Commercial U.S. property/casualty insurers face diminishing reserve redundancies that have boosted results as the soft market continues with no immediate end in sight, observers say.

Meanwhile, catastrophes also loom as an issue, with the year's hurricane season still ahead, although the Japan earthquake is unlikely to have a major impact on the primary U.S. insurance market, observers say.

Ten major property/casualty insurers reported $21.64 billion in 2010 net income (see chart, page 10). This compares with a $779.9 million loss for 2009, when American International Group Inc. reported a $10.95 billion loss for the year and Hartford Financial Services Group Inc. reported an $887 million loss.

Net premiums written for the largest insurers increased 2.3% to $128.29 billion in 2010. The group reported a 100.3% combined ratio vs. 96.5% a year earlier.

While there has been some deterioration in operating profits, “We would say that, given the soft market and tough economy, results are adequate for conditions,” said James B. Auden, an analyst with Fitch Ratings Inc. in Chicago.

“Reserve redundancies continued to support earnings and kept a lot of companies' combined ratios below 100%,” New York-based Standard & Poor's Corp. Director John Iten said. “On the other hand, you've got pricing, at least on the commercial side, that really hasn't improved much,” with single-digit declines continuing in most lines.

Mr. Auden said AIG, which posted a $4.2 billion net charge to strengthen Chartis Inc.'s loss reserves in the fourth quarter last year, was an “outlier” insofar as reserve development trends. “Just about every other company reported favorable reserve development,” he said. This means “while your profits are higher, it's masking some weaker current-year results.”

Reserve releases in 2011 will be “down relative to the levels of the last two or three years,” but will “not go away entirely for most companies,” said Mark Dwelle, an insurance analyst with RBC Capital Markets, a unit of RBC Dominion Securities Inc. in Richmond, Va.,

However, Laline Carvalho, a director at S&P in New York, said, “We don't think that companies will be able to take down more and more reserves.”

While there has been favorable reserve development for the 2003-2007 years, reserving was less robust for 2008-2010, particularly in casualty lines, where there have been continued price decreases and business has been more competitive, Ms. Carvalho said. There will be “adverse reserve development in the future if companies take down too much of their reserves,” she said.

“Those cushions are no longer there,” said Anthony Diodato, group vp at Oldwick, N.J.-based A.M. Best Co. Inc. The concern is insurers are “taking from one accident year to support another accident year, to the point where nothing's left, and you're going to start seeing reserve strengthening” as a result.

Meanwhile, soft commercial property/casualty pricing is expected to continue. “We don't see any real movement in commercial lines pricing positively in the near term, so we think that current accident year performance will continue to worsen for the sector,” said S&P's Mr. Auden.

Amit Kumar, vp at Macquarie Securities Group in New York, said while some of the larger insurers, including Travelers Cos. Inc., CNA Financial Corp. and Chubb Corp., were able to achieve “a modest amount of traction” and increase rates, smaller insurers have struggled to do so. “There's no indication that a market turn is in sight or imminent on the U.S. commercial side,” he said.

“The biggest factor is the economic conditions,” Mr. Kumar said. “The economy is still challenged and in a modest recovery mode; and, unless you see a broad-based improvement in exposure, it's difficult for across-the-board rate increases” in nonlife business.

“On the flip side, you had loss trends, which have generally remained benign. You had localized catastrophe losses, but on the liability side, except for workers comp, loss trends have been generally within companies' expectations,” Mr. Kumar said.

Rates will continue to fall, but in the low single digits, said J. Paul Newsome, managing partner at Sandler O'Neill & Partners in Chicago.

Jim Amen, managing partner with Philo Smith & Co. in Stamford, Conn., said he expects insurers “will hold the line” on rates, with “maybe very, very light” continued softening in the market.

However, RBC's Mr. Dwelle said, “Much will depend, ultimately, on where some of these cat losses come in, but we are expecting at least some firming, generally driven by a firming demand picture and improving U.S. economy.”

“Folks continue to shy away from workers comp and some particularly long-tail lines, because the pricing isn't there, and obviously cannot be covered by investment yields,” Mr. Amen said. He said he anticipates a “continued shift from longer-tail to medium and shorter-tailed lines.”

S&P analysts said asbestos reserves are an area of concern.

“There's been an uptick in the increase of asbestos reserves,” said S&P's Mr. Iten. “While not huge,” it has been seen more than in recent years.

Companies that reported increased asbestos reserves include AIG and ACE Ltd., while CNA entered into a deal under which it transferred its asbestos liability to National Indemnity Co. last year.

In addition, the hurricane season now looms after two relatively quiet years, analysts say.

In light of the global catastrophes, “anybody who operates on a wider (geographical) basis has already felt some pretty sizeable losses. That said, this isn't peak season yet,” Mr. Dwelle said.

Observers said they anticipate relatively small merger and acquisition deals in the coming year.

“You don't see too often” the big headline-grabbing acquisitions, said Best's Mr. Diodato. But many insurers are looking for specialty lines to augment their business and expand growth opportunities.

As an example, Mr. Dwelle pointed to Toronto-based Fairfax Financial Holdings Ltd.'s acquisition last year of Woodland Hills, Calif.-based workers compensation insurer Zenith National Insurance Corp. in a $1.4 billion deal and its merger agreement with Southfield, Mich.-based First Mercury Financial Corp. in a $294 million deal.