We are in the 12th year of the "traditional" three-year underwriting cycle.

Industry pricing fundamentals, especially in the commercial lines arena, are abominable, and we have begun to see some fraying around the edges. During the third quarter of 1997, we saw a few earnings bloopers, mostly from smaller to medium-sized insurers, but there was a sprinkling of big boys in that mix, too.

Furthermore, more chief executive officers, verbally and in written commentary, are cautioning investors about their top-line and bottom-line expectations. It should be noted that, with few exceptions, managements tend to err on the optimistic side when discussing the prognosis for their own companies, notwithstanding the operating environment.

Industry punsters are also cautioning investors about the outlook but have yet to really cut their 1998 earnings estimates. Some are even starting to pop out higher 1999 projections and hold to the belief that their favorite companies/recommendations will remain virtually unscathed in any carnage.

Industry gurus once again are dusting off their crystal balls and prognosticating the future. This is related to the advent of a new underwriting year and to the fact that there appears to be little else to talk about. The difficulty in calling a turn in pricing or underwriting cycle mirrors efforts to pick the shift in interest rate trends. You're wrong more often than you're right.

Having acknowledged our frailties, we nonetheless cannot ignore the opportunity to throw in our two cents. To begin with, no two underwriting cycles or pricing cycles are alike. Trees do not grow to the sky, and we do not believe that the bounce off the bottom this time, whenever it occurs, will be as powerful as the 1985-1986 recovery.

Everybody knows that commercial lines pricing is bad. Our take is that it is far worse than most analysts realize. In many instances, we sense prices are equal to or below 1985 levels when one adjusts for changes in terms and conditions. In fact, we do not understand how some companies can be making any money.

We are beginning to see some discussion of the current paid-to-incurred loss ratio and some speculation that because it is over the 100% mark, the cycle will turn. We unequivocally agree that after the 100% mark is reached, the next step is negative operating cash flow. In essence, above par, insurers are liquidating their reserves.

The current fly in the ointment is that the industry is apparently very well capitalized, as shown by the current 1:1 premiums-to-surplus ratio. While we do not quarrel with the theory or logic of a turn, the fact is the industry has simply not felt enough pain, and we are probably 18-24 months away from an inflection point.

While the pain ultimately will be related to underpricing, the real sticker is likely to be the material increases in retention levels and in an increasing number of instances, insurers falling prey to broker and client pressures to write multiyear contracts, in which they basically abrogate their pricing flexibility.

We suspect there are an increasing number of instances where multiyear contracts are being written on national accounts on an occurrence basis instead of on a claims-made form. This practice is likely to result in numerous insurers being kicked several times after they are down.

It is amazing that the industry is again exposing itself to a boom/bust scenario. One would have thought something was learned from the last debacle.

We continue to believe a reversal of fortunes will be caused by some type of financial catharsis that will come out of left field. Exposures to the Year 2000 problem, potential tobacco liabilities and/or the unwinding of some inflated expectations on relatively recent acquisitions tied in with the marvels of purchase accounting could start the ball rolling.

Earlier, we alluded to the fact that when the cycle finally does turn, we are not likely to see the type of euphoric bounce that followed the unwinding of the 1984-1985 crunch. Our perspective is based on the belief that capital has become much more fungible and moves very quickly within the industry. Hence, supply and demand distortions are likely to be addressed quickly. Furthermore, there is some subtle margin erosion on the horizon as it relates to the securitization of insurance risks and the prospect of "banking spread fees" infiltrating the business. More on this at a later date.

Myron M. Picoult is a vice president and senior insurance analyst at Wasserstein Perella Securities Inc. in New York. He is the past president of the Assn. of Insurance & Financial Analysts and a member of the New York Society of Security Analysts. This article and past articles by Mr. Picoult can be found online at www.businessinsurance.com/ticker/index.html.