Unless 2007 is a year of severe catastrophes, property and casualty insurance rates will probably go into freefall, leaving newcomers in the market struggling to survive.

That is the dire warning from industry expert David Bradford, editor-in-chief of insurance information and analysis provider Advisen, who said reinsurance rates had already started to plunge drastically within the last month.

Despite some impressive first-quarter results from many property and casualty (P&C) insurers and reinsurers in the Bermuda market, things are already getting tougher.

“My impression is from anecdotal evidence, just talking to people, is that it’s just in the last 30 days that rates have really started to plummet,” Mr. Bradford said. “So it could be that in the second-quarter numbers we’ll see that impact start to come through. And it will be fascinating to see what happens with the July 1 catastrophe renewals.

“Across the board the rate of softening is accelerating. If we see a fairly light year for catastrophes, I think the risk is that the bottom could just fall out of the pricing in the marketplace.”

So does the industry need a major catastrophe or two?

“It’s a sad thing that the rate levels in the industry are reliant of the level of capital and policyholder surplus and at this point in time, the only thing that’s going to bring that down to a rational point would be a very severe year for catastrophes,” Mr. Bradford said. “Otherwise, it’s going to be a bloodbath, possibly for the next couple of years.”

As the capital supporting insurance operations, known as policyholders’ surplus, increases, competition for business rises, putting a downward pressure on rates.

The danger for the industry is that rates become unrealistically low, resulting in underwriting losses that eat into policyholders’ surplus. When sufficient capital has been lost, rates start to harden (rise) again.

But this normal industry cycle has been disrupted by the unusual events of 2005, when Hurricanes Katrina, Rita and Wilma cost an estimated $66 billion in losses, while the P&C industry was still able to post a total profit of $44 billion.

“The 2005 hurricanes were a fascinating event because we had a year of record-shattering catastrophe losses combined with a year of very solid profits, which is pretty unprecedented in the industry,” Mr. Bradford said.

“It disrupted the normal operations of the cycle.

“It split the market in two. One section of the market, in catastrophe-exposed risk, has been operating on a different set of rules from the rest of the marketplace.

“Capacity was withdrawn from catastrophe-exposed business to non-catastrophe-exposed business, so it forced down rates in other lines even more aggressively as a result.

“But the sky-rocketing catastrophe premiums attracted a lot of capital, north of $30 billion, which is now sitting in an interesting position, especially after the state of Florida essentially created $12 billion to $16 billion of its own new reinsurance capacity.

“How that capacity for catastrophe business is going to be effectively deployed is going to shape up this year and next year. If we don’t see a really severe year for catastrophes then we might see catastrophe business starting to plummet.”

Florida legislators effectively put the state into the reinsurance market in an attempt to reduce the cost of property insurance to homeowners. Many Bermuda insurers and reinsurers have reported little impact from the change, but the effects will become much clearer during the July 1 renewal period.

A total of 12 new insurance companies were established on the Island last year, several of them looking to meet the demand for property catastrophe capacity. Such newcomers faced an uncomfortable start, Mr. Bradford said.

“I think it’s going to be a tough time for these companies and if any of them develop the critical mass they need to be major viable players remains to be seen.

“Since Katrina, you have additional capacity as well in the form of things like sidecar arrangements that were intended to be relatively short-term capital, or at least renewable capital.

“One thing I think that will happen, particularly with Florida coming in with extra capacity, is that it could probably sour hedge funds and other investors from the opportunities in catastrophe reinsurance. We may see a withdrawal, or a lessening of interest, from that segment of capital providers.”