According to a special report published by Fitch Ratings, more competitive property andcasualty (P&C) insurance premium rates and the potential forreduced favorable reserve development as well as higher catastrophelosses in 2015, are leading to a forecast toward break-evenunderwriting results and lower returns on equity (ROEs) in thefuture.

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The report, titled U.S. Property/Casualty Insurance ProfitFundamentals, reviews fundamental drivers of profitability forthe P&C insurance industry and gives some perspective on wherethe industry is headed.

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Pressure on performance

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The two drivers of profitability and ROE for U.S. P&Cinsurers are underwriting andinvestments. Underwriting returns are a functionof underwriting profit and loss margins and operating leverage(premiums/equity). The investment contribution to ROE depends onthe investment yield and asset leverage (invested assets/equity).Changes in other profit drivers over time (lower asset yields andreduced asset and operating leverage) have driven the potential ROEfor a given combined ratio significantly lower over time.

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U.S. P&C insurers generated underwriting profits in the lasttwo years. In trying to sustain this underwriting performance,P&C insurers are pressured by heightened price competition anddiminished loss reserve strength that will reduce earnings benefitsfrom favorable prior-period development. The industry statutoryreturn on surplus (ROS) is forecast to decline to 6.5% in 2015 from8.1% in 2014.

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Underwriting performance and profitability

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Underwriting performance is the most volatile and influentialdeterminant of profitability for P&C insurers. Results areinfluenced by variability in competitive forces that influencepremium rates, losses from catastrophe events and volatility inloss cost trends.

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Declines in other profit drivers mean that maintaining orimproving returns on capital depends on better underwritingperformance. For the U.S. P&C industry, a 10% statutoryreturn on adjusted ROS currently corresponds with a 7% underwritingmargin or a 93% combined ratio, whereas a decade earlier a 99%combined ratio would generate a 10% industry ROS.

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For additional information and to get your copy of the report,visit the Fitch Ratings Insurance Sector.

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