Insurers Choosing Riskier Investments

This study presents an opportunity for insurers to compare their company's asset allocation to those of their peer group.

The data for this study is aggregated and analyzed from the May 2002 National Association of Insurance Commission filings. A summary of the findings for the p-c industry is presented below.

First, we find that investment patterns of insurance companies over the past five years confirm anecdotal evidence of a trend toward increased investment risk exposure within the insurance industry. Insurers have become increasingly willing to incorporate more credit and market risk in their portfolios in an effort to earn higher margins and increase their profitability.

Figure 1 shows the holdings of the p-c market over the last five years.

Property-casualty companies have steadily increased their allocations to corporate bonds, opting to move away from government bonds. Corporate bonds accounted for 23 percent of invested assets (weighted by market value) in 2001, while government bonds represented 12 percent.

The allocation to equities dropped for a second straight year, falling 14 percent last year to 16 percent of the total portfolio (compared to a 12 percent drop in the S&P 500), reflecting the poor performance of the equity markets.

Over the last year, due to hardening premiums and the delayed recovery of the equity market, insurance companies have begun increasing their allocation to municipal bonds, sheltering their investment portfolios from excessive taxes during more profitable years ahead.

Examining allocations by size of company, we find that those p-c insurers with larger books of insurance business consistently invested twice as much in equities than companies writing smaller amounts of premium. When allocation percentages for the different investment types were weighted by premiums, equities accounted for 34 percent of investments for all p-c insurers in 2001.

Large companies exhibit investment patterns that are highly correlated with the industry. However, small companies–with less than $250 million in total net admitted assets–lag the industry in the amount they allocate to equities and other alternative investments (such as mortgage loans and real estate), investing more conservatively than their larger counterparts.

In 2001, for example, only 8 percent of small company investments were in equities, while 19 percent of large company investments were allocated to equities. As seen in Figure 2, over the past two years, small companies have also increased their allocation to cash (13 percent in 2001)–twice as much as large companies–signifying higher liquidity requirements.

Like large companies, small p-c companies have also steadily increased their holdings in corporate bonds at the expense of government bonds.

We also studied the impact that the type of company may have on the choice of investment strategy. We divided all p-c insurance companies into Stock, Mutual, Lloyds, Reciprocal, Risk Retention Group and U.S. Branch groupings, and discovered that allocations for these companies vary considerably by type of company.

Over the last five years, Lloyds companies have aggressively increased their allocation to corporate bonds–from 3 percent in 1997 to 29 percent in 2001–at the expense of government bonds, stepping up their exposure to credit risk. They have consistently held extremely low levels of equities (less than 1 percent). Over the last year, a 20 percent increase in cash (to 13 percent) and a corresponding 20 percent decrease in municipal bonds (to 39 percent) can be attributed to recent losses incurred.

Stock and Mutual companies, which comprise the majority of the industrys asset base, exhibit investment patterns consistent with those of the industry as a whole.

Different sets of investment trends were revealed when we grouped the p-c insurance industry by their lines of business. A snapshot of year-end 2001 compares allocations to corporate bonds and equities for various lines of business to that of the industry in Figure 3.

Medical malpractice, workers compensation and private passenger auto companies invested a small portion in equities, favoring allocations to corporate bonds. Since reinsurance companies are not the first dollar payers, they have historically invested heavily in equities–35-55 percent of their portfolio–as they are better able to withstand any short-term volatility within their investment portfolios. Other Liability companies proved to be more averse to credit risk, investing less than 30 percent in corporate bonds and equities combined.

In summary, over the last five years, insurance companies have taken more investment risk–both credit and liquidity risk. The trend indicates a move away from government and short-term investments and into corporate bonds and equities. Insurance companies are choosing to invest in higher yielding and/or higher risk instruments.

With premiums rising and an expectation of increasing profits, signs point to an increased exposure to municipal bonds as well.

It will be interesting to see how–or if–companies alter their allocations in anticipation of the impending rebound of the equity market and strengthening economy.

An interactive version of the Annual Insurance Industry Asset Allocation Study, allowing for customized analysis, is available at http://snapshot.bbh.com/aastudy.

Reproduced from National Underwriter Property & Casualty/Risk & Benefits Management Edition, July 22, 2002. Copyright 2002 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.