The reinsurance industry is under threat, according to financial newspaper The Economist.

In an article focused on the industry, the UK-based publication said insurers were increasingly bypassing reinsurers and offloading their risk directly to the capital markets instead.

It highlighted the partnership of insurer Ace Ltd and money-manager BlackRock, who earlier this year formed a joint Bermuda-based company that will effectively bypass the reinsurance market.

The article detailed the spike in “alternative capital” supplied by pension funds, hedge funds and the like, largely entering the industry in the form of catastrophe bonds.

It quotes James McPherson of professional services firm PwC as saying that insurance companies have merged into a smaller group of global players who are retaining more risk and consequently buying less reinsurance.

Most of the The Economist’s observations will not be news to those who make their living from the industry in Bermuda, which is a major global centre for catastrophe reinsurance. The competitive pressures have led several companies to seek to merge with rivals.

However a graph accompanying the article and reproduced with this story (see under Related Media), gives a 25-year view of pricing changes and the amount of alternative capital in the industry. It shows clearly how pricing has slumped as third-party capital has poured in, markedly so over the past three years.

The article make the point that it has become more difficult for reinsurers to raise rates in the way they used to after major catastrophes, because of the influx of competing capital.

“In the aftermath of hurricane Katrina in 2005, some reinsurers put their prices up by as much as 50 to 100 per cent,” The Economist stated. “In contrast, the string of expensive disasters in 2011, including the Tohoku earthquake and tsunami in Japan and the Christchurch earthquake in New Zealand, did not lead to a rise in market-wide premiums, despite costing the insurance industry $116 billion, much of it reinsured.

“Catastrophe reinsurance prices have fallen in seven of the past ten years. Willis, a broker, says that the price for protection against disasters — normally the highest-margin part of the business — fell by 10 per cent last year on a like-for-like basis.”

While catastrophe bonds and other insurance-linked securities remain largely untested, the article states, and some capital market investors may be taking on risks they do not understand, the distribution of risk more widely than the relatively few global reinsurance firms is no bad thing.

The Economist suggests that reinsurers should venture into new markets in the many underinsured parts of the world. A case in point was Nepal, where less than 1 per cent of the estimated damage from the recent earthquakes was insured.

“The more capital available for reinsurance, the faster the insurance market can grow in such places,” the report added. “Rather than fighting over crowded and shrinking markets in America and Europe, reinsurers would be wise to broaden their horizons — provided the pension funds don’t get there first.”