Downgrades Trickle Down For Commercial Lines: S&P

In an underlying report published earlier this week, S&P revealed, however, that the stable outlook has a limited time horizon of just six to nine months.

While the report doesn't indicate whether S&P expects the outlook to turn negative once again after that, most of the factors discussed in the report?"U.S. Commercial-Lines Insurance Midyear Outlook 2004: Market Finds a Wary Equilibrium"?are potential negative impacts on future earnings and financial strength.

The main positives supporting the outlook change are an 11 percent gain in commercial lines premiums in 2003, a decline in the number of failures among companies in the sector (falling to 20 last year from 28 in 2002), and strong earnings growth which S&P expects to continue through the first half of 2005.

Another "argument for optimism" is that there are a bunch of different faces on the senior management teams at most large insurers, the S&P report said. "They're not the guys of the previous soft market," analyst Grace Osborne said in the report, indicating that the decisions of new team members will be based "more on sound financial principles."

With the sector awash in downgrades in recent years, the pace of rating slippage slowed in first-half 2004, the report said. Analysts expect that trend to hold for several months, with the few downgrades that continue to trickle through being limited to medical malpractice insurers and a few workers' comp writers, the report said.

Turning to the many negatives on the horizon for commercial insurers, analyst Tom Upton noted that investor expectations will "weigh against pricing discipline" of the new right-thinking management teams.

As for loss-reserving impacts, a factor frequently highlighted as a potential negative by rating analysts, S&P predicts that insurers can keep reserve hikes out of the headline for the next year or so. But that's not because reserves for past years have been shored up. On the contrary, reserve additions for these years will simply be hidden from public view as insurers cancel out additions with reserve takedowns for more recent years, which they have reserved conservatively, analyst Bob Partridge suggested.

Among other potential negative impacts, the S&P report listed everything from construction defect claims to terrorism to silica litigation.

"The thing to watch out for is legal expenses," Mr. Partridge said, referring to silica. Drawing a comparison to asbestos, he said, "For the first decade, about 90 percent of all payments were defense costs. That's where the issue with silica may arise."

In a separate report also published this week, titled "Silica Concerns Grow But Disclosure Limited," analyst John Iten went further, warning that "silica could be the next asbestos."

The actual timeframe over which S&P has maintained a "negative" outlook on the commercial lines sector is not clear. In the late 1990s, S&P placed a negative outlook on the property-casualty industry as a whole, moving to individual outlooks for the commercial lines, personal lines and reinsurance sectors within the past three years.

In separate announcements, S&P said that the outlook for personal lines remains stable and the outlook for reinsurance remains negative.

With respect to reinsurers, S&P noted that " U.S. reinsurers would continue their downward ratings slide were it not for the reticent support of overseas parent companies," explaining why the sector remains negative on a standalone basis.

All three midyear outlooks are available on RatingsDirect, Standard & Poor's Web-based credit research and analysis system. Those who are not RatingsDirect subscribers can purchase the reports by calling 212-438-9823 or by sending an e-mail to research_request@standardandpoors.com.

The issues raised in the reports will be the focus of Standard & Poor's Annual Insurance Conference in New York from June 15-17, 2004.