A.M. Best Special Report: The Calm After the Storms -- Record-Setting Results Let P/C Industry Catch Its Breath.

OLDWICK, N.J. -- Another year of devastating catastrophe losses was expected for 2006, but Mother Nature spared the property/casualty industry and allowed carriers to report record-setting results: Not only was an underwriting profit achieved--a rare feat--the combined ratio fell to its lowest level since 1953. All this occurred amid price softening and a modest increase in competition, according to the 2007 Property/Casualty Review/Preview report from A.M. Best Co.

Despite the limited catastrophe losses in 2006, rates for catastrophe-prone areas will remain elevated. This reflects more conservative pricing, reduced capacity for certain segments and higher reinsurance costs on these risks. A soft market prevailed in most other lines and segments, with a gradual release of the tight knot previously surrounding terms and conditions. Still, underwriting is expected to remain generally prudent, despite these early indications of potential future problems. In addition, new capacity has entered the market and is placing more demands on profitability targets.

On another front, those writing in terrorism-exposed areas will face important underwriting decisions as the extension of the Terrorism Risk Insurance Act (TRIA) comes to an end. It is uncertain how much, if any, permanent federal protection will be in place. Workers' compensation companies are particularly exposed, given their inability to exclude this risk and the lack of affordable reinsurance protection. Limited capacity and widespread nuclear, chemical, biological or radiological (NCBR) exclusions offer little reassurance to these carriers.

As the ability to quantify concentration exposures becomes that much more critical, enterprise risk management (ERM) remains at the forefront as a means for companies to measure all their risks and the correlation of these risks. Modeling companies have come forward to provide the much more detailed information that rating agencies seek on insurers' largest events and how these events correlate. The question then becomes how much surplus can insurers lose--or are they willing to lose--without jeopardizing their current ratings or keeping their management teams awake at night.

Given this greater scrutiny of exposures, many insurers are looking for increased protection through traditional reinsurance. Many are also looking at alternative sources such as catastrophe bonds, industry loss warranties and sidecars. Following the significant catastrophe losses of 2005, these additional forms of capacity increasingly have been used and, for some insurers and reinsurers, represent a material component of their capital management strategies.

Although the industry was spared in 2006 from a major event, it would be naive to think these exceptionally strong results will continue in 2007 and beyond. In the volatile and cyclical property/casualty industry, another devastating event is sure to come. It may be terrorism, a natural catastrophe, a stock market crash, under-reserving or simply undisciplined underwriting. The impact of this event, or events, will be split unevenly between those companies that have prepared themselves through ERM and prudent underwriting, and those that continue to ride the market cycle with their fingers crossed.

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Founded in 1899, A.M. Best Company is a full-service credit rating organization dedicated to serving the financial services industries, including the banking and insurance sectors. For more information, visit www.ambest.com.