The U.S. property-casualty industry's third-quarter statutory surplus may decline as much as 8 percent–down $42 billion–through the first three-quarters, according to Towers Perrin, citing insurer equity and credit-related losses on asset portfolios, hurricane catastrophe losses, and a spike in directors and officers liability claims.

Additionally, if the stock market fails to recover from steep losses precipitated in recent weeks by the financial crisis, Towers Perrin said the surplus decline could approach $80 billion, or 15 percent, by the end of the year.

Meanwhile, Fitch Ratings warned last week it is likely to reduce the ratings of U.S. and European insurers and reinsurers because the global financial meltdown will soon force them to write down the value of their investments.

The firm said this action is likely for 12 insurance and reinsurance sectors globally, including the U.S. property-casualty and title insurance sectors, as well as the property-casualty sector for France, Germany, Italy, Switzerland and the United Kingdom.

As a result, Fitch analysts said, the firm has decided to revise its rating outlook to “negative” from “stable” for these sectors.

Among other issues, Fitch voiced particular concerns about global reinsurers due to their ceding arrangements, which makes them especially vulnerable to ratings downgrades.

All the warnings primarily reflect the fallout from “significant deterioration in the global financial markets and its impact on insurers' balance sheets and financial flexibility,” the rating firm said.

“Potential liquidity pressures are generally less severe for insurance companies than they are for other types of financial institutions,” Fitch analysts noted.

Nonetheless, the analysts added, “Fitch believes liquidity could become pressured for some…reinsurance companies, especially if they experience declines in their credit profiles that lead to erosions in market confidence.”

As for p-c insurers, declines in investment values and capital have exacerbated other pressures the sector was already facing, including ongoing intense competition and “soft” premium rates in many lines of business, together with the expected general deterioration of underwriting results and reductions in reserve releases as compared to recent years, according to Fitch.

While capital pressures could ease the softening trend in pricing, Fitch analysts cautioned that “it would be premature to predict a shift to a hardening market.”

As for reinsurers, the analysts noted that they could face some liquidity pressures in the current volatile financial market environment.

In many cases, reinsurers use bank letter-of-credit facilities to provide security for ceding companies, the analysts said, noting that “it is not uncommon for such facilities to contain ratings triggers that require the reinsurer to post cash collateral if their financial strength ratings fall below a defined level–typically below 'A-minus.'”

In addition, the analysts said, “some reinsurance contracts contain cancellation or recapture provisions also tied to ratings triggers that could cause the reinsurer to fund the return of a portion of premiums to the ceding company in unwinding a contract.”

“Buyers of commercial insurance will need to pay more attention to insurance purchasing decisions and consider contingencies in renewal planning,” said Stephen Lowe, managing director of Towers Perrin's global Property & Casualty Insurance practice. “The focus will now be on the quality of security offered by insurers.”

Mr. Lowe added that buyers also will need to include insured claim liabilities in their overall management of counterparty risk. “Since the capability to estimate gross liabilities–rather than just net retained liabilities–is essential to measuring counterparty exposure, some companies may want to develop or refine these estimates,” he observed.

The financial meltdown also might stop the softening p-c insurance market in its tracks, according to the consulting firm.

Commercial insurance prices declined about 5 percent in the first half of 2008, on top of similar declines in each of the prior two years, according to the most recent Towers Perrin quarterly Commercial Lines Insurance Pricing and Profitability Survey, noted Mr. Lowe.

“The current situation will cause price levels to stabilize, if not increase,” he said, adding that while losses are widespread, “we aren't expecting any company failures. However, some downgrades from the rating agencies are likely.”

He called the current financial crisis a “wakeup call for all companies. Risk management is now more than ever an imperative. Recent failures are examples of failures in risk management, not of risk management.”

Mr. Lowe said the magnitude of the failures makes clear the need for “a strong risk culture, deployment of tools to support risk-based decision-making, and clearly stated risk appetites.”

Despite the reports of doom and gloom, it could have been worse, according to a report from Willis, which noted that the general insurance industry has experienced a relatively contained impact from the credit crisis because of its limited exposure to subprime investments.

“The general insurance sector as a whole appears to have remained relatively isolated from the direct impact of the credit crisis so far,” Sally Bramall, managing director of Global Carrier Management at Willis Group Holdings, said in a statement.

“While there have been some notable exceptions, these have been companies that have stretched the boundaries of traditional insurance, assuming more of a 'financial superstore' structure,” she added.

Unlike banks, insurers did not play a key role in each link in the chain of transactions that originated mortgage loans, and subsequently bought, warehoused and distributed the derivatives to investors throughout the financial sector, Willis said.

The report also noted that the investment portfolios of general insurance companies typically contained smaller proportions of subprime-exposed collateralized debt obligations and less mortgage-backed securitizations compared to banks.

Most of the direct impact on insurer underwriting portfolios has been limited to errors and omissions and directors and officers lines, where liability claims can be made.

The estimated market loss from D&O and E&O litigation could range from $6 billion to $20 billion, with claims related to subprime litigation expected to evolve slowly, and insurers thus far able to absorb losses, according to Willis.

While there were some notable exceptions that stretched the boundary of traditional insurance, most insurers have so far remained isolated from the direct impact of the credit crisis, the report said.

There will “inevitably be some wider impact on the investment portfolios and investment returns of general insurance companies” that will become more evident in coming reporting seasons, Willis predicted.

Anticipated moderation of the current soft market appears to justify a stable ratings outlook, the report concluded. However, those ratings will be subjected to review as the financial turbulence continues in the coming months, Willis warned.

Special Reports /

Industry's Surplus Might Sink 15 Percent, Dropping $80 Billion By Year's-End

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