Property-casualty insurers, faced with a limited reserve cushion, will likely need to choose between raising rates or allowing their combined ratios rise, according to an analysis.

Insurers have largely harvested the ample reserve redundancies that had been embedded in their balance sheets at year end-2007 through earnings in 2008, according to the Moody’s Investor Services analysis.

“Reserves were adequate as of year-end 2008,” Analyst Enrico Leo said in a statement. “But the industry’s reserve releases during 2008 came in at the very high end of our year-end 2007 range.”

Moody’s said it expects companies to report less benefit in their 2009 earnings from reserve releases and, in some cases, to even post deficiencies. Given the scenario, increasing prices or allowing their combined ratios increase over the medium term are their only choices, according to the ratings service.

“Despite the enhanced price monitoring tools and increased transparency and focus on profitability over the last several years, we believe that the inherent challenge for P&C insurers remains maintaining underwriting discipline, predicting loss cost trends, and monitoring terms and conditions, which often cause greater damage than pricing declines,” Leo said.

Calendar 2008 marked the fourth consecutive year of favorable reserve releases, a switch from earlier in the decade. During 2008, the property-casualty insurance industry posted nearly $14.3 billion in favorable reserve development, or about 2.8% of prior year-end carried reserves.

Favorable reserve development occurred across all major market sectors during 2008. In the report, a breakout of the top 50 primary insurance groups illustrates that commercial line insurers reported about 2% of favorable reserve development as a percentage of prior year reserves, whereas personal lines companies reported about 1% favorable development, and diversified carriers nearly 4%.

Moody’s notes that improvement over prior years stemmed from more favorable market conditions, price increases, better underwriting discipline, favorable loss cost trends, and relatively few natural catastrophe losses in 2006 and 2007.

“As a result, companies were able to strengthen their balance sheets and build up redundancy in their reserves, ultimately manifesting it through earnings in recent years,” Leo said.