Property-casualty insurers facing continued market volatility this year must focus on coping with factors such as price stabilization, claims inflation and increased regulation, a consulting firm said.

That advice was contained in the Ernst & Young Global Insurance Center's US property/casualty industry outlook for 2009, which found in 2008 the p-c sector had been spared serious impact from the financial crisis.

"Insurers will need to address a wide range of risks, including continued volatility in investment and underwriting performance, a potentially active mergers and acquisitions (M&A) market and a more rigorous regulatory landscape," advised Peter R. Porrino, global insurance director for Ernst & Young's Global Insurance Center.

Mr. Porrino said, "Looking ahead, this may be the beginning of a transitional, if not transformational, environment for the industry," and "Those insurers with strong leadership and financial flexibility will be poised to move forward in this unstable market.

Ernst & Young cited seven areas that it said insurers should address.

Listed first was a redirected focus on premium pricing. The firm said in most p-c business segments, pricing levels have remained soft for the past four years, but early signs of pricing negotiations show that the market is firming in most lines.

Ernst & Young said that there should be a move toward price stabilization as insurers and reinsurers focus on loss volatility and the potential for megalosses in highly developed, catastrophe-prone locations.

At the same time, the company noted that losses in directors and officers and errors and omissions products are likely to result in price increases in those markets.

Insurers were advised to monitor claims inflation risk. Ernst & Young said the economic climate is likely to continue in a volatile pattern that drives claims costs.

The consultants said that, recession and deflations concerns aside, over the longer term the industry will have to consider the massive deficit spending undertaken by the federal government. Insurers' exposure to inflationary risk, it was noted, can be fundamentally different from the factors that drive inflation in the broader economy: medical costs, construction costs and tort issues continue to account for the lion's share of the industry's inflation trend.

Companies, said Ernst & Young, should prepare for changes in regulatory oversight because momentum for changes in insurance regulation is building.

Based on market events, including the federal involvement in the banking industry, "it is almost certain that the industry will face increased and more intrusive regulation. This is likely to include closer monitoring of activities and financial performance and to require greater consistency and transparency," Ernst & Young predicted.

Companies, the firm said, should prepare for changes in accounting requirements and moving forward, a thorough understanding of accounting issues will be critical as companies prepare to adopt a new financial reporting platform.

Ernst & Young noted that with the expected convergence of US Generally Accepted Accounting Principles and International Financial Reporting Standards, companies are beginning to prepare for the anticipated change to a market-consistent framework. Insurers must plan for those changes, which will include significant operational modifications, it counseled.

Insurers must also work on controlling expenses, said Ernst & Young, pointing to a decade in which expense ratios have been steadily rising.

The firm said underwriting, acquisition and general expense ratios, as a percentage of premiums, are expected to come in at 27.5 percent for the p-c industry overall in 2008, higher than any year since 1999.

Ernst & Young said premiums and sales should have grown in tandem, "but this has not happened. As a result, the p-c industry is likely to see more expense-cutting in 2009, but the cuts must be strategic or they could result in more troubles."

On the topic of risk modeling, Ernst & Young called for a rethinking. Insurers, the firm said, will need to incorporate lessons learned into their risk management functions.

It said a significant finding in the past year is that companies should not rely too fully on risk models, but should make them part of an organization's overall risk management process.

Senior management, said Ernst & Young, must review and adjust models within the framework of real-world trends and influences.

As a final piece of advice, the company said insurers should watch for new M&A activity, noting that total insurance properties currently available for sale exceeds all the M&A activity for the past several years combined.

Some companies will emerge from the current situation with strong balance sheets and use a portion of their capital to fund acquisitions. However, they will likely wait until the depth of the current economic downturn, and its impact on operating performance, is better understood, Ernst & Young predicted.

Mr. Porrino said, "While there are many uncertainties in today's economic climate, those same challenges can become great opportunities for the companies that remain flexible."

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E%amp;Y Suggests Focus Factors For Insurers In '09

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