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P/C insurers try to build on 2009 momentum

Intense competition, excess capacity factor in ongoing soft rates

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A revived investment environment, reserve releases and relatively low catastrophe losses helped many large U.S. commercial property/casualty insurers overcome weak premium growth and soft rates in 2009.

But insurers' reserve cushion is growing thin and rates continue to be soft with no indication when the market may harden, observers say.

Ten major insurers that release their quarterly results reported a $779.6 million loss in 2009 vs. a $94.39 billion loss in 2008. Excluding American International Group Inc., the nine remaining insurers posted a 107.7% increase in net income to $10.17 billion. Net premiums written for all 10 insurers decreased 3.7%, to $128.73 billion. The 10 insurers posted a 96.4% combined ratio for 2009 vs. 95.9% for 2008 (see box).

The fourth quarter of 2009 was “another good quarter similar to the first three,” with no major catastrophes and good reserve development, said Cliff Gallant, an analyst with Keefe, Bruyette & Woods Inc. in New York.

“We still have a soft market that is not really showing improvement; and with the economy, you have exposures shrinking,” so premiums have declined, said James Auden, an analyst with Fitch Ratings in Chicago.

But many large commercial writers “reported pretty good underwriting results for the year, and some of that's fueled by the later cat season and also by quite a bit of favorable reserve development.” In the hard-market years, insurers were able to post reserves more conservatively, and “they're taking reserves down from those years,” he said.

In addition, Mr. Auden said, “Companies' capital position really rebounded over the course of the year, and a lot of that was due to the recovery in the investment market.”

“I see continued improvement economically” in 2010, said Bill Bergman, Chicago-based analyst with Morningstar Inc. There appears to be “some pretty good momentum on that score and that's going to help in terms of demand” for insurance, he said.

However, observers say insurance rates remain soft this year.

Bruce Fell, Stamford, Conn.-based senior consultant for Towers Watson & Co. and leader of its property/casualty insurance practice in the Americas, noted that Towers Watson's most recent Commercial Lines Insurance Pricing survey found that rates were flat in the fourth quarter, with marginal declines for the previous three quarters.

“Price declines seem to be less severe than they were last year” overall, said Stewart Johnson, a portfolio manager with Stamford, Conn.-based Philo Smith & Co. Looking at specific lines, “umbrella business is still under tremendous pressure, whereas certain segments of (directors and officers) and (errors and omissions) are actually doing OK.”

Edward Keane, an analyst with Oldwick N.J.-based A.M. Best Co. Inc., said companies are “still seeing rate decreases for the most part, but they're starting to decelerate. And from what we're hearing from mid- to large commercial carriers,” a gradual increase may begin in the second half of this year, he said.

However, “We're somewhat skeptical rates will improve materially in the near term,” said Fitch Ratings' Mr. Auden. “From a competitive standpoint, there's a lot of capital in the market looking to write business, so that kind of competitive dynamic really hinders any positive movement in pricing. And it's likely underwriting performance will need to get worse before it gets better, and we don't see capital moving out of the market.”

“There are two things I'm looking for: One is improvement in pricing and the other is a pickup in insured units,” Philo Smith's Mr. Johnson said. “Companies are beating each other up to cut prices to win new business. If the business environment is expanding,” that will lead to an increase in insured units, “which should take some pressure off of pricing,” he said.

“There does seem to be a fair amount of excess underwriting capacity” in the market now, said Cathy Seifert, an equities analyst with rating agency Standard & Poor's Corp. in New York. “I'm not sure what the catalyst” will be that will harden rates, she said.

Mr. Auden said that catalyst could be significantly worse underwriting results, such as “a spike in loss costs due to inflation or some other economic change. That could spur activity.”

In addition, “A large cat or some big event that drains capital from the market could do it.” But it is more likely the market will continue “where rates are broadly inadequate, but not terrible,” said Mr. Auden. “We don't see the market reverting to the late "90s period, where accident-year combined ratios were 115%.”

Pano Karambelas, vp at Moody's Investors Service in New York, said to the extent that the insurance industry continues to build capital, “you'll probably see a continuation of softening” insurance pricing.

“Any sort of bloodletting in terms of results would tend to have an impact on the underwriting behavior of carriers” in rates, but the competition will be extended if the industry continues to post profits and grow capital, Mr. Karambelas said.

While many insurers benefited in 2009 from reserve redundancies, “we're concerned that the reserve cushion is not nearly as strong as it was a few years ago,” Mr. Auden said.

“The outlook is a bit of a concern because, as the redundant reserves are used up, I think these tough economic periods can really wreak havoc on reserving practices,” which “could end up being reflected in a deficiency of loss reserves in the next couple of years,” said John L. Ward, CEO of Cincinnati-based Cincinnatus Partners L.L.C.

Significant negative reserve development means insurers “will probably have to start raising rates,” said Paul Newsome, an analyst with Sandler O'Neill & Partners L.P.

Meanwhile, the investment environment has improved but yields are low, observers say. Mr. Ward said about two-thirds of most insurers' invested assets are in fixed income securities and “we're in a period of very low interest rates.”

“I think we're going to see a noticeable drop in investment income as those bonds mature and get reinvested” in lower-yielding instruments, Mr. Ward said. Many companies “are taking a very safe and conservative strategy in their investment portfolio and in the business they write, and until that fear of the markets and the unknown gets back to normal, I think we're going to be underperforming overall in the industry.”

A.M. Best's Mr. Keane said he expects last year's move into safer fixed income and cash investments will start to stabilize “and in 2010 we might start to see companies go back into equities.” However, “I don't think everyone's rushing back to go into equities” and insurers' investments in lower-yielding securities will hold investment yields down.

On the merger and acquisition front, recent activity includes Max Capital Group Ltd.'s planned merger with Harbor Point Ltd. (BI, March 8) and may portend more M&A activity, experts say.

“We'll see more M&A” activity, Mr. Newsome said. “It's pretty natural for this part of the insurance cycle. You get more management teams interested in selling out because they realize that it could be a pretty difficult environment for them to continue in the next couple of years.”

While M&A deals may happen, “I don't necessarily think the big deals we saw a decade ago are going to repeat themselves,” Moody's Mr. Karambelas said. There was a lot of specialization a decade ago, but since Sept 11, 2001, “a lot of companies have diversified.” As a result, “I don't necessarily see the same sort of impulse or dynamic this time around for a major M&A wave.”

Mr. Ward said the one impediment to M&As is “the capital markets and the credit markets in particular still have not fully recovered, and it's very difficult to foresee a lot of M&A activity until sources of financing have returned to the markets.”