The reinsurance market is ripe for consolidation because the sector continues to soften, with alternative capacity in at least one area set to double over the next few years, a Nomura Equity Research analyst concluded recently in a new report.

“As the traditional business model comes under pressure, we expect that existing players will adapt,” Nomura analyst Clifford Gallant stated in an analyst note looking at the M&A outlook for Bermuda reinsurers. “Many may need to merge to survive. Eventually, companies that we may not yet think of as buy/sell candidates will take part. The pressures of a bad soft market cannot be understated, in our view.”

With this in mind, Gallant wrote that Bermuda insurers and reinsurers such as ACE Limited, XL Group and PartnerRe are “the larger, more diversified companies that have the opportunity to make acquisitions.” All are “well positioned strategically,” he said, though ACE is his top pick with a “buy” rating.

On the other hand, Gallant concluded that companies such as Aspen Holdings Limited, Montpelier Re Holdings Ltd., Platinum Underwriters Holdings Ltd. and Argo Group International Holdings, Ltd. “are more likely to consider consolidation” under current market conditions.

What is driving this? Gallant said that the continued “tidal wave” of alternative reinsurance options including catastrophe bonds, collateralized reinsurance, retrocessional reinsurance and industry-loss warranties is putting pressure on the consolidation of traditional reinsurers. In short, competition is lowering pricing and softening the market.

“Aon, a major underwriter of cat bonds and a leading advisor to pension funds (the leading buyers of cat bonds), sees significant demand for new issues and expects that alternative capacity could double over the next three to five years,” Gallant said.

Gallant added advantages of the new reinsurance model are becoming increasingly clear, in part because alternatives such as “cat bonds are less expensive than traditional capacity and are fully collateralized.”

He wrote that Endurance’s attempt to buy Aspen – both Bermuda based reinsurers – makes sense under these circumstances.

“Endurance is small, and, in our opinion, could end up on the selling side to survive unless it acts quickly to grow and diversify,” Gallant wrote.

While Gallant and Nomura see reinsurance consolidation as inevitable, they also point to some obstacles that could delay what they see as a necessary thing. These include rising investment yields, a major loss event, timing and entrenched management that has displayed “resistance to being acquired in recent years.”