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Cat losses hit insurer profits

Soft market continues despite sharp drop in first-half income

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Cat losses hit insurer profits

Property/casualty insurers, battered by two quarters of catastrophe losses, generally experienced significant drops in net income during the first half of the year despite continued reserve releases.

Yet many observers say the industry performed a bit better than might have been expected as the soft market persists despite firming of prices in limited categories.

Analysts also point out that insurers have entered the quarter traditionally hit hardest by hurricane losses.

The impact of the catastrophes was evident in a survey of large U.S. commercial property/casualty insurers that report quarterly results. First-half net written premiums for the group increased 7.4% over the same period last year and net income increased 17.8% in the same period. But the figure included a huge rebound by American International Group Inc., which had suffered a $799 million loss during the same period of 2010 followed by first-half 2011 net income of $2.11 billion. Excluding the AIG performance, the nine remaining insurance groups registered a 35.9% drop in net income over the same period a year earlier. The group's cumulative combined ratio deteriorated 8.5 points to 104.3% (see chart, page 10).

Still, some observers say the situation could have been far worse.

“Second-quarter results on an absolute basis were quite bad, mostly driven by large catastrophe losses,” said J. Paul Newsome, managing partner at Sandler O'Neill & Partners L.P. in Chicago. “But relative to expectations, it was a slightly different story. The results were actually typically a little bit better than what I was looking for, but not always.”

“There was a lot of good news, bad news going on over the first half,” said Mark Dwelle, an insurance analyst with RBC Capital Markets, a unit of RBC Dominion Securities Inc. in Richmond, Va. “Really, no one was spared catastrophe losses; but at the same time, almost everybody enjoyed at least a modest degree—if not a significant degree—of new premium growth and rate firming.”

“We always expect catastrophes to occur; so even though the story for the first half was very high catastrophe losses, we still think property/casualty companies fared well,” said Enrico Leo, assistant vp-insurance team at Moody's Investors Service in New York.

Mr. Leo said prior-year reserve releases still are occurring, which helps offset catastrophe losses.

Prior-period reserve development may be a little slower now than a year ago, said James Auden, an analyst with Fitch Ratings in Chicago. Reserve redundancy that developed during the hard market has diminished in the past few years, he said.

“On the investment side, the other driver of earnings, investment yields tend to be very low,” Mr. Auden said.

“I think it's pretty natural for reserves to fall over time,” said Sandler O'Neill's Mr. Newsome. “If anything, I've been surprised that the reserve releases have held up as long as they have.” Reserve releases are likely to decline slightly “as time goes on—as long as we don't get a major dose of inflation,” he said.

But not everyone views the sector's performance as favorably.

Meyer Shields, director at Stifel Nicolaus & Co. in Baltimore, said property/casualty insurers performed “not so well” during the first half.

“I think the catastrophes actually disguise how bad things are,” said Mr. Shields.

For the more than 50 companies that the firm tracks, reserve releases were “down about 60% year-over-year for the second quarter, he said. That means that underwriting profits are getting worse.

“There was a lot of chatter about the catastrophes. That was the big story in the quarter, but I don't think that was the most important,” Mr. Shields said.

Some analysts say some insurance rates are firming.

“I guess we're getting some of the outcome on the rate side that we expected, but I would have assumed it would have been more supported by economic growth than the fact that everyone lost money and had to pick up rate,” said RBC's Mr. Dwelle.

There has been “a little bit of improvement in the pricing environment in the second quarter compared to the first,” said Mr. Newsome, who also noted it was not broad-based.

“I think the critical issue is whether or not we have another round of very volatile investments that hurt insurer income, and investment income appears to be at a stage where a lot of insurers are showing a lower investment income,” he said.

“We are seeing premium growth maybe a little better than expected,” with generally stable pricing and some companies “reporting a modest uptick,” said Fitch's Mr. Auden.

Still, the insurance market remains “very soft,” Mr. Auden said.

“Price competition is still prevalent in the industry,” said Moody's Mr. Leo. “There are some pockets that seem to be hardening a little bit. But by and large, long-tail commercial casualty is still a soft market, but the rate of decline has slowed and, in some cases, bottomed out.”

For insurers, analysts say the hurricane season that runs through Nov. 30 could prove crucial.

“Peak hurricane months are upon us—that's the wild card,” said Mr. Leo. “Absent a large event, it's probably going to be more of the same—soft pricing, select pockets are going to be firming up in terms of rates.”

Mr. Newsome noted that the third quarter of any year typically is the worst for catastrophe losses for the property/casualty industry. He said a third quarter with light catastrophe losses would result in the industry remaining overcapitalized.

However, “if we have a bad one, things could be very different, because the second quarter was typically a loss for most insurers,” Mr. Newsome said.

Mr. Shields predicted “more of the same ahead,” saying he is not sure even a major catastrophe would drive the industry into a full-blown hard market.