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Unusually low catastrophe losses are bolstering commercial property/casualty insurers' financial results for now, but soft pricing could catch up with the industry next year.

Despite strong nine-month earnings, the industry simply cannot continue to post the strong results it has in light of the continuing competition in the market, which shows no signs of abating, many observers say.

The 23 major property/casualty insurers surveyed by Business Insurance posted a 55.9% increase in net income for the nine months ended Sept. 30, to $9.95 billion from the comparable period a year ago.

But, "I think it's going to be a very difficult year next year," said Michael Smith, an analyst with Salomon Bros. in New York. "There are fewer and fewer places to hide, and the well of reserve redundancies looks like it's being tapped out, if a well actually existed."

Jay Cohen, an analyst with Merrill Lynch & Co. Inc. in New York, said: "It appears the clouds are thickening on the property/casualty industry. The third-quarter results themselves were actually quite good earnings with a couple of exceptions. . .That's the good news.

"Premium growth, however, continues to be under pressure for many commercial lines companies, and we don't expect much change in the pricing environment," said Mr. Cohen.

"Maybe we're seeing the first chinks in the armor, so to speak," he said. "We do expect earnings pressure to rise over the next four quarters, and maybe we're starting to see this in the third quarter here."

"Most companies that we follow are sounding cautious in terms of earnings growth next year," said Ken Zuckerberg, vp at rating agency Moody's Investors Service in New York.

With no near-term prospect for a market cycle turn and continued pressure on commercial rates overall, operating earnings are expected to grow by a modest 5% to 10% next year, said Mr. Zuckerberg, who added insurers are wary about their growth depending upon "excessive reserve releases."

"I think in the fourth quarter of '97 and into '98 it's going to get worse, particularly for companies with a lot of commercial line exposures," said Peter Wade, an analyst with Lehman Bros. in New York, who noted the commercial lines premium growth among companies he follows was down 0.4% in the third quarter.

Most observers are reluctant to forecast when prices may harden. "I suspect that the catastrophe that turns the market will be just the manifestation of lousy pricing and underwriting decisions, but I'm not sure it'll necessarily occur next year," said Salomon Bros.' Mr. Smith.

"The problem with cycle turns is that in order for pricing to improve, there has to be a unanimous decision among all players that prices have to go up. When you have 1,000 players competing, it's pretty tough to get that unanimous decision.

"On the other hand, it only takes one player to turn the cycle down. Right now, there are too many companies that think, correctly or otherwise, that they have more capital than they need and they're trying to put that capital to work.

"It'd be a lot cheaper and simpler if they simply raked it into a pile and burned it," he said.

"I wouldn't expect a dramatic change in the market conditions in the next year," said Merrill Lynch's Mr. Cohen. "I think what has to happen for prices to harden is capital has to start leaving the business.

"Now, if underwriting results deteriorate dramatically, and the combined ratio zooms up to 115%, that indeed would start taking capital out of the business, but I wouldn't expect a dramatic rise in the combined ratio for next year."

Gloria Vogel, senior vp with New York-based Advest Inc., said, "I don't see any catalyst out there that's going to change the current environment short of, I guess, a real change in the interest rate outlook or change in the economic outlook that somehow depletes all the capital in the industry."

"I don't see anything that would suggest there's any turn in sight," said George Yonker, vp-finance for Seattle-based SAFECO Corp.

"I think there's two theories as to what could cause a market hardening," said Patrick A. Thiele, president and chief executive officer of the worldwide insurance operation of St. Paul Fire & Marine Insurance Co., who also said he sees no sign of an imminent change.

"One theory is it can't occur until a great deal of excess surplus is taken out" of the market, said Mr. Thiele.

The second theory, to which Mr. Thiele said he subscribes, is "cash flow will get so bad for the industry that to survive, some participants will have to raise prices."

"I believe that cash flow will get very bad over the next 18 months for the industry," he said. However, "Whether or not that's enough to turn the pricing cycle or not, I'm not sure," he added.

"I think the wild card is consolidation of insurance companies. The more consolidation that occurs between large companies, the more likely the soft part of the cycle will be extended," said Mr. Thiele, who noted he expects more consolidation.

However, Robert M. Steinberg, chairman and CEO of the Reliance Insurance Group in New York, said "I actually do see a change."

"I see the year 2000 as being the beginning of a stronger market," he said. While it will not be a "monster turn" along the lines of the hard market of 1984 and 1985, "I do think you will see some price increases in the lines of business where the returns are negligible."

This will continue until the market perceives rates are adequate and there is an adequate return "and then we'll come back down again. This is going to continue until capital and premium writings are more in line where they should be," said Mr. Steinberg, adding, "That's a long-term prospect."

Not included in BI's nine-month survey are results from American States Financial Corp., whose acquisition by SAFECO Corp. was completed Oct. 1 (BI, June 16).

Among other survey results:

The pace of premium volume growth continued to slow, with insurers reporting a 6% increase for the nine-month period, to $72.09 billion. For the first half, the 24 insurers participating in the survey reported a 7.4% increase, while a 9.6% increase was reported for the first quarter (BI, Aug. 25; May 26).

Investment income increased 16.5%, to $12.82 billion for the period. This is a slower growth rate from the 26.1% increase posted in the first half.

Underwriting losses for the companies surveyed improved by 66.8%, to $1.85 billion. For the first half, insurers reported a 61.6% improvement.

Insurers reported a 102% combined ratio, the same as reported for the first half. This compares with the 106.9% combined ratio posted for the first nine months of 1996.

Policyholder surplus increased 21.5% among the 21 insurers reporting this data, to $63.21 billion for the same period a year ago.

Low catastrophe losses and continued intense competition were the major factors affecting nine-month results, say observers.

"The comparisons were quite good because of the lack of any major storms, but apparently there's still a lot of price competition going on," said Advest's Ms. Vogel.

"The most significant positive development was the unexpected and unusually low level of catastrophe losses, which it appears were well below the same periods of '96 and one of the lowest quarters in the past several years from a catastrophe point of view," said John Ward of the Cincinnati-based Ward Financial Group. "That by far was the reason why results were strong in the quarter."

Mr. Ward also pointed to the stock market. "The equities market continued to be volatile but strong, and so that added a positive dimension to performance for the quarter," he said.

However, he added, "Tough competitive pressures remain probably the single biggest factor impacting the fundamentals of the industry."

"Basically, the earnings were stronger than I had expected to see, but the underlying quality and the drivers behind those earnings are showing some serious erosion," said Mr. Smith.

"Momentum is very clearly slowing on the revenue line," he said.

"Premium growth and investment income growth was generally much slower in the third quarter than it had been at the six months, when we look at earnings this year vs. last year. Most of the improvement, of course, is in the underwriting account, and that improvement is resulting mostly from very benevolent weather.

"The gods have treated us very well this year, and when you consider that premiums are not growing fast enough to even cover the increase in economic value of insured exposures, and add to that the likelihood that we will have a normal year for catastrophes, whatever a normal year is, you have to quickly reach the conclusion that underwriting results won't improve from where they are and more likely they will deteriorate next year."

"The fundamentals are starting to show through," said Mr. Wade. For the four prior quarters, insurer results were 2% higher than Wall Street expectations. For the latest quarter, though, many earnings reports "were barely in line," despite reserve releases and low cat losses, he said.

The third quarter "is really the first quarter where investors began to see accelerating deterioration in the operating fundamentals of the insurance group," he said.