Commercial property/casualty insurers have benefited so far this year from relatively low catastrophe losses, but as the hurricane season continues, they cannot expect their luck to hold out indefinitely.

Price competition is continuing to put pressure on margins, which will inevitably be reflected in insurers' earnings reports.

"The first half of 1997 we would characterize as fortuitous, with fairly light catastrophe experience coupled with stable profit margins," creating good earnings trends, said Weston M. Hicks, an analyst with Sanford Bernstein & Co. in New York. "But it was luck rather than skill," he added.

Furthermore, while the industry has enjoyed a slowdown in claims cost growth, particularly in workers compensation and liability lines, "we believe that the good news from that trend is largely out," said Mr. Hicks.

There also will be more intense competition, he predicted, with prices continuing to fall as the weather enters "its most volatile period."

"Right now, I don't see anything necessarily changing dramatically," said Gloria Vogel, senior vp with Advest Inc. in New York. "But I'm a bit concerned because we're going into hurricane season and there's a sense of complacency out there, and everybody seems to have reported so many good numbers.

"I don't know how much better things can get, because pricing is eroding, so we know there's some underlying deterioration going on," Ms. Vogel said.

Eric Simpson, senior vp with A.M. Best Co. in Oldwick, N.J., pointed to reserves. "We are extremely concerned with the low reserve levels being established by companies, and we believe that these unusually favorable results will unravel quickly, whether it be in the fourth quarter, where companies typically true up their reserves, or certainly going into 1998. These great results cannot be sustained and are incompatible with the current marketplace conditions."

The 24 major property/casualty insurers surveyed by Business Insurance posted a 42.7% increase in net income, to $6.6 billion from $4.63 billion for the comparable period in 1996, when companies were more severely impacted by both catastrophes and environmental reserve increases (BI, Aug. 26, 1996).

"The obvious driver behind this year's improvement is the absence of catastrophes, so I think it's fair to say there's a better probability of deterioration on that account going forward than there is of improvement," said Michael Smith, an analyst with Salomon Bros. in New York.

Craig Elkind, a director at Standard & Poor's Corp. in New York, said he is concerned about insurers' reliance on catastrophe modeling. "A lot of companies today are getting very dependent on catastrophe modeling, and though they've done a better job of getting in all the information on their risks, so they have full information going into the model, I think the jury is still out, and time has not proven the models are accurate or close to accurate."

These models are based on historical events, and while they may be accurate over the long term, they could be "significantly off" in their applicability to any one event or series of events, said Mr. Elkind.

Meanwhile, observers point to continued price competition.

"It sounds like a broken record," but price competition is "as virulent as we've seen it in the last two years," said Patrick A. Thiele, president and chief executive officer of the worldwide insurance operation of St. Paul Fire & Marine Insurance Co. While the competition has not necessarily accelerated, "it has stayed at a very high level."

At the same time, there are indications of an increase in paid and incurred losses, despite the relative paucity of catastrophes in 1997 compared with 1996, he said. "Obviously, if you have paid losses going up and prices going down, cash flow is squeezed," which longer-term will lead to slower investment income growth and hurt the bottom line, said Mr. Thiele.

"Nothing's changed," said Robert M. Steinberg, chairman and CEO of the Reliance Insurance Group in New York. "Competition is fierce and business is all under pressure. I say it's going to continue for the foreseeable future. I see nothing on the horizon that would make this change."

Mr. Steinberg added, "The industry wasn't designed" to write business at premium to policyholder surplus ratios of 1.1-to-1 or 1.2-to-1. "It's got to be 1.5-to-1 to 2-to-1 to make the kind of returns on capital that shareholders will respect," and until it does, insurer stocks will continue to sell at price-to-earnings ratios lower than that of American industry overall, he said.

Companies are complaining they have not seen the current market conditions in the commercial property/casualty insurance market since the mid-1980s, said Michael Lewis, senior insurance analyst with Dillon Read & Co. in New York.

"That trend shows no signs of easing, and I guess you've got to start seeing these inadequate rates showing up in underwriting results, which has not been the case to date," Mr. Lewis said.

"There's really nothing I've seen that would indicate there's going to be any change," said George Yonker, vp-finance for SAFECO Corp. in Seattle.

"If anything, I would expect prices to continue to fall," said Barbara Stewart of Stewart Economics in Atlanta. "There is no reason to expect them to even hold." At the same time, she noted, the emergence of capital market approaches to spreading risk is adding even more capacity to the business.

Among other BI survey results:

With continuing price competition, net premiums written for the 24 insurers surveyed increased 7.4% to $48.91 billion from $45.52 billion. This is a decline from the 9.6% increase reported for the first quarter and the 9.9% increase reported for year-end 1996 (BI, May 26; March 24).

Investment income increased 26.1% to $8.87 billion from $7.04 billion. The year-to-year comparison reflects two special dividends totaling $1.15 billion paid to Nationwide Mutual Insurance Co. from Nationwide Corp., its downstream holding company. This led to a 264.4% increase in Nationwide's investment income, to $1.62 billion from $445.5 million.

Underwriting losses for the companies surveyed improved by 61.6% to $1.34 billion from $3.49 billion. This compares with a 44% improvement in the first quarter. In 1996, underwriting losses widened by 57.4%.

Helped by the lower catastrophe losses, the combined ratio improved to 102%, compared with 107.5% for the comparable period a year ago. This compares with the 102.2% combined ratio posted for the first quarter and 106.1% ratio for all of 1996.

Policyholder surplus increased 11.9% to $62.39 billion from $52.41 billion for the 22 insurers reporting this data. For the first quarter, the 19 insurers reporting this data for 1997 and 1996 posted a 19.7% increase.

One factor that has helped results is insurers' reduction of redundant reserves, though this factor can be difficult to measure, some observers say.

"I look at that as something that has to happen rather than something that is done by companies to mislead people," said Sanford Bernstein's Mr. Hicks. If claims costs decline and reserves prove to be redundant, they have to be released, he said. "There's nothing sinister about it."

"I can't quantify it," said Salomon's Mr. Smith. "I think there's a general assumption that insurance companies have been finding reserve redundancies, which is the outcome of a decade of much lower inflation than had been reserved for 10 and 15 years ago. How much longer the industry can do this remains to be seen."

Advest's Ms. Vogel said: "I get the sense reserve cushions aren't as strong as they have been historically. I don't think we're seeing companies put as much away as they have in the past."

Over the past couple of years, there have been some "fairly large takedowns" for recent accident years, said S&P's Mr. Elkind. He noted that while some of these reserves have been added to prior-year reserves, they also have been used to help earnings.

Some of these takedowns may have been justified, but to the extent they were related to lower paid-loss or inflation trends over the last few years, "I don't think companies can count on those things to continue over the longer term," said Mr. Elkind. "They could be kidding themselves, but you won't know if they are for several years."

"The industry has not only in all likelihood exhausted the prior-year redundancies, but it's skimping on current year reserves," said A.M. Best's Mr. Simpson.

"It's a very volatile industry," he warned. "Unforeseen losses crop up. There could be another wave of mass tort liabilities. The industry should prudently be setting aside some (incurred-but-not-reported) reserves, a cushion for such surprises."