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 p&c stock prices to remain flat in2010 with the risk of weak book value growth and low ROE,valuations remaining low, and every line on the income statement“more likely to disappoint than positively surprise,” the firmsaid.

“The upside is that perhaps significant disappointment will leadthe industry to the eventual hard market turn that much quicker,”the analysts added in their report, “2010 Outlook: The Market IsRight–P&C Valuations Following Fundamentals.”

The New York-based KBW said it views the “widely held”expectations of a 9-to-11 percent ROE for the industry as likely todisappoint.

Premium volume, according to KBW's analysis, could be even lowerthan expected as competitive pressures worsen and buyer budgetsremain tight in a tough economy.

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

KBW foresees that expense ratios might rise as premium volumefalls and management teams invest in 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, with the firm noting 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 a 9-to-11 percent ROEexpectation is low, while the odds of disappointment are high–andin either case, KBW believes valuation expansion is unlikely.

On the positive side, KBW found valuations are near all-timelows and well below book value, barring a major catastrophe,another round of credit market losses or a spike in loss costinflation, book values are unlikely to decline.

The group could tread water, according to KBW, which noted thatit focuses its recommendations on companies with sound long-termgrowth strategies including ACE, Allied World Assurance CompanyHoldings 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 that p&cstocks are “cheap,” trading below book value–which may not bepossible because the overall premium volume decline might be worsethan 5 percent.

The study said that the industry's combined ratio, excludingBermuda-based insurers, is “deteriorating, but not terrible for anestimated level of 99 [in 2009] and better than 105 for 2010–betterthan the historical average over the last 40 years.”

Regarding merger activity, KBW said it expects that the mostlikely acquisition targets are still small-to-midcap specialtyplayers with strong niche-market positions.

If improved market conditions create more deals, KBW ishighlighting names such as American Safety, Eastern Insurance,Navigators Group, SeaBright Insurance and The Hanover InsuranceGroup as potential candidates to be involved.