The commercial insurance pricing cycle is bottoming out at last. But with the economy contracting, rates are not expected to start rising in general until the fourth quarter of this year, or perhaps even the first quarter of 2010, Advisen Ltd. predicts.

However, one investment firm foresees a hardening market as early as midyear.

The problem remains supply versus demand, according to Advisen--a New York-based insurance analytics and research firm that produces the quarterly "Benchmark Survey" of market conditions with the Risk and Insurance Management Society. Advisen estimated that the property-casualty insurance industry was roughly $100 billion overcapitalized as of the end of 2007.

Advisen said policyholders' surplus--statutory accounting terminology for the capital supporting underwriting operations--thus needed to be reduced by about $100 billion through losses, dividends, share buy-backs or other means to bring insurance supply in line with demand.

However, U.S. policyholders' surplus declined only $36.8 billion, or 7 percent, for the 12 months ended Sept. 30, 2008.

And while consulting firm Towers Perrin forecasted as much as an $80 billion decrease in industry surplus by the end of 2008--moving the market much closer to the bottom of its soft cycle--the demand side of the equation also has changed since the end of 2007, which might perhaps delay a rebound in p-c pricing, Advisen suggested.

With the global economy now officially in a recession, some suggest the economy might contract and post negative growth in 2009 due to the closing of businesses and millions of layoffs.

As companies disappear or downsize, explained Advisen, the demand for insurance not only decreases but falls at a pace faster than the contraction of the overall economy, thus tempting carriers to price more competitively to acquire and retain business.

While going without insurance is not an option for most companies, many will look for ways to slash their insurance bills. An obvious option is to raise retentions--which will increase the use of captives and other alternative risk-financing mechanisms, taking more funds out of the traditional p-c insurance market, Advisen noted.

Advisen predicted that more companies will also gravitate to low-cost providers, even if it is necessary to loosen financial security criteria. Although these are typical responses to hard market conditions, it is likely that companies will resort to them even before the market turns, as they are squeezed by a deteriorating economy, according to the firm.

Another factor that could keep market conditions competitive in some sectors is a weakened AIG battling for renewals, according to Advisen. Because AIG is perceived by its competitors as vulnerable, competition for its clients will remain intense, said the firm--warning that this heightened level of competition could keep price levels in some segments of the commercial lines market depressed after economic factors indicate the market should be hardening.

All these factors will help prolong the current soft market, Advisen predicted.

However, Advisen warned that one or more very large catastrophe losses could trigger a sudden and sharp increase in insurance prices. But if catastrophe losses are mild to moderate in 2009, average commercial insurance prices will not begin to creep higher until the fourth quarter of 2009 or the first quarter of 2010.

Not every line of business will increase at the same pace, Advisen added. For example, premiums already have increased for financial institution D&O and E&O coverage, where claims are up sharply because of the meltdown of the subprime mortgage market and ensuing credit crisis.

The reinsurance market will firm up sooner than the overall primary insurance market, placing upward pressure on heavily reinsured lines such as excess liability, Advisen observed.

While grim economic conditions might hinder any attempt to raise insurance premiums in the short term, the inability of carriers to bolster their balance sheets with investment gains has been substantially diminished, while reinsurance rates are reportedly rising, putting counterpressure on primary insurers to raise rates wherever and whenever possible.

"In years past, insurance companies recouped underwriting losses with investment income, but in 2008 the combination of underwriting losses and material investment losses means a five-year soft market is coming to an end," David K. Bradford, Advisen's executive vice president and chief knowledge officer, said in a statement.

"The global recession may delay the return of hard market conditions by keeping demand for insurance down, but once the hard market sets in, it is likely to last longer than was the case in recent cycles," Mr. Bradford added.

Meanwhile, security analysts at Sandler O'Neill--a New York-based investment banking and advisory service--were more bullish, predicting that significant capital losses in the fourth quarter of 2008 will cause property-casualty insurers to raise prices, prompting a hardening market by the middle of the year.

The analysts said p-c insurers suffered from losses as high as 20 percent in their investment portfolios in 2008, but that on a price-to-book ratio many p-c insurers are trading at levels not seen since the 1970s.

Back then, interest rates were much higher, noted an analysis by Paul Newsome, a managing director, and Edward Shields, associate director at Sandler O'Neill's Chicago office.

In fact, many insurers with solid capital levels and high claims-paying ratings are trading below book value, they said. "The relationship between return-on-equity and price-to-book values is also as uncorrelated as we have ever seen it," the two said in their report.

They also noted that most investors believe the relationship between ROEs and price-to-book values has been a primary way in which insurance companies have been valued for many years.

The investment losses, the report said, stem from declines in the values of high-grade corporate bonds and in municipal bonds, in which p-c insurers are heavy investors. Municipal bonds, the analysts said, had a very difficult fourth quarter, and that will weigh on insurers' balance sheets.

"When we last estimated the effect of investment returns on the insurers' book value, we estimated that the average bond portfolio would be down about 4.5 percent," the report noted.

Insurers with heavy equity investments would be most hard hit given what happened to that sector during the quarter, the analysts said, noting that equity investments have since rebounded somewhat.

The report predicted that many p-c insurers will not start to look at price increases until they have calculated their year-end 2008 statutory statements.

Based upon conversations with a number of insurers, Mr. Newsome and Mr. Shields wrote: "We think that many company managements will be surprised when they see their capital levels."

Typically, they said, statutory annual statements are compiled by March. "We think that the rating agencies will then add additional pressure to raise prices when they criticize many insurers for having less capital than necessary to maintain current ratings," the report added. "This should set the stage for a solidly hard market in the middle of the year."

According to the analysis, while many insurers--particularly large national insurers--are holding the line on insurance prices, many continue to lower prices.

"We believe American International Group, many mutual insurers and many regional insurers lack pricing discipline," the study said.

(With additional reporting by Arthur D. Postal.)

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