LONDON (Reuters) ? European insurers? financial nightmare created by the equity market meltdown has ended and the industry?s prospects for next year are relatively bright, the world?s second largest reinsurer said yesterday.

?The worst is over,? Swiss Re?s Chief Economist Thomas Hess told journalists at a meeting in London.

The recovery in equity prices since markets hit multi-year lows earlier this year will staunch the haemorrhage of capital that has flowed out from the industry recently, he said.

Rising interest rates will help beleaguered life insurers while the huge reserve strengthening that has badly hit non-life insurers? profits has peaked, he said.

Now the capital pressures that jangled investors? nerves this year have receded ? although insurers? solvency remains fragile, according to Swiss Re ? the key to rebuilding investor confidence is ?fixing the profitability gap,? Hess said.

The underlying profitability of the non-life sector is better than current figures suggest, he said, because they have been masked by large reserve additions for long-term exposures such as asbestos and for underwriting mistakes made on business written in the late 1990s, especially in the United States.

Prices continue to rise, especially in loss-making liability lines of business, Hess said, adding that he does not see industry premium rates softening in the next two or three years.

?I doubt we will see a soft market (where prices dip to unprofitable levels) until 2006,? he said.

Life insurers must work hard to reduce their costs and they have to rethink the kind of products they offer in order to boost their earnings, Hess said.

Swiss Re forecasts long-term interest rates will continue to rise modestly into 2005, benefitting life insurers, said John Fitzpatrick, head of Swiss Re?s life and health unit.

However, he warned that this will not solve the problems in the industry, the biggest of which is the large numbers of guaranteed-return policies they have on their books.

They need to offer fewer guaranteed policies, which can put insurers under immense financial strain when investment returns are low, in favour of unit-linked products, Hess said.