P&C Investment Income Woes Predate Financial Crisis

The investment income woes of property/casualty insurers did not begin with the 2008 financial crisis, new analysis from Fitch Ratings reveals.

Noting that the market values of fixed incomes and equities recovered quickly in the wake of the crisis, the report examines the underlying causes of the long-running trend toward diminishing returns. “Over the last 15 years, investment yields have declined significantly, with the industry’s yield moving from 5.7 percent in 1996 to a current level of under 3.8 percent,” the report states. “The industry yield was 7% as recently as 1990.”

Presently, the industry finds itself in a low investment yield quandary hemmed in by low interest rates and bonds yields. Moreover, the trend toward lowering portfolio risk finds insurers increasingly eschewing riskier but potentially more profitable investments such as equities. “Unaffiliated stock holding have declined to 12 percent of industry invested assets from 16 percent over the last five years and non-investment grade bond holdings remain low at around 2% of invested assets,” the report states. “As such investment income is unlikely to materially grow going forward and any profitability improvement will hinge on changes in underwriting performance.”

Nonetheless, when assessing individual companies, the report did find some interesting anomalies regarding portfolio composition and the inherent trade off between risk and reward.

With $162 billion in invested assets as of year end 2010, National Indemnity was the largest P&C insurer studied. The company had the highest returns overall, but also significantly higher volatility when unrealized gains/(losses) are considered. The second largest insurer, State Farm ($122 billion) also maintained above average unaffiliated equity holdings. As a result State Farm has higher volatility than peers, but its average return for the period remains below the industry norm. 

Conversely, several companies (Chubb Group, USAA, Travelers, and AIG) managed to record above industry average total returns with below industry volatility.

For ratings purposes, Fitch favors the latter approach. “Fitch believes that a more conservative approach to asset management is an appropriate strategy given the predominance of risks tied to the underwriting activities of a property/casualty insurer. While positive investment results are important to contributing to overall returns on capital, generating investment results that are on par with industry or peer norms with lower return volatility is viewed positively in the rating process.”