Ratings agency AM Best has maintained its negative outlook for the reinsurance sector for next year.

It said that ongoing market challenges will hinder the potential for positive ratings action and might even translate into negative ratings pressures, and warned: “The companies that are not proactive will not lead their own destiny.

“It is likely that several franchises that exist today will be sporting the logo of another brand by the time this soft market has run its full course.”

The agency said that pressure on investment yields and underwriting margins would hit profitability and place a drag on risk-adjusted returns and financial strength.

Its end-of-year report stated: “The market headwinds at this point present significant longer-term challenges that industry players need to work through.

“Interest rates remain extraordinarily low, despite the recent action taken by the US Federal Reserve.

“These weak operating fundamentals are being exacerbated by continued weakening demand from primary insurers as they retain more business to leverage their own excess capacity.

“While a broader cyber reinsurance and insurance solution in the market as well as pending regulatory changes in the European Union and China may, over time, provide some new business opportunities for reinsurers, it is too early to gauge any potential benefits.”

The report noted that reinsurers are responding to the challenging market by employing greater capital market capacity to help optimise results and reduce probable maximum loss for peak zones as a percentage of capital.

AM Best estimated that convergence capital accounts for about 20 per cent of the dedicated global reinsurance market capacity, a percentage that has increased steadily over the years.

The agency said that was why cycle management had been a key strategy for companies with the capability to move between primary and reinsurance platforms.

The report added: “There has also been meaningful effort to embrace new opportunities and geographies, produce fee income and a subtle migration into asset classes that will produce some increased investment yield.

“Further market consolidation is also a likely response to the current market environment as balance sheet scale becomes an even more important attribute to retain and win new clients.

“Merger and acquisition activity remains an important strategic option to gain greater scale and diversification as companies navigate the market cycle.”

The report added: “However, merger and acquisition does have potential hazards and can have either a positive or negative rating consequence depending on the quality of the partners, earnings accretion and execution risk.”

AM Best said that balance sheets in the sector were “well-capitalised and capable of withstanding various stress scenarios”.

But the report warned that strong balance sheets could be hit by increased pressure on earnings, favourable reserve development wanes, earnings become more volatile and the ability to earn back losses after events is prolonged by “the instantaneous flow of alternative capacity”.

The report added: “All of these issues reflect increased concern that underwriting discipline has diminished as companies look to protect market share at the expense of profitability.”