Completing its assessment of the U.S. commercial market, A.M. Best issued an industry outlook update that notes stability in the market despite soft market conditions, the anticipation of less favorable loss reserve releases and a contracting economy.

While the pricing behavior of commercial lines insurers is always difficult to predict, most key indicators would suggest a flattening in commercial lines rates as we move into the later part of 2010. This shift in pricing will be prompted by intensified margin compression and the need to compensate for lower investment yields, a weaker overall economy and less robust reserve releases. A.M. Best says it also believes loss cost inflation, combined with today’s modest risk-free rate of return, should further fuel up-pricing.

For the vast majority of commercial lines insurers, investment impairments and mark-to-market adjustments through 2009 have been manageable, as balance sheets remain relatively intact with capital levels that remain appropriate for their ratings. On the other hand, earnings prospects for commercial lines insurers will likely be dimmed by slower economic growth, fewer new business opportunities, weaker investment earnings and moderating cash flows due to the decline in new money yields.

While some of the storm clouds have cleared in 2009, the rating agency believes that commercial lines insurers are now at a crossroads. Depending on which direction this segment moves will set the tone for this segment for years to come. If competition intensifies in 2010, there’s little doubt that this segment will suffer the consequences. Thus far, key indicators and behavior among most insurers does not suggest that this is the case.

Over the next 12 months, A.M. Best says it expects some continued moderation in underwriting and operating profitability. Albeit lower than in previous years, profit margins for this segment should remain relatively solid. In past years, a major contributor to this segment’s profitability has been favorable prior-year loss-reserve development. However, given the extent of loss-reserve releases over the past few years and higher initial loss ratio selections, these benefits will diminish in 2010 and beyond.

A.M. Best reports that it does not expect rating actions to move profoundly in one direction, with the number of upgrades/positive outlooks and downgrades/negative outlooks to be fairly balanced over the next six to 18 months. During this period, A.M. Best also believes the overall commercial lines segment will continue to maintain adequate balance sheet strength, profitability and liquidity. Therefore, A.M. Best continues to view the outlook for the commercial lines segment as stable.

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