Commercial insurance buyers will likely have to endure the hard market at least through next year, if not beyond.

Although higher rates are beginning to flow down to the bottom line, lower interest rates-which hurt investment income-will prompt worried underwriters to keep rates up, analysts say. In addition, the need to maintain adequate reserves for asbestos-related losses, among other factors, will prolong the hard market, they note.

Meanwhile, first-half results for commercial property/casualty insurers were essentially in line with expectations, with income bolstered by the higher rates as well as light catastrophe losses.

The 15 major commercial property/casualty insurers surveyed by Business Insurance that report this data posted an 82% increase in aggregate net income, to $6.1 billion, for the first half of 2002.

Other key results from the 17 insurers BI surveys are:

c Fueled by rate hikes, net premiums written increased 17.1%, to $54.59 billion.

c Insurers' aggregate combined ratio for the first half improved to 101.4%, compared with 111.3% for the prior-year period.

c Policyholder surplus declined 1.7%, to $53.97 billion.

"The second quarter was a continuation of the progress we saw in the first quarter and that we had seen last year," except for the effects of the Sept. 11 attacks, said Michael Smith, an analyst with Bear Stearns & Co. in New York. "Written premiums for the companies I follow were up about 20% year over year, and that was fairly consistent with what we saw in the first quarter.

"Combined ratios continued to improve, although they actually backed up a little bit in the second quarter compared to the first quarter. I think some of that was seasonal, since we saw the same thing last year," Mr. Smith said. In addition, "cash flows were remarkably better. As a result of the improving cash flow, we're beginning to see some stabilization of the investment income."

Gary Ransom, senior vp at Hartford, Conn.-based Conning & Co., said that rates increased even faster in the second quarter than they did in the first quarter, particularly in areas such as directors and officers liability. That line, he said, has been plagued by stock market troubles and the growth in class-action suits.

Stephan Petersen, vp at Cochran, Caronia & Co. in Chicago, said, "Overall, (the second quarter) was probably the first quarter we saw some serious evidence of fundamental improvement in the industry."

"We're starting to see better underwriting selectivity," which is improving margins, Mr. Petersen said. Furthermore, "we saw pretty strong evidence of good cash flows," with the industry's asset base growing again. "It looks like we're finally getting past" the poor 1997-2000 accident years, he said.

Insurer results were in line with expectations, said Brian Meredith, senior property/casualty insurance analyst with Banc of America Securities in New York. "I expected that investment income would continue to be weak for many companies, which it was. And, in addition to that, we had a fair amount of realized losses from some troubled credits, which popped up from several companies.

"As far as underwriting results go, you began to see a little bit of the benefits of the rising price environment that we've been in since 2000," though these were moderated by reduced investment income, Mr. Meredith said.

"There weren't many big surprises from a bottom-line earnings standpoint. Top line premium growth in many cases was better than we had expected and also in many cases showed acceleration from the first quarter," said Jay Cohen, an analyst with Merrill Lynch & Co. in New York.

Underwriting margins "showed, in general, nice improvement over the recent trend," helped by relatively low catastrophe losses, he said. "The only disappointing aspect of the second quarter was investment income, which was hurt by lower interest rates and, in some cases, lower income from partnership investments," Mr. Cohen said.

John Ward, chairman and chief executive officer of Cincinnati-based Ward Group, said that, for many years, poor underwriting results and strong investment gains characterized the industry's financial performance.

Now, though, "that dynamic has completely reversed," with underwriting results and discipline "looking pretty positive" while investments "are not holding up their end of the bargain and, in many cases, are having a negative impact on the bottom line."

Analysts expect stronger financial results for the foreseeable future, with most predicting the hard market will continue at least through 2003.

"I had been anticipating the cycle would kind of stagger to its conclusion next year," said Bear Stearns' Mr. Smith. "But now, I think that with the changed economics in the industry, principally a more volatile earnings stream in the year ahead...coupled with a lower contribution from their investment portfolios," insurers will need to keep prices up to meet investor expectations, said Mr. Smith. "I think we can see prices remain firm throughout 2003."

"It looks like underwriters are certainly a long way from being tempted by market share again. Our perspective is that interest rates are more likely to drop than rise, which we think is going to keep insurers focused on underwriting margins," said Cochran's Mr. Petersen, who said he expects the hard market to extend into 2004.

"A lot of companies seem to be using the price increases to strengthen the balance sheet rather than let it fall to the bottom line, and they're doing it to a greater extent than I might have expected six months ago," said Mr. Ransom of Conning. As a result, it could be another year before the rate hikes are fully reflected in earnings, he said.

Mr. Ransom said he anticipates rates will continue to rise for the Jan. 1, 2003, renewals, though "after that, it's a question mark."

Reserves, however, remain an issue, say analysts. "Certainly, even for companies that have historically held adequate reserves, we're seeing the level of adequacy decline," said Karen Davies, senior credit officer with rating agency Moody's Investors Service in New York. "And then there's other companies that we believe have historically not held adequate reserves, and we've seen the level of adequacy deteriorate for them as well," she said.