Double-digit rate hikes are working their way to the bottom lines of property/casualty insurers-a trend that is expected to bolster results for the rest of this year and probably into 2003.

Despite improved first-quarter results and the expectation that rate firming will continue, analysts say insurers also face some potential threats to profitability. These include rising asbestos liabilities and reserve inadequacy, as well as the continual threat of losses from terrorism and other catastrophes.

For the first quarter ending March 31, the 15 property/casualty insurers surveyed by Business Insurance that report this data posted a 24.8% increase in net income to $3.41 billion compared with the first three months of 2001.

Other key results posted by the 17 insurers surveyed by BI include:

• Net premiums written increased 14% to $27.29 billion, compared with the first quarter of 2001

• The combined ratio improved to 100.1% from 103.3%.

• Policyholder surplus for the 15 insurers that report this data dropped 8.4% to $40.72 billion.

"It's probably the best quarter in over 10 years for the group," said Cliff Gallant, an analyst with Keefe, Bruyette & Woods in New York. "We saw some very strong top-line growth and fairly attractive combined ratios. About the only partial offset was that investment income was weak overall," he said.

"Earnings were much better than they were last year and generally above expectations," said Michael Smith, an analyst with Bear Stearns & Co. in New York. "The only two negatives are that investment income continues in a downward trail and cash flow from operations was not as strong as you might have expected it to be given the premium growth."

Michael Paisan, an analyst with Williams Capital Group in New York, said, "It was a mostly positive quarter from the standpoint of generating slightly higher than expected earnings growth."

The impact of rate hikes "began to show up in the first quarter," helped by a "very benign catastrophe quarter," he noted.

The outlook for future quarters is positive as well, say analysts.

Other analysts expect rate hikes to continue into next year.

"I don't really see a reason" for the rate hikes to slow as long as the insurance industry still faces the threat of another terrorist attack, asbestos and reserve inadequacy issues, all of which "would tend to keep insurers raising prices," said Todd Bault, an analyst with Sanford Bernstein & Co. in New York.

"We could see some pretty explosive earnings growth for the latter part of this year and into next year," said Mr. Paisan.

"I think the second half of the year is going to show extremely strong growth," said Mr. Smith. But, he added, while earnings momentum should continue into next year, "there are clearly some concerns about things like asbestos liability that is putting some pressure on the stock."

Matthew Coyle, a director at rating agency Standard & Poor's Corp. in New York, said property/casualty insurers can be divided into "tier one" companies-which are insurers that have at least adequate reserve positions-and the more numerous "tier two" companies-ones that have potentially deficient reserve positions.

"Everyone's going to benefit from the price increases, but the tier one companies stand to gain from this favorable pricing environment more so than the companies that have the reserves issue," he said.

Karen Horvath, vp at Oldwick, N.J.-based A.M. Best Co., also pointed to the impending hurricane season as a potential cloud on insurers' horizon. "It would be optimistic to say results are going to continue at this particular level throughout the year," she said.

Other analysts also do not expect rate increases to continue at their current levels.

For the next couple of quarters, "the rate hikes will continue with the momentum that we've seen, but I think by the end of this year and the early part of 2003 we're going to start to see some moderation," predicted Stephan Petersen, vp at Cochran, Caronia & Co. in Chicago.

Next year will mark a second round of "solid rate increases" for many insurers and, for some insurers that were "ahead of the curve," it could even be the third round of hikes, he explained.

"You're probably going to see a pull back from 20% to 25%-plus rate increases to something a little bit more in line with the low teens," he said.

"I think year-over-year rate increases will probably slow just because the rate increases were so strong over the past 12 months," said Mr. Gallant. It depends, though, on particular lines of business, he said. The rate of increase for catastrophe or property lines, for instance, may slow, but directors and officers liability, medical malpractice and workers comp "are still seeing very strong increases."

The impact of mounting asbestos liabilities on insurer profitability remains a concern for some analysts.

Last month, for example, Pittsburgh-based PPG Industries Inc. and about three dozen insurers agreed to pay $2.7 billion to settle current and future asbestos claims arising from a PPG affiliate (BI, May 20).

"It continues to be sort of the monkey on the industry's back, and it just doesn't seem like it'll go away," said Mr. Gallant.

"It will be hanging out there for a long time," agreed Gary Ransom, senior vp at Hartford, Conn.-based Conning & Co. "The only plausible thing that could cause it to settle down some would be some congressional action of some sort, but if Congress doesn't do anything to simplify matters in the court room, it's just going to continue on.

"We'll have settlements here and there and reserve increases occurring intermittently and it will be hard to judge ahead of time who gets hit," he said.

"We still think the industry's carrying a sizeable (reserve) deficiency," said Mr. Coyle, pointing to the workers compensation line in particular and, to a lesser extent, reserves for medical malpractice, general liability and commercial package business.

Alan Murray, vp at Moody's Investor Service Inc. in New York, agreed. "There is a significant deficiency...that leads us to believe what would otherwise be the euphoria of a market recovery is going to be really dampened, certainly in 2002" and perhaps in 2003, as well, "which begs the question of how sustainable is the current market recovery."

However, John Ward, of the Cincinnati-based Ward Financial Group, said strong first-quarter earnings "gave a lot of companies some relief in terms of earnings, and I don't anticipate any major surprises on the reserving front."

Another potential problem overhanging the industry is the ongoing threat of another terrorist attack.

Judy Blades, executive vp for business insurance at the Hartford Financial Services Group Inc. in Hartford, Conn., said there is a widespread belief that an eventual attack is a certainty "and this time around, unlike Sept. 11, companies are not going to have reinsurers to step in because they're not offering terrorism coverage, and so the industry is a lot more vulnerable than we were for the 9/11 loss."