"This is not going to be a pleasant fourth quarter. Inevitably, there will be surprises that are likely to cause rating actions," said Mark Puccia, a managing director in Standard & Poor's insurance ratings.

In Mr. Puccia's view, unprecedented losses in several lines of business, poor investment returns, and depleted capital levels have all come as a reality check on the lax underwriting practices that prevailed through most of the 1990s.

He added that all of the U.S. insurance industry has still not absorbed how they should deal with changed conditions.

Mr. Puccia said there is a generation of underwriters who have never seen combined ratios below 100 who need retraining so their "habit of pricing to win business, rather than making an adequate rate of return, can be unlearned."

Mr. Puccia said insurers plagued by "fragile balance sheets and inadequate reserves," need a much lower combined ratio than the 105 percent achieved in the first half of 2002, to produce respectable rates of return and to restore credibility. "The industry needs a combined ratio in the low 90s."

Insurer payouts on claims and expenses should amount to less than 95 percent of premium income, rather than outstrip premium income as they usually do, he advised.

Mr. Puccia suggested this might be possible in the current arena of robust price increases, were it not for the industry's legacy of "woefully inadequate pricing from 1997 through 2000, for which insurers are still paying dearly, and the gaping shortfall in reserves set aside to pay future claims."

Asbestos lawsuits, along with professional-liability business, where the magnitude of payouts has far exceeded earlier expectations, and workers' compensation, the industry poster child for inadequate pricing, are the worst areas of underreserving, according to S&P.

Even after five quarters of reserve strengthening, beginning with the "kitchen-sink" fourth-quarter 2001, about one-quarter of the industry has not owned up to the extent of its reserve shortcomings, by S&P estimated.

This will not shield companies from rating actions, said Bob Partridge, managing director. "For companies that haven't ponied up, to the extent we estimate they are underreserved, we make a dollar-for-dollar deduction from the capital level we use in deciding the rating," he explained.

Nevertheless, Standard & Poor's negative outlook on the U.S. property-casualty insurance industry reflects only the near-term direction of ratings, not their absolute level. "It's very solid, basically a very highly rated industry," said Mr. Partridge, "so it's not going to sink into the ocean."