The hero of XL Capital's (NYSE:XL) fabulous first-quarter earnings were its investment managers, who helped boost net investment income 19% and net income by 20%.

Net income from investment fund and manager affiliates skyrocketed to $156 million for the quarter, versus $97 million last year. The alternative portfolio had a 5.5% return for the quarter -- a pretty substantial return, given that investment grade fixed income investments yield 5.5% over the course of a year. XL Capital's managers placed some timely bearish bets on the subprime debacle, which paid off big-time when the meltdown forced New Century to declare bankruptcy (see our Fool by Numbers for more details).

In the conference call, management noted that pricing was still rational. We've seen similar comments in the past by competitors at WR Berkley (NYSE:BER), AXIS (NYSE:AXS), and Markel (NYSE:MKL).

Overall, pricing generally declined in the low to mid-single digits. In terms of specific lines, aviation was soft (also echoed by competitors), U.S. public directors and officers insurance (D&O) pricing was down almost 10%, but European D&O was more stable.

Despite fears that we are currently in a soft market, XL's management believes we're more in a state of equilibrium. Pricing has been helped by the low interest rate environment -- which tempers expectations for investment income and forces insurers to stay disciplined. In the late '90s, insurers veered toward irrational pricing, often in anticipation of making up for underwriting losses in the skyrocketing securities markets.

XL noted that it has had success with long-term agreements in Europe. In contrast to the '90s, when these sorts of agreements included discounted pricing and lax terms and conditions, XL noted that clients who sign up now aren't looking for discounts, but for stable capacity -- which again, helps out with rational pricing. XL also believes that its role is evolving, and that clients now treat XL as a partner rather than a provider of excess insurance capacity. This helps shore up retention rates.

Although the alternative investment returns are sure to be lumpy (don't expect a 5.5% quarterly return every quarter), so far management's smart bets have paid off big for shareholders.

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Fool contributor Emil Lee is an analyst and a disciple of value investing. He doesn't own shares in any of the companies mentioned above. Emil appreciates your comments, concerns, and complaints. The Motley Fool has a disclosure policy.