Although reserve strengthening by commercial property/casualty insurers dampened 2002 returns, industry analysts say insurers are now more secure and better positioned for stronger profits this year.

As insurer results improve, analysts also expect the momentum for continued price increases will abate.

Last year, insurer profits, combined ratios and policyholder surplus all were improved compared with 2001, according to a Business Insurance survey of 17 major commercial property/casualty insurers. The 2001 results, though, reflected some of the industry's worst losses in history due to the Sept. 11 terrorist attacks.

Insurers "addressed the critical and important issues that needed to be addressed in order to set the stage for better earnings in 2003 and 2004, so they had to kind of take their lumps in 2002" said Michael Paisan, an analyst with Legg Mason Inc. in New York.

Because of reserve issues, "Results were pretty disappointing," Mr. Paisan said. "By the same token, I think that the balance sheets today are better than they were a year ago," he added.

Among the surveyed insurers that reported this data, net income surged 30.2% to $6.81 billion. Liberty Mutual Insurance Co. does not report net income.

Other results from the BI survey include:

c Net premiums written increased 16.9% to $109.66 billion, spurred largely by firmer rates in nearly all lines.

c Insurers' aggregate combined ratio improved to 108.3% compared with 116.8% for 2001.

c Policyholder surplus for the insurers that report this data increased 2.4% to $55.28 billion. American International Group Inc. has not yet reported its year-end policyholder surplus.

Gary Ransom, senior vp at Hartford, Conn.-based Conning & Co., said 2002 results "were dominated by filling balance sheet holes, and so it was all about setting the stage for future earnings power rather than really reporting or seeing any earnings power" in 2002.

"The list of companies that took charges seems endless," whether it was for asbestos or for reserves for the years 1997-2000, Mr. Ransom said. "I'd have to say virtually every company probably had to add to reserves for those years" whether it was reported as a charge, or a matter of moving reserves around, he said.

Underwriting results for 2002 were disappointing, but not totally unexpected, said Michael Smith, an analyst with Bear Stearns in New York.

"There was a lot of anticipation a year ago that the fourth quarter of 2001 would be the so-called kitchen sink quarter, when insurance companies would throw everything, including the kitchen sink, into the quarter," he said.

"The reality is the insurance industry couldn't afford it a year ago, having weathered the World Trade Center losses," he said. However, "we're clearly beginning to see the balance sheets cleaned up. We were seeing it through nine months, and the fourth quarter just continued the process."

The worst of the reserving may be behind the industry, some analysts say.

"I have a feeling that the big monster out there-asbestos-is going to be less of an issue than it was," said Chris Winans, a principal and senior equity analyst with The Williams Capital Group in New York.

Insurers have made substantial reserve additions for past liabilities over the past two years and, at the same time, tightened terms and conditions for current business, he said.

Stephan Petersen, vp at Cochran, Caronia & Co. in Chicago, agreed. "I think the heavy lifting is pretty much done in terms of asbestos" for many insurers, he said.

Insurers still need to increase reserves, particularly for workers compensation and medical malpractice lines, said Karen Horvath, vp with Oldwick, N.J.-based A.M. Best Corp.

However, she added, "while there is a reserve shortfall remaining, I don't think you'll se the magnitude of the charges that we saw in 2002."

But Mr. Smith of Bear Stearns said he expects to see more additions to reserves. "I think we're still going to see some more reserve increases throughout the landscape. I don't think the industry has fully paid for the blunders that it created for itself in the late `90s years by any means."

But the earnings outlook for property/casualty insurers is clearly improved, he said.

"I think earnings are going to be much more visible in 2003 and 2004, certainly than they were in 2002," said Mr. Smith.

"I think, in general, earnings will look better in '03 than they did in '02 primarily because the industry hopefully won't have to take large asbestos charges again this year," said Mr. Petersen of Cochran, Caronia.

As earnings improve, commercial rate increases are expected to moderate.

"I think pricing power is going to start to decline bit by bit through this year, and you'll still see rate increases, but I think the magnitude of the rate increases is going to start to ease," said Mr. Winans. "I don't think there's any question that we're at the peak in terms of pricing. It's just a question of how long does it take to get to the next trough."

Rate increases will likely begin to slacken, said Mr. Smith.

"I think we're going to see continued price increases, but at a much slower rate of increase than we've seen over the past two or three years," said Mr. Smith.

Meanwhile, improved underwriting results have been somewhat undermined by low interest rates and a poorly performing equity market, both of which have hurt insurers' investment returns. Last week, Chicago-based CNA Financial Corp announced it was revising its year-end results to reflect an additional $32 million of after-tax impairment losses on equity securities, bringing its net realized investment losses to a total of $149 million for the year.

CNA's announcement is "a good example of how this investment income area is coming back to haunt the industry," said John L. Ward, chairman of the Cincinnati-based Ward Group. "To me, one of the challenges in the industry is the continued downward spiral of investment results, and I think many believe that by this time into 2003 we would see some things turning, both in the equities markets and in the interest rate environment."

Mr. Paisan, however, pointed to the increased cash flow generated by the higher premiums. "The fact that interest rates are low doesn't help, but many of the better-positioned companies are generating significant cash flow, and that's going to help mitigate some of the slowdown resulting from the lower interest rate environment," he said.