The rise of insurance-linked securities (ILS) and other forms of alternative capital remains bad news for the reinsurance sector, according to Fitch Ratings.

“Fitch continues to view the emergence of the alternative reinsurance market on balance as negative for traditional reinsurers’ credit quality and financial strength in the current competitive market environment,” the ratings agency says.

“While there are some positives for individual companies, the added competition and increased supply of capacity from the capital markets have served to meaningfully dampen reinsurance pricing and resulted in a deteriorating profitability profile for the reinsurance sector.”

Alternative capital – especially ILS – has flooded the reinsurance market in recent years and has been popular with insurers that want to protect against risk in US catastrophe classes.

Private equity, hedge funds and pension plans have contributed to the pool of alternative capital.

“The future growth rate of non-catastrophe property ILS is more uncertain and likely to be slower than that achieved across catastrophe classes, because it is unclear whether the size of losses that would be required to satisfy the return requirements of investors would ever be generated,” Fitch says.

The agency does not expect the downward spiral in reinsurance pricing to bottom out next year, as some industry executives predicted at this month’s Reinsurance Rendezvous in Monte Carlo.

“The difficulty in accepting the market’s optimism stems from the reality that a number of fundamental factors that influence pricing remain negative,” Fitch says.

“Reinsurance demand will continue to be subdued, while strong capitalisation will see fierce supply-side competition persist… some reinsurers view defending market share by writing business below the technical price floor as being an acceptable risk.”