A few years of major catastrophes and horrible market returns pinched profit margins at property and casualty insurers. This year is shaping up much differently.

If you took out an insurance policy in the 1960s or ‘70s, you likely dealt with a locally owned and operated insurer. But the insurance industry has undergone a radical transformation in the intervening decades; consolidation has led to the emergence of national insurance firms that dominate specific product lines.

This trend brought a high degree of commoditization to the market, leaving only two ways for companies to differentiate themselves from the competition: price and quality of service.

Even amid this cutthroat environment, several factors make property and casualty (P&C) insurers attractive.

For one, insurance rates are again trending upward after five years of extremely competitive pricing. And equities and fixed-income securities have rallied substantially, generating solid gains for insurers’ investment portfolios.

This combination of rising premiums and better investment performance should make 2010 a solid year for most P&C insurers. Names that focus on quality underwriting and operate in niche sectors are the best way to play this trend.

Chubb Corp (NYSE: CB) is the 11th-largest P&C insurer in the US and the largest writer of directors and officers liability insurance, a product that protects corporate officers and directors in claims of negligence.

Chubb weathered the financial crisis with aplomb for a number of reasons. Instead of focusing on rapid premium growth, management emphasizes profitable underwriting.

For the past few years Chubb lagged peers that aggressively slashed prices to bring in business. But its forbearance has left it well-positioned to compete in the current environment; its policyholders won’t suffer the shock of a dramatically higher bill come renewal time.

Stable pricing should enable Chubb to generate modest growth while other insurers struggle to retain customers. Chubb also benefits from a conservative investment portfolio that emphasizes fixed-income securities over equities.

Overestimating future returns and underestimating risk isn’t unusual in the insurance world; it’s not uncommon to find investment portfolios that are extremely heavy on equities–a risky proposition for insurance firms.

The company’s asset managers also largely avoid mortgage bonds and had no exposure to subprime issues in the run-up to the credit crisis.

Chubb’s combined ratio–a measure of profitability that subtracts insured losses from earned premiums–has averaged 90 percent over the past five years, a testament to the company’s rigorous underwriting standards. Chubb Corp is a buy up to 55.

Allstate Corp (NYSE: ALL) resembles Chubb in terms of its focus on high-quality underwriting but it isn’t afraid to take on the competition in a price war.

Allstate also has a large financial division that accounts for 14 percent of revenue, so there’s even more operational leverage built into the company.

Its investment portfolio took a pounding during the recession because of sizable investments in illiquid mortgage- and asset-backed securities.

Valuations have improved since the market implosion, but huge markdowns on these holdings weighed on results at the height of the mortgage and credit crises.

Coupled with hefty disaster-related losses, these writedowns pushed Allstate’s combined ratio to 96.8 percent. That being said, Allstate should stage a strong recovery.

Whereas many of its peers depend on independent agents who are free to sell any product they wish, Allstate has a captive team of around 13,000 agents who only distribute Allstate insurance.

Add in the network of financial advisors who also distribute Allstate insurance and annuities, and you have one of the largest distribution networks in the US. No wonder Allstate is the second-largest personal P&C insurer in the US based on premiums written.

Management also has worked tirelessly to refocus the company’s efforts on profitable business lines and is dropping policies that aren’t likely to turn a profit. With a 2.4 percent yield and solid turnaround prospects, Allstate Corp is a buy up to 36.

The best way for P&C insurers to build margins and ensure a sticky customer base is to focus on a niche market.

National Interstate Corp (NasdaqGS: NATL) specializes in P&C insurance for trucking outfits and the passenger transportation industry. In some markets it also provides personal insurance to owners of recreational and commercial vehicles.

National Interstate has turned a profit every year since 1990 and sports a combined ratio of 86.5 percent–a reading that’s tough for any insurer to match.

Three factors drive that strong profitability.

First, National Interstate’s strong underwriting criteria minimize insured losses.

Second, operating in such a tightly focused market and specifically targeting underserved areas reduces competition and provides a degree of pricing power.

Finally, National Interstate offers a self-insurance program whereby it administers a policy for which it collects a small fee, but the insured party is responsible for its own claims payments.

Although several other providers offer this service, National Interstate has enjoyed a strong response to the offering from several large outfits and generates fee revenue with almost no liability. National Interstate Corp is a buy below 24.

Benjamin Shepherd is editor of Louis Rukeyser’s Wall Street and co-editor of Global ETF Profits.