A new report by Conning Research & Consulting offers a “gloomy” view on growth prospects for the property and casualty industry, and an industry analysis from Keefe, Bruyette & Woods (KBW) suggests insurers reconsider cost reductions, including reducing salary, to improve profitability in the face of economic and market challenges.

In its “Property-Casualty Forecast & Analysis” report, Conning says a concern is that after the compression of revenues in recent years, many anticipated a rebound in both the economy and in interest rates by now, neither of which has occurred.

“Not only has the economy faltered, but concern about the economy has increased,” explains Clint Harris, analyst at Conning. “The government has been trying to recharge the U.S. economy by keeping interest rates low enough to encourage investment. The consequence of all of this is that bond yields have gone lower, and that is a significant driver in revenue for insurers.

“Therefore, Conning’s 2011 premium-growth forecast has decreased with the sliding economy to only 2 percent to 3 percent,” Harris continues. “The industry-forecast combined ratio, north of 106 percent, includes additional deterioration in the underwriting results and adjustments for the record catastrophe activity of the second quarter. Of course, we are closely watching second-half tropical-storm results.”

Conning issues its analyses on a quarterly basis, with the focus of each typically varying, depending on market conditions and stressors. For this latest iteration, the firm’s analysts targeted premium loss and investment returns for the entire year for 2011, 2012 and 2013.

Regarding how continued premium erosion—and the resultant decrease of underwriting margins—bodes for the P&C industry, Harris says, “There is some better news here. All of these things can lead to insurers becoming more conservative. More insurers are starting to talk about areas where they see premium rate firming. This is a condition that normally comes ahead of a true turnaround of underwriting cycles.

“When insurers become stressed in terms of underwriting margins decreasing and, in this case, also investment margin decreasing, there has to be some proactivity,” Harris adds. “One short-term solution is managing operating expenses more aggressively, and carriers have embraced this. Although that can result in increased workloads and maybe fewer hires, mass layoffs are very unlikely.”

The KBW analysis, though, contends that the industry is not yet talking about cost cutting. However, the analyst firm says lack of growth may force the issue.

“Many companies already went through a round of layoffs and cost cuts in 2008-09—always a painful effort and not one which management teams want to go through again,” the firm notes.

But KBW adds, “As hopes for a meaningful improvement in the economy fade and the end of the soft-market pricing appears to be more of an easing rather than a traditional hardening, we believe that a lift to premiums may yet be distant. Cost cuts, in addition to capital management, may be the easiest tool available to improve profitability.”

KBW says its review of industry expenses for companies under its coverage show “significant growth” in recent years in salaries, head counts and advertising spending. “All of these increases occurred despite a slowdown in growth and worsening margins,” says KBW.

The industry’s expense ratio, the firm says, has grown steadily from 24.6 percent in 2003 to 28.3 percent in 2010. Actual expense growth has declined since 2006, KBW notes, but that has not kept pace with the decline in premium growth, leading to the rising expense ratio for the industry over that time.

Analyzing where the industry’s expenditures are coming from, KBW says salaries have increased 16 percent since 2005, to $27.3 billion. KBW notes that Allstate and Liberty Mutual have managed to decrease salaries paid from 2006 to 2010, while Geico increased salaries by almost 22 percent.

Advertising for the industry increased 72 percent from 2005 to 2010 to over $5 billion. “The $2.1 billion increase in advertising…is eye-catching and brings to mind the barrage of insurance commercials we all frequently skip over as we use our DVRs,” KBW says.

From 2006 to 2010, State Farm has increased its advertising by almost 105 percent, and Progressive increased advertising by nearly 87 percent. Geico’s advertising budget, though, is nearly 50 percent higher than the next-largest competitor, KBW notes.