The key to recovery, Kearney said, is for insurers to make focused efforts on improving underwriting results and enhancing operational performance. The firm advocated increased use of strategic partnerships.

In examining claims costs, Kearny said that they amounted to 64.91 percent of p-c insurer costs compared with 13.58 percent for administrative expenses.

Kearney suggested that significant economies of scale in the claims area could be captured by a claims utility providing information technology and process services to multiple insurers.

Illustrating the potential for economies of scale, Kearny noted that small homeowners insurers average $2,793 for claims compared with $2,091 for "large players" such as State Farm, Allstate, Nationwide, and USAA.

Besides claim cost improvement, "with sagging investment results, insurers need to improve their core underwriting competence through rigor and innovation in risk pricing, expertise in market segmentation and effective portfolio management," said Tom Dente, the A.T. Kearney vice president who led the analysis.

"Improvement in underwriting alone, however, will not close the performance gap in an industry where return on equity has been very low over the past five years," said Stefan Spohr, a principal with Kearney.

"Cost performance must be addressed, and our experience with [property-casualty] insurance clients shows that transforming the claims process, for instance, could generate cost efficiencies from 12 to 25 percent," he noted.

"Extrapolating savings of 12 percent to the overall industry claims cost would shave 10 points off the U.S. p-c sector's projected combined ratio of 120 in 2001," Mr. Spohr estimated.

Mr. Spohr added that aggressively transforming the claims function to take advantage of new technologies can have a dramatic impact on profitability.

Kearny noted that costs associated with reviewing and settling claims involve insurance examiners who initially review claims, third-party repair shops and contractors who fix damage associated with claims, and issuance of payments to customers.

In the claims area, opportunities for significant cost reduction include improving process efficiencies, restructuring supply chain operations, and leveraging technology and third-party resources to achieve economies of scale, Kearny said.

Uncertainty over terrorism coverage and new types of risk with greater possible losses have created a temporary imbalance in the insurance market with demand for new areas of coverage greatly outstripping supply, according to Kearney.

The likelihood of longer-term higher prices and new ways to mitigate risk present an opportunity for the most savvy insurance companies to enter the market to close the supply gap, Kearney said.

Adding capacity to insurance supply during past shocks--including Hurricane Andrew and the Northridge earthquake, both in the early 1990s--has proven extremely profitable to those companies willing to move early and accept the risk, Kearney noted.

Despite the uncertainty over terrorism insurance and scope of coverage, Kearney said rate increases expected to range anywhere from 20 to 65 percent will create similar opportunities this time.

The company suggested that higher prices will provide the incentive necessary for insurance companies and financial institutions to seek alternative means of risk transfer beyond the traditional re-insurance market.

One result, Kearney said, will be an increase in the use of capital market products seeking to securitize insurable risks linked to single or multiple events, such as hurricanes or potentially even terrorist attacks.

Kearney said it anticipates there will be new forms of insurance capital markets solutions that would be traded like traditional securities over public and private exchanges.

"With recent low prices in the industry, there's been little effort to seek out alternative risk transfer mechanisms," Mr. Spohr said. "But with the realization of much greater risk levels and higher pricing, the choice of spreading risk across the multi-trillion dollar capital markets instead of the $100 billion re-insurance market becomes a compelling one.''

Marketplace uncertainty will cause a flight to quality insurers and strengthen the position of the top players in the industry, according to Kearney.

The consultants advised that the remaining companies need to take stock of their market position and core capabilities, and seek out strategic partnerships to round out those capabilities

"The historical vertical structure of the insurance industry will become more virtually integrated as companies partner with each other and non-industry companies to compete successfully with industry leaders," Mr. Dente said.