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

KBW further estimated that loss ratios could deteriorate as weather normalizes, reserve releases decline and soft rates flow into results.

KBW foresees that expense ratios might rise as premium volume falls 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 may disappoint, with the firm noting that balance-sheet risks include weakening 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 ROE expectation is low, while the odds of disappointment are high–and in either case, KBW believes valuation expansion is unlikely.

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

The group could tread water, according to KBW, which noted that it focuses its recommendations on companies with sound long-term growth strategies including ACE, Allied World Assurance Company Holdings Ltd. and Hanover Insurance Group.

A portion of the equity analysts' 56-page report says that with the sector having a “not great but not too terrible” fundamental outlook, many investors reach the false conclusion that p&c stocks are “cheap,” trading below book value–which may not be possible because the overall premium volume decline might be worse than 5 percent.

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

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

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