After suffering through a year of elevated property losses and poor underwriting results in 2011, U.S. commercial lines insurers are in a position to deliver improved operating results this year. Fitch Ratings believes that increasing commercial insurance rates and premium volume growth will contribute to better run-rate underwriting performance, but loss reserve deterioration and weak investment performance will impede a restoration of industry returns on capital to prior hard market levels.
Underwriting results for commercial lines segments weakened significantly last year, driven in particular by poor results in commercial multiperil and specialty property lines. The industry aggregate commercial lines accident year loss and loss expense ratio for 2011 rose sharply to 77.6% from 70.2% in 2010 according to data compiled from SNL Financial, representing the worst accident year performance in commercial lines since 2001.
Unusually high catastrophe loss experience was the primary cause of this poorer underwriting performance in 2011, as domestic insurers were battered by severe inland tornado and storm events, as well as Hurricane Irene.
While casualty insurance results have been less volatile than property segments, underwriting trends in casualty businesses remain poor relative to hard market years in the mid-2000s. Surprisingly, industry results indicate that workers' compensation, while still one of the weakest casualty segments, posted an improved accident year loss ratio in 2011.
Pricing data gathered from various market sources point to a recovery in commercial lines pricing over the past two quarters. While this market pricing shift is encouraging, and should help to stabilize underwriting performance in 2012, rates need to improve considerably more for commercial lines to return to underwriting profitability and solid returns on capital.
We think that there is momentum for further rate improvement over the near term, but several factors are likely to inhibit a return to the strong profitability achieved in the previous hard market. Namely, market underwriting capacity was not materially affected by 2011's industry downturn. As a result, recent rate increases have been driven more by a reaction to losses than a real shift in competitive fundamentals.
Also, profit pressure from declining investment yields continues to raise the bar for the underwriting profits that will be required to generate an adequate return on capital in an extended period of low interest rates.
For additional detail on recent underwriting results for commercial lines insurers, see Fitch's upcoming special report "Commercial Lines Underwriting Performance" at www.fitchratings.com .