P-C Insurers Remain Loyal To Muni-Bonds

The property-casualty industry has enjoyed several years of strong pricing, and thanks to a benign claims environment–2004 hurricanes notwithstanding–profitability last year was high.

Even many companies that suffered large losses during prior periods of heavy claims and underwriting losses now have exhausted loss carry-overs and have again become tax-payers. This change led to the first of the anticipated asset allocation trends for 2004–a boost in the allocation to tax-advantaged municipal bonds.

Aggregate holdings of municipal bonds by p-c insurers reached 37.75 percent of assets at the end of 2004, up from 36.1 percent at the end of 2003.

Municipal bonds consistently have been the largest single asset class in p-c portfolios and the only asset class whose portions in portfolios rose each year for the past five years. In contrast, the municipal-bond allocation in life-health insurers' portfolios was only 16.4 percent, only slightly higher than it was five years before.

However, while p-c profitability is expected to continue in 2005, we do not expect to see a comparable boost in the allocation to municipal bonds. That's because p-c insurance company directors will not want to incur Alternative Minimum Tax liabilities. The AMT is triggered when the relative income contribution from tax-advantaged sources–that is, municipal-bond income–passes a formula-driven threshold.

Higher investments in municipal bonds was funded by cutting back on equities and corporate bonds. The aggregate equity weighting in p-c insurance portfolios was at 13.72 percent at the end of 2004. The equity weighting for the p-c industry rose very modestly in 2004 from the year-ago period. The increase had been expected since stock prices rose some 9 percent in 2004, but we were surprised by how little it increased.

In our view, low interest rates and the tight credit spreads available in bonds for most of 2004 made stocks more attractive. So, it was surprising that the equity weighting did not rise more in 2004.

Also, the improved tax treatment of common stock dividends led us to expect that p-c insurers would boost the equity allocation more dramatically–but that's not what we found.

At the end of 2004, corporate bonds, in total, were the second-largest asset class in p-c industry portfolios–at 20.56 percent. This category includes Asset-Backed Securities.

Investing in corporate bonds represents one of the most dramatic contrasts between the p-c and life-health insurers. The life-health industry in total allocated over 54 percent of assets to corporate bonds last year. Corporate-bond exposure for the p-c industry, on the other hand, fell steadily since a recent peak weighting of 22.47 percent in 2001. The current weighting is nearly same as the weighting of 20.52 percent at the end of 2000.

We also were startled to see the allocation to cash equivalents remain high in 2004. While the cash equivalent allocation fell to 8.99 percent in 2004 from 9.52 percent in 2003, the very low level of short-term interest rates meant that the return from these assets was marginal at best.

Even more surprising is the trend in cash-equivalent assets since 2000. In a period that saw short-term interest rates drop steadily from over 6.00 percent at the end of 2000 to 1.00 percent in mid-year 2004, the cash allocation rose by 3.41 percent from a base of 5.58 percent.

The aggregate allocation to government securities was pretty much unchanged in 2004. In fact, the aggregate government allocation has moved only within a narrow range during the last five years. The government category includes notes and debentures from government agencies and enterprises and mortgage-backed securities packaged by same organizations as well as all U.S. Treasury issues.

The catchall category, "Other Assets," made up 5.18 percent of p-c portfolios at the end of 2004. This category includes ownership of the company's buildings and contents. It also includes more esoteric assets such as hedge funds, private equity and other real-estate investments.

Interestingly, the Other Assets category also shows a sharp difference in the portfolios of life-health and p-c insurers. As might be expected, Other Assets represented over 16 percent of life-health portfolios last year. That's because life-health companies usually have longer duration liabilities than p-c insurers. Therefore, life-health companies typically have much larger allocations to private equities and investment real estate than do p-c insurers.

Complete results of the Brown Brothers Harriman's Asset Allocation Study, which includes figures by company size, ownership structure and source of premiums, are available online for free at http://salsa.bbh.com/aastudy.

Michael Walsh is vice president, relationship manager, at Brown Brothers Harriman & Company. Jayant Kumar is assistant vice president, relationship manager. They are both in New York.

INFO-GRAPH #1

Flag: By The Numbers

Head: Where Did P-C Insurers Invest In 2004?

Municipal Bonds: 37.75%

Corporate Bonds: 20.56%

Equity: 13.72%

Gov't Securities: 12.93%

Cash Equivalents: 8.99%

Other Assets: 5.18%

Preferred Stock: 0.87%

Line Graph:

Flag: Five-Year Trend

Head: P-C Insurers Prefer Munies

Caption:

Municipal bonds consistently have been the largest single asset class in p-c portfolios and the only asset class whose portions in portfolios rose each year for the past five years.

Note for Production:

(We have graph from BBH, or we can also remake it using data from http://salsa.bbh.com/aastudy/ To obtain data, for Industry, choose property-casualty, choose "All" for other business categories. For "Weighting" choose "Market Value" and for "Report" choose "5-year" For abbreviated labels in the chart, refer to categories from INFO-GRAPH #1.)