Bermuda-based reinsurers face weakening earnings after heavy catastrophe losses already in the first five months of the year.

That is the view of credit rating agency Standard & Poor’s, which also believes that softening reinsurance pricing and shaky financial markets could add to reinsurers’ difficulties.

S&P released its report on Bermuda and US reinsurers on Friday.

Last year, Bermuda reinsurers made a combined profit of around $12 billion, buoyed by a lack of catatsrophe claims and surging financial markets.

But 2010 has brought much more challenging conditions, with the Chile earthquake and the deadly European windstorm Xynthia resulting in estimated claims of around $2 billion for the Bermuda market, and more losses stemming from the Deepwater Horizon oil rig explosion.

“The sector’s strong operating performance in 2009 came from a combination of few significant catastrophe losses that year and substantial recovery of invested assets as capital market conditions improved,” said Standard & Poor’s credit analyst Laline Carvalho. “At this stage, conditions in 2010 don’t look as promising.”

The lively catastrophe activity so far this year signals potentially weaker operating performance and more volatile balance sheets for the year, particularly if catastrophe activity remains high through the remainder of 2010, S&P said.

“We also believe that continued softening in premium rates for most reinsurance lines and limited opportunity for profitable growth will likely hamper the sector’s results this year,” the report said.

“Finally, we also expect that the continuation of soft pricing conditions for US commercial lines — combined with reduced reinsurance purchasing by primary insurance companies as a result of weak global macro-economic conditions and higher risk retention — is likely to pressure reinsurers’ earnings, at least over the next six to 12 months.”

However, the ratings agency said its concerns were lessened by US and Bermuda reinsurers’ significant excess capital positions, strong liquidity and conservative investment strategies.

Balance sheets were much stronger balance than 18 months ago. And despite continuing downward pressure on reinsurance premium rates, S&P so far believes that pricing for most reinsurance risks is still producing good underwriting profits.

“In our opinion, US and Bermuda reinsurers’ ongoing commitment to enterprise risk management (ERM) and bottom-line profitability have kept reinsurance management teams from engaging in predatory competitive pricing,” S&P said.

“Primary companies, rather than reinsurers, have experienced most of the price reductions so far in this soft cycle.”

S&P expects reinsurers’ earnings to remain volatile, given the high unpredicatbility of the risks they underwrite.

“In our view, the more important question is whether management teams at these companies will be able to translate their strengths into actions that secure their ability to produce strong, long-term risk-adjusted operating returns,” S&P added.