternative market shaken upthe industry. “Much like what happened in the 1990s to the publiclytraded U.S. domiciled reinsurers (none is left), we expect that amore efficient business model will force change in the reinsuranceindustry,” states the report.

The advantages for buyers are clear, according to the report.“As a risk-management product, cat bonds are less expensive thantraditional capacity and are fully collateralized,” says thereport.

Alternative capital is currently pressuring property/catastropherates the most, with rates already down double-digit percentagessince 2012 “in what appears to be a traditional soft-market freefall,” says Nomura.

But it is quickly spreading to other lines, the report notes.“The establishment of Watford Re, by highly respected Arch Capital,will be a major alternative underwriter of casualty risks.” Nomuraexpects to see more players form similar vehicles, possibly eyeingliability lines such as auto or workers' compensation as“potentially stable sources of assets” for asset managers.

Potential “wild cards” that could change Nomura's outlookinclude a major loss event, which “would open up questions ofreserve and balance-sheet quality and could derail activity,”Nomura says. Asked if investors who are bringing all of thiscapital into the reinsurance market will stick around should amajor loss event occur, Gallant tells PC360 that is the bigquestion. “I think, yes,” he says. “They seem to be sophisticatedinvestors, aware of the risks they are taking.”

Nomura also cited rising investment yields and “entrenchedmanagement” that resists acquisition as potential wild cards.