Recent reports generally agree that the property and casualtyindustry outlook for 2014 is “stable,” with rate increasescontinuing, but moderating from the pace of the last two years.

Ratings agency Moody's Investors Service recently gave the global P&C industry a stable outlook fornext year. Fitch Ratings yesterday offered a similar assessment,giving a stable ratings outlook to both commercial and personallines, and a stable sector outlook as well.

Fitch says its ratings outlook reflects that “a large majorityof ratings in Fitch's universe currently have stable ratingoutlooks, and over the next 12−18 months limited rating changes forindividual issuers are anticipated.”

The sector outlook takes into account improved fundamentals inthe industry, but also an expected peak in the market cycle.“Returns on capital are forecast at approximately 8.5% in 2013 and7.4% in 2014, and are unlikely to improve further in the currenthardening market phase to the double-digit levels achieved from2004−2007 due to looming competitive pressures and the profitstrain from low investment yields,” Fitch says.

Fitch's report provides insight into some of the key factorsthat point to a stable outlook for the P&C industry.

Demonstrated Aggregate Loss ReserveStrength

Fitch notes that 2013 will be the eighth consecutive year offavorable calendar-year prior-period reserve development. Theratings agency notes that, aside from benefitting from conservativereserve levels in the 2003−2006 accident years, the prolongedlow-interest rate/inflation environment “has also promotedstability in loss costs and reserve adequacy.”

Fitch expects the pace of favorable development to decline in2014, and notes that some key segments, such as workers'compensation and commercial auto, have shown reserve weakness.Additionally, some companies such as Tower Group, MeadowbrookInsurance Group and QBE North America have reported recent adversereserve development.

But Fitch says it continues to believe that the industry'soverall loss reserve position is adequate.

Reinsurance Competition Benefits PrimaryInsurers

Fitch says ample traditional reinsurance underwriting capacity“is augmented by considerable growth in third-party capital andalternative vehicles such as catastrophe bonds and side cars.”

The ratings agency says insurance securitizations “have reacheda critical-mass level” and are likely now a permanent fixture inthe reinsurance market.

Catastrophe bond issuance, Fitch notes, reached near-recordlevels of more than $6 billion through the first 11 months of 2013,with expected strong issuance during the final month of theyear.

As a result, reinsurance pricing is projected to decline at 2014renewals, says Fitch.

Primary insurers, therefore, “will have a greater opportunitygoing forward to reduce the overall reinsurance spend, or optimizeproperty reinsurance structures and add to top-layer coveragewithout ceding additional premium relative to prior years.”

Signs of Slower Premium RateIncreases

Broad-based rate increases across nearly all segments for thelast two years have represented “the most significant factor behindthe turnaround in insurers' operating performance,” according toFitch.

While the increases are expected to continue in primaryinsurance lines, Fitch notes there are signs that the pace isbeginning to slow. The ratings agency points to the Council ofInsurance Agents & Brokers' Quarterly Commercial Market Pricingsurvey, which indicates that rates across all segments were up 4.3% in the third quarterversus 5.2% in the previous quarter.

For personal lines, Fitch says MarketScout's monthly barometerhas hovered between 3% and 4% throughout 2013.

Fitch says it anticipates a more pronounced flattening inpricing to materialize in the second half of 2014.

Low Yields Restrict InvestmentIncome

“Total reported statutory investment returns will be boosted bysubstantial unrealized investment gains from equity investments in2013, barring unusual year-end market movement,” says Fitch.“Investment income from interest and dividend payments will declinemodestly in 2013 as growth in investment assets is not offsettingreductions in portfolio yields.”

Fitch says investment contributions to earnings will continue tobe pressured as Federal Reserve monetary policy “remainsexpansionary and supportive of lower rates.”

Uncertainty of Terrorism Reinsurance ProgramRenewal

The Terrorism Risk Insurance Act (TRIA) is set to expire at theend of next year, and Congress is hearing from all sides aboutwhether to renew the program, allow it to sunset or renew it withmajor alterations.

Over the last decade, says Fitch, commercial-property insurershave enhanced their ability to measure and model exposure toterrorism events, with net exposures managed through theavailability of large reinsurance limits through TRIA.

Withdrawal of the program without readily available substitutecoverage “will likely move insurers to exclude terrorism fromproperty coverage to manage risk aggregations in urban centersdeemed at greater risk of terrorist events,” Fitch notes.

The ratings agency adds, “Regulatory requirements in most statesdo not allow insurers to exclude terrorism coverage from workers'compensation policies. Without a program similar to [TRIA],insurers may choose to withdraw workers' compensation underwritingcapacity from urban markets to manage risk concentrations.”

Catastrophe Losses Below HistoricalNorm

While cat losses were below historical norms in 2013, Fitchstresses that the “modest respite…does not diminish perspectives onthe potential risks of natural disasters as population and propertyexposures in coastal areas and earthquake prone regions continue toexpand.”

Fitch notes that losses from hail storms, tornadoes and forestfires were still substantial in 2013, but hurricane season was farless eventful, with just 13 named Atlantic storms, two hurricanesand no major hurricanes. According to the National Oceanic andAtmospheric Administration (NOAA), this was the least activehurricane season since 1982.

Outlook Sensitivities

While Fitch gives a stable outlook to the industry, it pointsout the following potential factors that could change that outlookto negative:

• “A Sequence of Adverse Events: While anunforeseeable large loss event could sharply reduce the industry'scapital position, at current capitalization and leverage levels, itwould likely require a series of adverse events to unfavorablyshift capital levels to a magnitude that would promote a change toa negative rating outlook.
• “Volatility from Catastrophic Events: Exposureto insured losses from natural catastrophes remains the largestsource of underwriting volatility for property/casualty insurers.Projected modeled losses from tail events, such as a Category 4Miami hurricane or New Madrid earthquake would sharply affectcapital for a wide number of insurers and reinsurers and provokeother unforeseeable potential market disruption.
• “Sharp Loss Cost Trend Shift: Low inflationand more muted economic growth have promoted greater stability inloss cost trends and continued reserve strength. An interestrate/inflation shock would not only affect asset values, but alsoclaims costs. Unanticipated sharp changes in general inflation ormajor loss cost components such as medical expenditures, litigationsettlements or commodity prices, would potentially foster anextended period of insurance underpricing and reserve deficiencies,particularly in longer tail business segments.”