The figure demonstrates that the p-c industry?particularly the commercial-lines sector?still faces challenges, S&P said.

Commenting on p-c commercial lines, S&P warned that its outlook on the segment is still "negative" despite three years of pricing hikes and improving investment performance.

The ratings firm listed a number of risky factors for its current outlook on p-c commercial lines, including reserve shortfalls and reinsurance recoverable issues, as well as construction defect claims and silica liabilities. Nevertheless, S&P said the pace of its downgrades in this sector is expected to slow this year.

The ratings firm explained there are now two distinct trends driving the financial strength of the commercial lines sector: improved pricing on current business and the reserve inadequacy for legacy business, such as asbestos and workers' compensation.

In the first half of 2003, S&P observed, premiums brought in by U.S. p-c insurers exceeded losses and expenses for the first time since 1986, and premium volumes for full-year 2003 are set to exceed 2002 by almost 15 percent.

S&P said the improved pricing?also helped by tighter terms and conditions?is leading to significantly better operating results. The ratings firm forecasts that the pricing would remain modestly ahead of claims inflation in 2004 and boost operating performance into 2005.

S&P also said supporters of higher pricing can find encouragement from signs of reduced competition, including the merger agreement between St. Paul Cos. Inc. and Travelers Property Casualty Corp. to create the second-largest commercial-lines writer in the United States. Furthermore, sales of renewal rights on current business have also lowered the number of players in some lines of business.

Examining investment portfolios, S&P said that when realized and unrealized capital gains are added, insurers made $16.5 billion in the first half of 2003, compared with a loss of $8.9 billion during the first half of 2002.

But on the down side, the reserve inadequacy continues to hurt commercial-lines insurers, S&P said. For some lines, such as workers' compensation and certain liability lines, payouts on a policy can be spread over several years or even decades. Although asbestos liabilities have proven the most potent menace for insurers of late, even without them the industry's reserves are still about $60 billion deficient, according to S&P.

In 2003, there were five workers' compensation companies out of total p-c company failures, S&P said. Professional liability, namely directors-and-officers coverage, also caused hefty reserve charges, notably by AIG and Chubb Corp., the two largest players in that business. Reserving problems are also widespread in the medical-malpractice field, the firm found.

In the personal-lines segment, S&P said U.S. homeowners' insurers are riding "a pricing surge" that will continue to boost operating performance in 2004. Premium rates in auto coverage, though rising at a slower pace, are also helping to ensure that the personal-lines sector as a whole remains on its stable ratings course for S&P.

This favorable rate environment, along with the declining frequency trend, is having a positive effect on profitability for both homeowner and auto lines. The ratings firm estimates that the combined ratio for 2003 in the personal-lines sector was about 103, down from 109 in 2002 and more than 120 in 2001.

For 2004, S&P says there is real potential that price strengthening for auto insurance lines over the near term might not sustain 2003 increases. With auto insurers enjoying strong profitability, competitive pressures are building up. For homeowners' lines, S&P says it has noted a decline in non-catastrophe losses; however, homeowner rates are expected to continue to rise, driven by rising construction costs and expensive natural disasters.

S&P also noted that home and auto insurance are highly susceptible to intervention by state insurance regulators and sometimes by state legislatures. In this respect, the industry has found "grounds for both cheer and dismay" last year.

On the positive side, fears about mold liability?once called the next asbestos?are diminishing, as most states now permit mold exclusions in insurance policies.

In New Jersey, where at least 25 auto insurers stopped doing business in the past decade, legislation was enacted in June 2003 which now permits larger and faster rate increases. It also phases out New Jersey's take-all-comers provision, which had forced companies to write policies for all but the very worst drivers. Companies can also cancel policies obtained through false information.

Several developments were seen as negatives. S&P noted that the Texas Department of Insurance, under a law passed in June 2003, imposed premium-rate cuts on 24 homeowners' insurers operating in the state. In California, the insurance department imposed regulations restricting insurers from selecting customers based on their claims history. In addition, bills introduced in the California legislature would set limits on an insurer's ability to non-renew policies, require insurers to seek prior approval of underwriting criteria, and prohibit use of information from credit checks. S&P said these examples illustrate the inherent volatility of doing business in a highly regulated environment.