Despite Market Progress, P/C Rating Downgrades Top Upgrades

The financial strength of the U.S. property/casualty insurance industry remained strong over the past year, maintaining the operating momentum achieved from the prior 12 months, according to a recent A.M. Best report. Improved operating results contributed to the industry’s growing surplus base as insurers rode the wave of compounded annual rate increases and tighter terms and conditions, causing loss ratios to decline in most lines. With healthy earnings reported by the industry, operating leverage continued to decline slowly, while premium and reserve adequacy improved, representing a true strengthening of the industry’s collective capitalization.

However, the report says the full balance sheet replenishment from the soft market will take several more profitable years, as a sizable $59 billion loss-reserve deficiency must be overcome. In addition, Best continues to be concerned with the quality of capital, as substantial reinsurance recoverables, terms and quality of reinsurance and inadequate loss reserves potentially could have a negative impact on capital. Just as the overall strength and quality of capital differ among the industry’s varying players, the wealth of surplus gains has not been distributed equally.

Furthermore, while many insurers have benefited from this favorable pricing cycle, others have found it difficult to reverse several years of inadequate pricing that led to poor underwriting returns. Despite further improvement from last year, rating downgrades outpaced rating upgrades over the 12-month period ended July 12, 2005, for the fifth consecutive year. The reader should note that this study covers the 12-month period ended July 12, 2005, and therefore the effects of catastrophes in the latter half of 2005, most notably Hurricane Katrina, are not factored into the analysis.

The basis for the majority of rating downgrades continues to be the adverse development of prior accident year loss reserves, especially for commercial-lines carriers that are exposed to longer-tail liability lines such as workers’ compensation, general and products liability, medical malpractice, directors and officers, and surety.