Fitch Revises Outlook on U.S. Commercial Lines Sector to Stable

Fitch Ratings has revised its rating outlook for the U.S. commercial lines insurance sector to stable from negative. Fitch had maintained a negative rating outlook on the sector since September 2000.

The revised outlook reflects Fitch’s expectations for fewer rating changes in the near term, and that the number of rating downgrades will more closely equal the number of upgrades going forward. A major contributing factor behind this change in outlook is Fitch’s somewhat improved view of the industry’s reserve position.

Operating results for commercial insurers have been adversely impacted for the last three years by unfavorable reserve development from recent accident years in longer-tail commercial lines and older asbestos exposures. Fitch’s recently updated reserve analysis indicates that the industry still has a material reserve deficiency, but the deficiency has declined somewhat due to recently reported adverse development and indications that reserves for the most recent underwriting period are being set more conservatively.

Fitch believes that its current ratings incorporate potential reserve shortfalls that still exist for many insurers. Thus, if reserves do develop unfavorably, but remain within expectations, then ratings will be affirmed. Negative rating actions may still occur in cases where reserve charges exceed prior expectations.

While prior period reserves are expected to continue to develop adversely going forward, the earnings impact from development is expected to moderate. Also insurers have recently experienced improvements in underwriting performance and earnings for their current book of business that dampens the effect of past reserving issues on current earnings.

Barring any unusual events, the U.S. property/casualty insurance industry is on track in 2004 to report its first underwriting profit since 1978. The commercial lines sector is participating in this improved performance as commercial insurers reported a first quarter 2004 combined ratio of 94.7 percent and a full year 2003 combined ratio of 101.2 percent according to Insurance Services Office, Inc. (ISO).

Currently, pricing conditions in commercial insurance are adequate across a wide spectrum of the market. Although premium rate increases in the sector have moderated from those prevalent in 2002 and 2003, and will likely decline in the near term, Fitch does not anticipate a return to the grossly inadequate pricing and aggressive underwriting practices of the late 1990s in the intermediate term.

Factors that may contribute to pricing stability in the near term include the removal of many unsuccessful commercial underwriters from the market through insolvencies and market exits over the last several years, and interest rate and investment market conditions that are not conducive to ‘cash flow underwriting’.

Fitch will continue to monitor pricing and underwriting trends closely going forward to assess the potential for the market to maintain profits at or near current levels, and forestall the inevitable return to softer pricing conditions.