Each week The NAIC’s Capital Markets Bureau monitors developments in the capital markets globally and analyzes their potential impact on the investment portfolios of US insurance companies. A list of archived Capital Markets Bureau Special Reports is available via the index.
Analysis of Insurance Industry Investment Portfolio Asset Mixes
The asset mix of an insurance company’s investment portfolio varies over time based on different influences, including both macroeconomic and industry-specific factors. The general state of the global economy, industry trends, market and political events also impact investment management decisions. Similar to other industries, an adjustment to risk appetite tends to also result in an adjustment to investment strategies and philosophies. In a strong economy, risk appetite tends to increase and the converse is true during poor economic conditions.
The NAIC Capital Markets Bureau studied the insurance industry’s portfolio mix across the five general insurance company types (life, property/casualty, fraternal, health and title) as of year-end 2010, year-end 2008 and year-end 2005. Depending on the insurer type, portfolio compositions could vary, due mostly to appropriately matching assets to liabilities and taking into consideration relative duration and liquidity risk. For example, life companies have longer-term liabilities than property/casualty companies; therefore, the former invests more heavily in longer-term assets, such as bonds with 30-year maturities, than the other industries.
Consistently in each of the three analyzed years, bonds represented the majority of insurance industry investments, ranging between 68% and 71% of total cash and invested assets. And, within the bond sector, the largest type across all three years was corporate bonds, ranging between approximately 43% and 48% of total bond investments. Investment across other asset types tended to vary.
This report discusses our findings relative to asset mixes, a breakdown of the bond sector and a further breakdown of the bond exposure as of year-end 2010 into sectors/industries. In addition, we show the asset mix and bond sector breakdown as of year-end 2008 and year-end 2005.
Year-End 2010 Investment Portfolios: Economic Distress Continues
As of year-end 2010, the U.S. economy seemed to be on a path to recovery; however, over the past few months, this has become uncertain. There is continued distress within the financial markets, particularly banks, as well as ongoing concerns about residential and commercial real estate, which appears to be worsening modestly. As a result, current market sentiment indicates a “flight to quality”; that is, a conscious move to safer, less-volatile and shorter duration investments.
At the same time, the insurance industry invests with certain overall strategies in mind, such as matching assets to liabilities in terms of maturity and interest rate risk, including managing duration; liquidity requirements; and overall risk appetite/volatility tolerance. Combined with the investment strategies that each insurance company has documented in their statement of investment policy and guidelines, they also take into consideration macroeconomic trends and fundamental credit analysis in determining their investment portfolio composition.
As the table above shows, as of year-end 2010, the majority of insurance industry investments were in bonds (69.7% of total cash and invested assets) followed by investments in common stock (10.3%). Bonds also were the largest component of investment portfolios across each of the five insurance company types. Bonds include categories such as corporate debt, municipal bonds, structured securities, U.S. government bonds and foreign government bonds. In addition, as of year-end 2010, more detailed information was available regarding insurance company investments’ book adjusted carrying value (BACV) of securities lending collateral and derivatives exposure, both of which were less than 1% of total cash and invested assets for the entire industry. Note that the market typically refers to notional values, and not BACV, when referring to derivatives.
Life companies accounted for the majority of industry cash and invested assets in terms of BACV, at 65% of total cash and invested assets as of year-end 2010. Property/casualty companies represented the second-largest, at 30.1% of total cash and invested assets. Because life companies hold the largest amount of industry invested cash and assets, we analyzed the investment portfolios’ asset type breakdown by life company size using the most recent data available (July 2011). As the table below shows, corporate bonds are, consistently and by far, the largest asset type regardless of company size. And, bonds in aggregate (that is, corporate bonds, structured securities and U.S. government bonds) represent at least 80% of invested assets across all life company sizes.
In terms of specific bond types within the aggregate insurance industry, the table below shows that approximately half of all bond investments were corporate bonds as of year-end 2010. It was also the largest category for four of the five insurance company types. The one exception, property/casualty companies, had its largest exposure in municipal bonds, at approximately $355 billion in BACV, or approximately 39% of property/casualty companies’ total cash and invested assets. For life companies, corporate bonds represented almost $1.4 trillion (or 57.1%) of total cash and invested assets.
Corporate bond exposure is predominantly investment grade credit risk; however, there is a portion that is below investment grade, some as a result of downgrade activity post-purchase by the insurance companies, while others due to active purchases. Most corporate bond investments made by the insurance industry are also in names that are relatively liquid.
As the table above shows, the percentage mix of bond types varies between the different insurance company types due, in part, to duration management and risk appetite. For example, municipal bonds are the largest bond type for property/casualty companies, at 38.7% of total property/casualty cash and invested assets as of year-end 2010. However, municipal bonds are only 4.8% of total life companies’ cash and invested assets, primarily for tax reasons. Life companies also had the largest concentration of non-agency residential mortgage-backed securities (RMBS) and commercial mortgage-backed securities (CMBS), at 10.9%, compared to 4.5% for property/casualty companies and 7.8% for fraternal companies. Given recent turmoil within the housing sector, both RMBS and CMBS have been volatile over the past few years in terms of credit risk.
*BACV amounts within the structured securities section might not tie out exactly to the BACV amounts included in the Year-End 2010 Bond Breakdown table due to data sourcing differences.
As shown in the table above, our analysis also included a more detailed sector breakdown of the $3.5 trillion bond exposure as of year-end 2010. Finance-related industries — that is, banking, insurance, savings and loan/thrift and other financial services companies — represented 12.1% of total industry bond exposure as of year-end 2010. Within the other corporate sectors, utilities (including electric and water companies) represented 6.2% of total bond exposure, while consumer products and services (such as retail, home furnishings, food products and services) represented 5.3% of total bond exposure. Overall, structured investments, including government-agency and non-government agency mortgage-backed and asset-backed securities, represented about 23% of total bond exposure as of year-end 2010.
Given that common stock represented the second-largest investment within the industry’s asset mix as of year-end 2010, we also analyzed in more detail a sector breakdown of this exposure. Note that the table above shows a sector breakdown of the unaffiliated common stock investments only (that is, it excludes affiliated common stock investments), which, therefore, excludes approximately $317 billion in BACV of the industry’s overall common stock investments as of year-end 2010.
Banking, insurance and finance-related industries comprised the majority of common stock investments at 18.2% of total unaffiliated common stock holdings as of year-end 2010. The second and third largest common stock holdings included consumer products (17.3%) and debt/equity/other funds (13.2%).
Investment Profile During the Financial Crisis: Year-end 2008
The U.S. financial crisis emerged toward the end of 2007, and it has continued along with an ongoing housing crisis and persistent high unemployment rates. As a result, during such stressful times, most investment managers seek to invest in less volatile, more short-term assets — at least until market conditions improve.
In terms of insurance company investments, as of year-end 2008, when some considered the crisis to have been at its worst, insurance company investments in bonds represented the largest asset type, at 67.6% of total industry cash and invested assets, which was relatively consistent with the industry’s bond investments as of year-end 2010. Similarly, as shown in the table below, common stock investments represented the second-largest industry investment, at 9.2% of total cash and invested assets. Cash and short-term investments were slightly higher, at 5.9% of total cash and invested assets as of year-end 2008, compared to 4.5% as of year-end 2010.
In terms of a breakdown by bond type for year-end 2008, similar to year-end 2010, corporate bonds represented the largest bond type for the overall industry, at 42.8% of total bonds as shown in the table below. This is just slightly lower than the 48.7% of total bonds as of year-end 2010. Also similar to year-end 2010, municipal bonds represented the second-largest bond type for the overall insurance industry at 14.8% of total bond exposure. Note that the percentage of each bond type may vary within each insurance company type.
RMBS represented 10.4% of total bond exposure as of year-end 2008. These were a risky investment given, at the time, the abundance and severity of ratings downgrades to these securities by Standard & Poor’s, Moody’s Investors Service and Fitch Ratings. Mortgage delinquencies and defaults skyrocketed, followed by a significant increase in foreclosures, thereby negatively impacting credit risk. While government agency-backed RMBS were not immune to the negative credit risk implications, especially as the government agencies — Federal National Mortgage Association (FNMA or Fannie Me) and Federal Home Loan Mortgage Corporation (FHLMC or Freddie Mac) — were placed under conservatorship by the U.S. government in 2008, “private label” RMBS without government backing were clearly the more volatile investments, and they suffered losses in the underlying assets, as well as severe swings in market value. The BACV of industry investments in RMBS and CMBS have since decreased.
Investment Profile During a Period of Prosperity: Year-end 2005
Prior to the financial crisis, the industry’s appetite for risk (and reaping the rewards for such investments) was more tolerable. To analyze the insurance industry’s asset mix during a recent period of economic prosperity, we reviewed the asset type breakdown as of year-end 2005. Not surprisingly, bonds represented the largest asset type, at 71.1% of total cash and invested assets, which was slightly higher than that of year-end 2008 and year-end 2010. Again, common equity was the second-largest asset type at 10.5%
Despite macroeconomic conditions, bonds in general have seemed to be the most attractive asset type that fits within the insurance industry’s investment strategy, perhaps due in part to the profile of insurance industry liabilities, among other reasons. As the table below indicates, corporate bonds represented the largest bond type for the industry at 44% of total bonds as of year-end 2005. Similar to year-end 2008 and year-end 2010, municipal bonds represented the second-largest bond type, at 13% of total bonds. Note that RMBS exposure was slightly less, at 9.9% of total bonds as of year-end 2005, compared to 10.4% as of year-end 2008. Structured securities investments overall were 26.8% of total bonds as of year-end 2005, which was not much different than exposure as of year-end 2008, which totaled 27.6%.
Despite changing economic conditions, the insurance industry’s asset mix does not appear to change significantly. Bonds have been the preferred investment type, and corporate bonds have been the preferred bond type. This is because corporate bonds represent an attractive investment relative to matching assets to liabilities, appetite for volatility and liquidity risk. Notwithstanding, the percentage of each of the remaining bond types varies between the different insurance company types. And, given the nature of the liabilities, insurance company asset managers tend to follow a buy-and-hold philosophy, particularly with respect to the life companies.
Even more interesting is the sector breakdown of the bond types, particularly for corporate bonds. While we were able to show this as of year-end 2010, we believe it will be interesting to compare this data to a sector breakdown for year-end 2008 and year-end 2005 in a follow-up article at a later time.
The Capital Markets Bureau will continue to monitor trends within the asset mixes in the insurance industry and report on any developments as deemed appropriate.
Questions and comments are always welcome. Please contact the Capital Markets Bureau at CapitalMarkets@naic.org.
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