With catastrophe losses mounting in the second quarter and themagnitude of premium rate declines easing, rumors of an end to thesoft market began to creep into insurance news headlines thismonth. However, net written premiums and underwriting profitresults for 2007 compiled for this edition of NU's annual Top 100ranking of the biggest property-casualty insurance companies andgroups give little indication that any change will come soon.

These statistics, presented on pages 14-18 of this edition,reveal that despite essentially no real premium growth in 2007,there were continued underwriting profits for mostinsurers–amounting to more than 4 percent of earned premiums onaverage last year.

The idea that “we may be nearing the bottom of the soft market,”expressed by Richard Kerr, founder and chief executive ofMarketScout, came in conjunction with data for a more recent timeframe–the release of the firm's June Market Barometer.

The barometer's composite commercial insurance premium ratedecline of 11 percent for June was the same level as the Maydecline, and down from a 14 percent drop estimated by the firm forJune 2007.

The notion that the month's indicator presages a near-termmarket shift, however, stands in stark contrast to theories ofother experts who believe that only significant losses orsubstantially inadequate premiums will fuel a turn to higherinsurance prices.

Speaking to National Underwriter in May during the CasualtyActuarial Society Seminar on Reinsurance, Paul Kneuer, senior vicepresident for Holborn Corp. in New York, for example, reiterated aview his firm put out in January–that a turn in the worldwidereinsurance market won't happen until the segment experiencescatastrophe losses of $50 billion, or three times the magnitude ofreinsurance losses from Hurricane Katrina.

Advancing a very different view of what drives cycles at thesame seminar, Isaac Mashitz, chief pricing actuary for Armonk,N.Y.-based Swiss Reinsurance American Corp., demonstrated that thehorrible soft market underwriting results experienced by primaryinsurers at the bottom of the last soft cycle had nothing to dowith extraordinary losses.

Instead, Mr. Mashitz showed that inadequate premiums were theculprit that produced accident-year loss ratios for commercialcasualty lines well in excess of 100 in the early years of thisdecade.

Expanding on Mr. Mashitz's analysis and adding expense ratioresults for these lines produces combined ratios well north of 120for the late 1990s and early 2000s– results that only the mortgageguaranty and financial guaranty lines have approached morerecently, in 2007 and early 2008.

While Mr. Kneuer's report discussed the impact of propertycatastrophes and capital levels on the worldwide reinsurancemarket, Mr. Mashitz set his sights on exposing cycle drivers forcommercial liability insurance lines–more precisely, asking whatdrives the dreadful underwriting results that come during the worstyears of a soft cycle for primary liability insurers.

During his presentation at the Boston actuarial gathering, Mr.Mashitz analyzed historical gross premiums and loss data foraccident years 1984-2006 for four casualty segments: commercialauto liability, nonprofessional liability (other liabilityoccurrence and products), workers' compensation, and professionalliability (other liability claims made).

Commenting on commercial auto liability, he highlighted the lackof growth in industry premiums from 1987 to 1999, noting that grosspremiums for the line were $15 billion in 1987 and only $15.5billion in 1999. “That's a 13-year span during which the industrydid not increase its premiums,” even though “there was growth inthe economy, some inflation,” he noted.

As a result, for the same years, the loss ratio grew from 72 in1987 up to a “clearly unprofitable” level of 106 in 1999. “Premiumsremained static, as losses grew more than 50 percent,” he said,displaying a chart revealing loss growth which amounted to just 3.5percent per year, on average.

“You'll see that pattern again and again,” he continued, goingon to make similar observations for the other casualty insurancelines he analyzed. For general liability, in fact, the pattern iseven more disturbing, he said–noting that premiums fell from $26billion in 1987 to $22 billion in 1999, while the loss ratio surgedfrom the low 50s to over more than 120.

Such patterns, he said, led him to consider what would havehappened if premiums had just increased steadily by small amountseach year, instead of remaining flat or declining in the late 90s,and then soaring from 1999 to 2002.

For each line, he demonstrated that such increases would havenearly eliminated the cyclical movements in loss ratios.

In the accompanying chart–titled “Soft Market Premiums”–NU hasrecreated a portion of Mr. Mashitz's presentation for accidentyears 1998-2006, with updated data now available for 2007, alsoadding information for accident year 2007. (Mr. Mashitz used dataavailable through 2006 for his presentation.)

“Low and behold, the cycle essentially disappears,” he said,pointing to the column of “restated loss ratio” figures and noting,for example, that for commercial auto liability, restated lossratios stabilize–remaining in a range from the mid-60s to low-70sfor most years in the 1987-2006 time frame.

“A simple premium increase of 3 percent per year would havetaken away the cycle for commercial auto [and] general liability,”he said, also noting that just a 4 percent increase would have hadthe same type of effect for the workers' comp line.

“The horrible results we have in the last soft market weredriven by inadequate premiums, not by an explosion in losses” forthese lines, he concluded.

Unlike Mr. Mashitz, who looked at premium adequacy for hisanalysis of the U.S. primary casualty market, Mr. Kneuer analyzedrelationships between gross premiums and capital for the worldwidereinsurance market dating from 2001 through the third quarter of2007.

Noting that there is no source of historical data for the entireworldwide reinsurance market, Mr. Kneuer combined information fromthe Reinsurance Association of America with information on Bermudapublic companies, European reinsurers and Lloyd's.

After adjusting for currency and accounting differences as wellas intercompany transactions, Holborn compiled summaries of grosswritten premiums, underwriting gains and losses, net income, andchanges in capital funds for more than 90 percent of the worldwidereinsurance market. The firm used the information to analyzehistorical leverage ratios–ratios of gross written premiums tocapital–and to develop estimates of premium, income and capital for2007 and 2008.

Added together, gross premiums for the latest full yearavailable–2006–topped $200 billion ($19 billion for U.S. reinsurersother than National Indemnity, $58 billion for Bermuda, $98 billionfor Europe, and $31 billion for the Lloyd's market), while year-endcapital approached $217 billion.

The resulting leverage ratio–.94-to-1–is a far cry from the1.7-to-1 ratios of 2001 and 2002 shown in his firm's report.

Worldwide premiums have grown slower than capital, Mr. Kneuerobserved, using his knowledge of market changes since third-quarter2007 to predict a continuation of that pattern for 2007 and2008.

Despite share buybacks and acquisitions, which released somecapital from the industry, his firm's resulting estimates(summarized on the accompanying chart, “Analyzing the ReinsuranceMarket”) reveal leverage ratios falling under .9-to-1 for 2007 and2008.

Interpreting the implications of these estimates for NU, Mr.Kneuer noted that for the industry to return to even a moderate1.25-to-1 leverage ratio–roughly the average of the historicalratios calculated for 2001-2006–would require a reduction incapital of at least $50 billion.

Mr. Kneuer, whose firm published the first report that NU cameacross this year containing the now much-repeated $50 billionfigure, put the number in perspective.

Reinsurers paid out somewhere between $15- and $20 billion inlosses after taxes for Hurricane Katrina. Therefore, it would takethree Katrina-sized events to reach an average historical leverageratio, he said.

Mr. Kneuer told NU at the May meeting that while the speed ofcapital charges related to subprime issues and somelower-than-expected reported premiums for reinsurers in the firstquarter have been a bit of a surprise, his firm's view of amarket-turning event has not changed fundamentally since theJanuary report.

The 2008 estimates contained in the report assume no individualcatastrophes over $10 billion and roughly $3 billion inprofessional liability reinsurance losses related to subprimemortgage issues.

Even with a major loss in 2008, reinsurers' capital will remainabove industry premiums, and it will be much higher than historicalnorms, the report said.

While natural catastrophes in 2008 may not turn the market, theyare occurring in record numbers, according to market reports. Inaddition, several second-quarter events are already producingunderwriting losses for some U.S. insurers–including two rankedamong the 100 largest property-casualty insurance groups.

Cincinnati Financial, the 21st-largest group in NU's Top 100,after recording a combined ratio of 90.3 for all of 2007–nearlyfive points better than the industry–recently reported that $115million in catastrophe losses will add 15 points to its combinedratio for the second quarter.

Columbus, Ohio-based State Auto, ranked 49th, which recorded acombined ratio for 92.4 in 2007, expects roughly $80 million inpretax catastrophe losses for the quarter–nearly four-times higherthan the level of catastrophe losses the company experienced insecond-quarter 2007.

While these isolated regional insurer reports give littleindication of the overall toll on the industry and the adequacy ofindustrywide premium collected to cover such risks, Standard &Poor's recently stated that second-quarter catastrophes–primarilyMidwest floods–are not expected to impact ratings for the majorityof rated companies.

The ultimate impact of the subprime and related credit crisis onthe industry is also unclear, but the most direct hit tounderwriting results became visible in the Top 100 rankings for2007. Financial guaranty and mortgage guaranty insurers, which showup with the lowest combined ratios in the industry for nearly everyyear in the history of NU's published rankings, emerged with theworst combined ratios in 2007.

In total, 11 financial guaranty companies included in therankings reported an average combined ratio of 159.1 in 2007,compared to 38.0 in 2006, while 38 mortgage insurers came in with acombined ratio average of 133.0 in 2007, compared to 70.7 in2006.

In first-quarter 2008, despite the fact that all 49 guarantyinsurers only contributed $2 billion in net premiums to a $112billion total for the industry, their overall first-quartercombined ratio of 275.9 was bad enough to add more than threepoints to the industry first-quarter combined ratio, bringing it toa breakeven level of 100.0.

Looking past the guarantors, first-quarter 2008 results and 2007figures presented on our rankings reveal a relatively unchangedpicture from the one Mr. Mashitz and Mr. Kneuer saw when they putout their studies.

For the industry as a whole, and for the top 20 groups takentogether, premium changes for 2007 were measured in tenths of apercent, with net written premiums for the top 20 rising only 0.1percent, and industry aggregate premiums down 0.2 percent overall.The only evidence of growth came for groups making acquisitions,such as Liberty Mutual's deal for Ohio Casualty, and QBE's dealsfor Winterthur U.S. and Praetorian.

The industry aggregate combined ratio deteriorated three pointsto 95.6 in 2007, compared to 92.4 in 2006. But even infirst-quarter 2008, it remained comfortably below breakeven fornonguaranty companies.

Not all lines continued to be profitable in 2007, however, asthe biggest line–personal auto liability–joined the smallestguaranty lines with an underwriting loss. The personal autoliability 2007 combined ratio of 101.2 marked the firstunderwriting loss for the line since 2003.