OREANDA-NEWS. Headline-grabbing M&A in the reinsurance sector may do little in itself to help firms cope with the harsh reality of falling prices and low investment returns, Fitch Ratings says.

We expect market conditions to remain weak in 2016, while company valuations have remained stubbornly high. This increases the risk that future acquisitions will not generate long-term value - a risk that will only grow as the pool of potential targets shrinks.

The recent acceleration in deals is no surprise given the combination of weak pricing and overcapacity, and we have said for some time that consolidation could have some limited benefits for the sector as a whole by reducing capacity. The main driver of recent deals appears to be an attempt to improve scale and diversity, which can be positive for firms in the long term.

Reinsurance deals announced to date fall within the range of 1.1x to 1.8x tangible book value, with acquisition multiples not showing any sign of falling despite firms' weakening results. If M&A activity continues into 2016 and earnings continue to fall, as we expect, there is a risk that acquisition prices will increasingly appear disconnected from the reality of a tough market environment. This adds to the already significant execution and integration risks associated with mergers.

Risks are particularly high in transactions where diversification is the driving rationale, as the acquiring company is entering into an area where it may not have expertise and the chance of making mistakes is higher. On the other hand, a combination of two struggling companies in the same reinsurance segment will have less execution risk but could offer very limited benefits. Mergers that are seen to be poorly conceived could create problems if reinsurance buyers become reluctant to place business over the longer term.

M&A has been particularly brisk among Bermuda-based reinsurers as they have been the most exposed to fierce competition from the growth in alternative capital, which, along with the absence of major loss events, has helped push premium rates down. Although the pace of premium rate reductions for bellwether property lines slowed to single-digit levels at the June and July 2015 renewals, rates are still falling. Bermuda-based reinsurers' investment portfolios also tend to be shorter-dated than those of the biggest European reinsurers, meaning that they have reinvested sooner into lower-yielding assets.

We expect Bermudan companies to remain among the most active in looking for deals as we believe alternative reinsurance has gained widespread acceptance and there is therefore no obvious catalyst for a significant reduction in this side of the market. Investors in alternative reinsurance gain portfolio diversification and limited correlation to other investment risks, and we therefore believe a significant proportion of these new investors would remain even if yields in other sectors improved or a major catastrophe event led to losses.