NU Online News Service, Dec.14, 2:12 p.m.EST

Disappointing returns on equity in the coming year may lead theproperty and casualty insurance industry to a quicker return tostiffer pricing, according to Keefe, Bruyette & Woodsanalysts.

The firm said it expects flat p&c stocks in 2010 with riskof weak book value growth and ROE, valuations remaining low, andevery line on the income statement "more likely to disappoint thanpositively surprise. The upside is that perhaps significantdisappointment will lead the industry to the eventual hard marketturn that much quicker."

KBW said it views the "widely held" expectations of a 9-to-11percent ROE for the industry as likely to disappoint.

Premium volumes, according to KBW's analysis, could be evenlower than expected as competitive pressures worsen and buyerbudgets remain tight.

It further estimated that loss ratios could deteriorate asweather normalizes, reserve releases decline and soft rates flowinto results.

KBW foresees that expense ratios may rise as premium volumesfall and management teams invest into new platforms.

Investment yields are falling and "income will be weak in 2010,"in KBW's view. Its analysts also expect that share buybacks maydisappoint and the firm noted that balance sheet risks includeweakening reserve positions and the potential of a "double dip"recession hitting investment portfolios.

The firm said the chance of meeting the 9-to-11 percent ROEexpectation is low, while the odds of disappointment are high andin either case, it believes valuation expansion is unlikely.

On the positive side, it found valuations are near all-timelows, well below book value, and barring a major catastrophe,another round of credit market losses, or a spike in loss costinflation, book values are unlikely to decline. The group couldtread water. KBW said it focuses its recommendations on companieswith sound long-term growth strategies including ACE, Allied WorldAssurance Company Holdings Ltd. and Hanover Insurance Group.

A portion of the equity analysts' 56-page report says that withthe sector having a "not great but not too terrible" fundamentaloutlook, many investors reach the false conclusion the stocks are"cheap," trading below book value, which may not be possiblebecause overall premium volume decline may be worse than 5percent.

The study said that the industry's combined ratio, excludingBermuda-based insurers, is "deteriorating but not terrible for anestimated level of 99 this year and better than 105 for2010--better than the historical average over the last 40years.

Regarding merger activity, KBW said it expects that the mostlikely acquisition targets are still small-to-midcap specialtyplayers with strong niche-market positions, and if improved marketconditions create more deals, it is highlighting "names such asAmerican Safety (ASI), Eastern Insurance (EIHI), Navigators Group(NAVG), SeaBright Insurance (SBX) and The Hanover Insurance Group(THG) as potential candidates to be involved.