Fitch has revised its sector outlook on the U.S. property/casualty insurance industry to stable from negative for both the commercial lines and personal lines sectors. A stable outlook for the sector indicates that Fitch believes a vast majority of insurer ratings will be affirmed as they are reviewed over the next 12-18 months.

The change in outlook reflects Fitch’s view that the industry withstood the recent financial crisis reasonably well, particularly in comparison with other financial services sectors. While the property/casualty market suffered material reductions in capital in 2008, insurers benefited from the investment market recovery in 2009, which, coupled with improvements in underwriting performance promoted a return to previous strong capital levels. The industry has also experienced a shift toward material net unrealized gains in investment portfolios for many insurers.

Since the October 2008 shift in sector outlook to negative, rating downgrades in Fitch’s property/casualty universe have outpaced upgrades by a ratio of approximately 12 to 1. More recently in 2010, the trend of rating actions has shifted more toward rating affirmations and revisions to a Stable Rating Outlook from Negative, at the insurance company level.

Fitch’s view that near-term less favorable industry profit fundamentals and traditional industry cyclical factors are adequately captured in current ratings was a key consideration in the shift to a stable outlook. Notably, premium revenues have declined for the last three years due to heightened price competition and the weak economic environment, run-rate accident year loss ratios have risen significantly, and investment yields remain low relative to historical norms. Fitch estimates that the industry produced a calendar-year statutory combined ratio of 101.9% in the first half of 2010. However, this result includes approximately five percentage points of favorable prior period loss reserve development and 3.8 percentage points attributable to catastrophe losses.

Future profitability prospects look better in personal lines than commercial lines do now. While the homeowners segment continues to be under-priced in many markets and insurers have faced an inordinate amount of losses from inland weather related events, the personal auto segment is experiencing aggregate price increases at a higher rate than loss cost growth. Industry aggregate personal lines results are also skewed by significantly weaker recent results at larger mutual insurers.

In commercial lines, premium rates continue to decline across nearly all segments, reflective of excess market underwriting capacity, and accident year combined ratios were over 100% in key casualty segments in 2009. Fitch believes that a near-term shift in pricing trends is unlikely based on current market fundamentals.

Fitch’s ratings are intended to remain generally stable during “normal” cyclical fluctuations, says the rating firm. While a return to the extremely soft market conditions of the late 1990s remains unlikely, industry underwriting performance has benefited from relatively stable loss cost trends in recent years. Continued pricing declines coupled with a significant rise in loss cost inflation for longer tail casualty lines would imply the development of an acute down cycle, and would potentially lead to a reassessment of Fitch’s commercial lines rating outlook.

Fitch anticipates the industry’ statutory return on capital will remain at the mid-single-digit level for the next several years. While capital formation is anticipated to remain more modest going forward, the market remains well capitalized on a risk adjusted basis for unforeseen events.

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