A.M. Best Co. has completed its assessment of the U.S. commercial market and is extending its negative outlook for 2006.
As a consequence, A.M. Best anticipates that there will be few rating upgrades or positive rating outlooks assigned in 2006 due to pricing deterioration in 2005, the expectation of continued, albeit lessened, reserve development and the dimmed long-term business prospects attributable to the emergence of a new soft cycle. This outlook is not a reflection of the results posted in 2005 but is more forward-looking, taking into consideration A.M. Best’s view of the sector over the next 12 to 36 months.
In 2005, U.S. commercial lines insurers continued to recognize the benefits of cumulative rate increases and actions taken in past years to strengthen both core and legacy reserves. During this period, A.M. Best believes that many U.S. commercial lines insurers were the recipients of much improved pricing, proving the old adage, “a rising tide lifts all boats.”
With the beginning of a new soft cycle now underway, however, A.M. Best believes price erosion, loss cost inflation and higher reinsurance costs will lower profit margins for the U.S. commercial lines sector in the intermediate term. In the near term, however, net underwriting profits are likely to be reported in 2006, assuming more normalized catastrophe losses and continued, albeit moderate, funding of prior year reserves.
While few can reportedly argue with price adequacy and the level of earnings improvements within the commercial sector today, A.M. Best’s outlook is prospective in nature and takes into consideration the future consequences of price softening and the assumption that terms and conditions have already been compromised in certain segments of the market. This outlook also recognizes the effects of internal and external pressures on optimizing capital, market overcrowding and the ever present potential for irrational behavior.
Based on these assumptions, A.M. Best is concerned with this sector’s ability to sustain any new pricing momentum over the long term. Although Hurricane Katrina may have helped stall further price cutting in the commercial property segment, its impact on commercial casualty pricing is likely to be modest.
Furthermore, the sector’s ability to preserve capital while maintaining balance sheet integrity through another prolonged soft cycle is of great concern to A.M. Best. Terrorism also casts a shadow on the long term prospects for this sector.
Going forward, A.M. Best believes rating upgrades will be few in number until companies can truly demonstrate their underwriting acumen through soft market cycles. Those companies that are able to navigate through these cycles will benefit from rating upgrades over time. On the other hand, those companies that have insufficient price monitoring tools, relaxed underwriting standards and are aggressive during soft markets are certain to face negative rating actions in the future.
A.M. Best has and will continue to take a more rigorous approach in its due diligence when evaluating companies’ capitalization, cycle management and risk management controls. Exposure to terrorism, its impact on capitalization and the uncertainty surrounding a long-term solution to this issue are key concerns. Catastrophe models will continue to be valuable tools for the quantification of risk, but not the only barometers.
As part of risk management and cycle management, companies will need to demonstrate their ability to monitor and measure risk and provide quality data and adequate underwriting and risk controls.
Consequently, A.M. Best will be requiring more detailed information through its supplementary rating questionnaire and in company meetings.
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