Stricter capital models and declining pricing could make 2007challenging for commercial line insurers, a new Standard &Poor's report said.

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But the rating agency is nonetheless maintaining a stableoutlook for commercial writers.

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As 2006 draws to a close, many commercial property-casualtyinsurers are generating exceptional earnings. "Many balance sheetsare in their best shape since the late 1990s, when the industryentered its last cyclical pricing downturn," the report said.

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Still, moderate but steady pricing declines across most lines in2006, a trend expected to continue in 2007, could slowly butsteadily erode profit margins next year. The impact of thaterosion, however, won't be fully reflected in sector earnings until2008, S&P said.

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"Overall, we believe the most serious threat to the commerciallines sector is the potential for a return to more competitivepricing," said Standard & Poor's credit analyst John Iten.

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The massive storm losses in 2005 temporarily slowed the pricedeterioration then underway in both property and casualty lines.Since then, casualty rates have continued to decline, whilecommercial property rates have strengthened somewhat.

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"Still, signs have emerged that property pricing might havepeaked," Mr. Iten said. "Low catastrophe losses could encouragemore aggressive pricing, but should not drive ratings over the nextsix months."

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A new model measuring insurer capital strength could makepositive actions less likely, the report said. The model will beused in tandem with existing capital models to assess the capitaladequacy of insurers as of year-end 2006.

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"Many companies' capital might look less strong under this newmodel," Mr. Iten said. "We don't expect to downgrade companiesbased solely on this new model, but we could take action on thoseit identifies as significant outliers."

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