Commercial property/casualty insurers, reeling from the double whammy of investment and catastrophe losses in the midst of a soft market, may begin to firm up overall rates next year, some observers say.

The market firming, though, is likely to be moderate, with no dramatic rise in rates expected, observers say.

A dozen major U.S. commercial property/casualty insurers reported a $34.06 billion loss for the nine months that ended Sept. 30, according to a Business Insurance survey.

Even excluding American International Group Inc.'s $37.63 billion loss, the remaining insurers reported a 73.2% drop in net income, to $3.57 billion, compared with the year-earlier period. Two other insurers also reported losses while the remaining nine all reported double-digit declines in net income (see chart, page 20).

Among other survey results:

c Net premiums written by the group increased 2.9%, to $110.36 billion.

c The insurers reported a 98.1% combined ratio vs. a 90% combined ratio for the comparable period in 2007.

c Policyholder surplus for the 10 insurers reporting that data decreased 7.7%, to $84.88 billion.

Observers point to the financial market crisis as a major factor driving nine-month results. They say property/casualty insurers' investment results have been hurt, although they have been not hit as hard as other segments of the financial services industry including life insurers.

"We were certainly not anticipating the level of declines in the equity and fixed-income markets that we saw in September and continuing into October, November, so that certainly has had an adverse effect on the financial strength on balance sheets," said John Iten, a director at Standard & Poor's Corp. in New York.

With the exception of AIG, said James B. Auden, Chicago-based senior director at Fitch Ratings, commercial property/casualty insurers were not affected by subprime mortgage issues, but they did have exposure to Freddie Mac and Fannie Mae. An even bigger issue "was the decline in equity markets and the widening of spreads in corporate and municipal bonds," he said.

John L. Ward, chief executive officer of Cincinnati-based Cincinnatus Partners L.L.C., said, "The industry has a reasonable exposure to equities, but it's not excessive by any means," and equities accounted for about 14% of invested assets as of year-end 2007.

Insurers tend to have a large portion of their investments in fixed-income securities and are heavily invested in corporate debt instruments and municipal bond securities, "and both of those securities have dropped in value in recent months because of a flight to safety" in moving to U.S. Treasury notes, Mr. Ward said.

Insurer underwriting results also have been affected by catastrophe losses, observers say.

It was a "remarkably miserable storm year," said Jeffrey Berg, an analyst with rating agency Moody's Investors Service in New York. With the "financial storm losses, people have forgotten the extent of how bad" the natural catastrophe losses were this year, Mr. Berg said

The Jersey City, N.J.-based Insurance Services Office Inc.'s Property Claims Services unit estimates that insured U.S. catastrophe losses totaled $22.1 billion for the first nine months of this year vs. $4.8 billion for the same period in 2007.

Mr. Ward noted that releasing reserve redundancies has cushioned insurers' results, but reserves are running out and "the relief provided by that source of earnings will be short-lived."

Jeanne M. Hollister, Hartford, Conn.-based managing principal of Towers Perrin's Americas property/casualty insurance practice, said, "I don't think that we've yet seen the deterioration in (directors and officers) results that we think ultimately will manifest itself."

She said more than 100 D&O-related class action lawsuits have been filed, "but I think the effects of that are more likely to be apparent in fourth-quarter results than they were in the third quarter."

Some observers say the market is poised for firming rates.

"I believe there will be a turn to the hard market in the short-term," driven by catastrophe losses coupled with the investment results, both of which are "likely to get worse before it gets better," Mr. Ward said. "The combination of those forces will lead us to a hard market" in 2009.

"There will be a flight to quality," Mr. Ward said. "I think policyholders and risk managers are concerned about the outlook" for the market. "There's somewhat of a sense of panic and I believe that will lead (buyers) to carriers that are highly rated and, in their view, the safest path," which will support "the underpinning of a shift to the hard market going forward."

With "the attenuation in the pricing declines and the early noise of potential hardening or firming up, we see the possibility of rates climbing in the medium term," Mr. Berg said.

"I have to imagine companies are going to feel more capital-constrained," said Ms. Hollister. Sustained demand with decreased capacity "is likely to result in increased prices." There will be more of a "general firming," though, as opposed to a big rise in prices next year, she said.

Through Sept. 30, the property/casualty industry's surplus declined an estimated 8% to 10% since the beginning of the year, Mr. Ward said.

"There is much hope that at the Jan. 1 renewals, we will see higher insurance prices, particularly in specialty commercial lines like D&O, large-account commercial and property reinsurance," said Paul Newsome, an analyst with Sandler O'Neill & Partners L.P. in Chicago.

"If it happens, it's clearly a firming of the market. It's not the broad, hard market that we saw after the World Trade Center disaster, but it's a cycle turn, we hope," Mr. Newsome said.

If property/casualty prices do not harden at the January renewals, "you could very well talk about something that's more midyear next year, when companies finally get their statutory filings, and rating agencies look at the numbers and start telling companies they must…raise capital to maintain their ratings," Mr. Newsome said.

However, Mr. Auden said, "We've seen a modest change in the level of rate declines in pricing, but broadly, rates are still going down." While the market's capital reduction could help in leading to rate changes, "there's still a ways to go" before that happens. "We think, at best, you'll see a stabilization in rates" next year, but it is very unlikely there will be a hard market.

"There may be a few segments of the market where you see better rates, like catastrophe markets given the high level of cat losses this year," and professional liability coverage for financial institutions, Mr. Auden said.

Meanwhile, observers note the state of the overall economy can affect commercial property/casualty insurers and point out that the economic environment has worsened since Sept. 30.

A prolonged recession "can have dampening effect on revenues," Ms. Hollister said. For example, employment payrolls are used as the base to determine workers compensation premiums, so fewer workers means less revenue even if rates do increase.