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Commercial property/casualty insurers are reporting record results despite the softening market.
"In terms of reported results, it's the best of times," said Andrew Colannino, vp in Oldwick, N.J.-based A.M. Best Co. Inc.'s P/C division.
The trend is expected to continue this year, with insurers still posting strong results--although not as strong as 2006--while overall rates continue to decline, observers say.
Boosted by low catastrophe activity last year and the continuing momentum of past rate hikes, the 14 major U.S. commercial property/casualty insurers surveyed by Business Insurance reported a 51.4% increase in net income, which rose to $31.76 billion in 2006.
Among other survey results:
"It certainly was a very good ending to an exceptional year," said John Iten, director at rating agency Standard & Poor's Corp. in New York.
Strong fundamentals, declining claims frequency, favorable reserve developments, growing investment income and successful state tort reform efforts were additional factors contributing to the strong results, say observers.
"While pricing is moderating, there's still profitability that was embedded in the casualty book" as a result of previous rate hikes, said Jeffrey Berg, a vp and senior analyst with Moody's Investors Service Inc. in New York.
"We did not see in 2006 any noticeable loosening of terms and conditions," which can be problematic, said John Gwynn, managing director at Memphis, Tenn.-based investment firm Morgan Keegan & Co. Inc.
There is anecdotal evidence that the industry has benefited from tort reform, although the trial bar may ultimately be successful in diminishing its impact, Mr. Gwynn said.
"Claims frequency continues to be lower than in previous years," said John L. Ward, chief executive officer of Cincinnati-based Cincinnatus Partners L.L.C., an advisory firm specializing in the insurance industry.
Furthermore, the industry had positive prior-year reserve adjustments compared with the previous four or five years, when "the reserve adjustments were adverse in a fairly significant way," Mr. Ward said.
"We had expected some deterioration in the fourth quarter, just reflecting the normal reserve strengthening, but there really wasn't much of that," said Mr. Iten.
Observers say the 2007 outlook is for another strong year for the industry, although it will not be as robust as 2006 because of the likelihood of more catastrophes and continuing soft pricing.
"We're projecting there will be some deterioration (in results), just because we expect a return to a normal level of cat losses," said Mr. Iten.
In addition, pricing softness "will start to show up in weaker margins during 2007," he said.
"The industry would be hard pressed to equal the level of 2006 results," said Mr. Ward. Most industry executives recognize "that it has to come down a little bit in 2007 and 2008, and so there's a lot of thought and consideration into how to brace for a year where soft prices are kicking into the marketplace in a fairly significant way," he said.
Maintaining pricing discipline and surplus levels "will be a challenge," but "I think the results will continue to be pretty strong in the foreseeable future, if for no other reason than just the very strong momentum and balance sheets as of the end of 2006 for the industry as a whole," said Mr. Ward.
"It would be difficult to match 2006" in terms of profits, combined ratios and return on capital, "but it should still be a pretty good year" barring severe catastrophes or unusual events such as terrorism, said James B. Auden, senior director at Chicago-based Fitch Ratings.
Mark Lane, an analyst with William Blair & Co. in Chicago, said the claims inflation environment remains benign, "so even though we're expecting price pressure to continue, margins should hold up pretty well for the underwriters given that the cost side is actually, in certain cases, coming down."
Prices will continue to moderate, say observers. "If there is another pretty light year for catastrophe losses, we think the pricing pressure will intensify as we move towards the back half of 2007, and we see almost nothing that's going to stop the market from continuing to become more competitive," Mr. Lane said.
Last year "was by far a record year for underwriting margins and underwriters are going to react to that, and try to aggressively price their renewal book," he said.
Price decreases in 2006 were about 8% to 10% "and I would expect to see it accelerate in 2007 and 2008--each year by a rate of about 10% to 15%," said Mr. Gwynn. "And as those weaker prices are absorbed into the income statements via earned premiums, that's how the pressure is going to come on underwriting profitability."
However, Mr. Iten said, "We don't think (the competition is) going to be 'falling out of bed.' We think it's going to remain fairly disciplined."
Meanwhile, many observers expect more merger and acquisition activity this year. Earlier this month, San Antonio-based Argonaut Group Inc. and Hamilton, Bermuda-based PXRE Group Inc. announced plans to merge. (BI, March 19).
Skip Hagerty, managing director at Philo Smith & Co., a Stamford, Conn.-based investment banking firm, said the M&A activity is being fueled by private equity investors and hedge funds who are aggressively seeking insurance investments, as well as by P/C insurers that can no longer grow organically in the softening market. "You've got pretty well-positioned balance sheets. There's no shortage of capital," he said.
Insurance executives appear open to entertain M&A discussions "more so than in the past," said Mr. Ward. "I think it'll be a strong year for M&A activity and I think we'll see more activity at the regional company level, and it won't be just limited to the large national companies."
Mr. Lane also said as the industry moves towards a more difficult period of the cycle, there may be more M&A activity, particularly among the newer Bermuda companies seeking a larger U.S. platform for their business.