Reinsurance rates look set to rise for the next two to three years at least, according to analyst Morgan Stanley Dean Witter, writes Yvette Essen.

Yet companies could face problems with capacity as US broker market reinsurers may be under-reserved by up to $5bn (£3.5bn).

Analyst Espen Nordhus said: “A number of powerful forces are coming together in such a way that we expect a major and sustainable upswing in global reinsurance markets.”

He said tough capital markets and adverse development would drive up premiums. “The cycle may turn, possibly for four to five years,” he said. “We can certainly say it will run for two to three years.”

Reinsurers, which have suffered massive losses over the past few years, will be relieved by the news that a rate hike is being forecast.

But Nordhus added some organisations may have failed to set enough aside for claims stemming from the 2000 year of account. And they may be forced to strengthen reserves, following re-adjustments during the previous two years.

“We see numerous signs of trouble appearing in the casualty reinsurance sector,” he explained. “Some reinsurers are probably under-reserved and Lloyd's is similarly bifurcated.

“There is an asbestos reserve for $20bn (£13.8bn). But there are indications this should be higher and it is underfunded by 50%. Another $20bn (£13.8bn) to $25bn (£17.3bn) need to be financed through price increases and shared among the few. Some of the players will be downgraded by ratings agencies.”

Nordhus also said “obscene” rewards for smoking-related diseases by American courts could result in further claims payouts.

He advised investors to focus on Swiss Re, Berkshire Hathaway, Aon and Munich Re.

But he predicted that, in the future, large players would try to seek alternatives to reinsurance by merging with investment banks and developing their investment banking skills.