Stricter capital models and declining pricing could make 2007 challenging for commercial line insurers, a new Standard & Poor's report said.
But the rating agency is nonetheless maintaining a stable outlook for commercial writers.
As 2006 draws to a close, many commercial property-casualty insurers are generating exceptional earnings. "Many balance sheets are in their best shape since the late 1990s, when the industry entered its last cyclical pricing downturn," the report said.
Still, moderate but steady pricing declines across most lines in 2006, a trend expected to continue in 2007, could slowly but steadily erode profit margins next year. The impact of that erosion, however, won't be fully reflected in sector earnings until 2008, S&P said.
"Overall, we believe the most serious threat to the commercial lines sector is the potential for a return to more competitive pricing," said Standard & Poor's credit analyst John Iten.
The massive storm losses in 2005 temporarily slowed the price deterioration then underway in both property and casualty lines. Since then, casualty rates have continued to decline, while commercial property rates have strengthened somewhat.
"Still, signs have emerged that property pricing might have peaked," Mr. Iten said. "Low catastrophe losses could encourage more aggressive pricing, but should not drive ratings over the next six months."
A new model measuring insurer capital strength could make positive actions less likely, the report said. The model will be used in tandem with existing capital models to assess the capital adequacy of insurers as of year-end 2006.
"Many companies' capital might look less strong under this new model," Mr. Iten said. "We don't expect to downgrade companies based solely on this new model, but we could take action on those it identifies as significant outliers."
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