With economic, interest-rate and competitive challenges expectedto persist through 2013, the title of Conning Research andConsulting's latest report aptly sums up the firm's recipe forinsurance-industry success in a year marked by numerous headwinds:“Nothing to Be Gained by Waiting for Things to Get Better.”

The report's theme is reinforced perhaps most clearly whenConning discusses the investment landscape for insurers. “Continuedlow interest rates will drive investment yields and investmentincome lower. Companies will be increasingly compelled to find away to move forward, no longer willing or able to wait for animproving interest rate environment,” the report states.

Conning adds, “We believe many companies had been planning onsome reversion of interest rates to higher levels, which perhapshas led to some inertia. This inertia is reinforced by conservativeinvestment policies and customary rules of thumb that limitsignificant change. With the Federal Reserve now pegging itssecurities purchasing activity to the unemployment rate and GDPgrowth, interest rates could remain low even longer than previouslyexpected.”

In the report, fully titled “U.S. and Global Insurance IndustryOutlook 2013, Economic, Capital Markets, and RegulatoryChallenges Continue: Nothing to Be Gained by Waiting for Things toGet Better,” Conning questions if this new reality will drivechanges in insurers' investment portfolios, but the firm notes thatso far there have been “relatively few significant actions.”Conning adds, “We do expect this topic to be front and center formany insurer boards and managements this year.”

Conning credits Allstate with taking “one of the bolder actions”on this front. In December 2012, the insurer indicated a change inits investment strategy, putting greater emphasis on hard-asset andinfrastructure investments and a greater allocation to public andprivate equities.

“[Allstate] also highlighted its views of the risks in the bondmarket, and as a result Allstate expects it will harvest a portionof its unrealized gains and expects longer-term bonds to become asmaller portion of its investment portfolio,” Conning states.

But the idea of adapting to a changing landscape is not confinedto investments. The Conning report also discusses how insurers areresponding to increased catastrophes.

Cat-loss experience since 2004 has averaged around $24 billionper year, or 5.4 points on the loss ratio, Conning says, notingthat this is “much higher than the average of the preceding 10years.” Both 2011 and 2012 saw cat losses that were more than 50percent higher than the long-term average, the firm adds.

“For insurers, the magnitude of losses has been less at issuethan the type of loss and where they have occurred,” says Conning.The firm says high losses in the Gulf of Mexico in 2004 and 2005drove insurers to shift exposures to the Midwest, only to see twoof the highest years ever for U.S. tornado loses in 2008 and2011.

“In 2013, we expect the industry will experience a repricing ofMidwest property exposures, at both the primary and the reinsurancelevels,” says Conning.

The report adds, “Volatility seems to be the new normal for mostproperty insurers. Adding to the uncertainty has been politicalreactions, as governors and state-insurance departments were quickto weigh in on the non-applicability of hurricane deductiblesimmediately following Sandy.”

Structural change also appears likely for reinsurers, saysConning, as capital-market alternatives challenge the traditionalreinsurance model. “Many investors seeking higher returns thanavailable in the bond or equity markets have found the ILS[insurance-linked securities] market to be a viable uncorrelatedasset class with attractive historical returns,” says the report,adding that with demand from investor capital exceeding the supplyof alternative-reinsurance products, downward pressure onreinsurance rates could result.

Reinsurers have responded by becoming activecat-bond issuers, and also by forming affiliations with ILS funds,“creating their own internal ILS capabilities, and raisingthird-party capital in sidecar vehicles.”

Conning says, “It is clear that many reinsurers are determininghow best to provide risk-transfer solutions to their clients whileat the same time not losing business to the ILS market. Thisconvergence of reinsurance and capital markets will continue toplay out, although returns for reinsurers and ILS investors arelikely to suffer.”

For the P&C sector in general, Conning describes thelandscape as constrained, if gradually improving. “Our overalloutlook for the [P&C] industry is for moderate premium growthand modest underwriting losses for 2013 and 2014, assuming a'normal' level of catastrophe loss activity,” the report says.

Conning expects the recent trend of rate firming to beconstrained by the industry's strong surplus position. “Companiesare not yet abandoning marginal business, hoping instead to hang onuntil conditions improve,” Conning says, in an observation thatappears to go against the general theme and title of thereport.