Lower Costs Help Cushion Falling Returns For Insurers: Conning

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Its no surprise that a steep drop in interest rates has put a dent in life insurers investment returns over the past 5 years. But a new study by Conning Research and Consulting Inc., Hartford, suggests that improving investment costs for insurers have helped soften the blow.

Life insurers saw gross investment returns fall from 8.1% to 6.8% from 1999 to 2003, due to tumbling interest rates, corporate defaults such as Enron and WorldCom, and rating agency downgrades, Conning notes.

Meanwhile, federal fund interest rates plunged from 6.5% to 1% from mid-2000 to the end of 2003, their lowest level in 50 years.

For corporate bonds, rates fell from about 7.4% to 4.4% between December 1999 and June 2003.

However, an improving investment expense ratio helped temper these setbacks, improving each year during the study period.

The life industrys average investable general account assets grew at an annual rate of 8.3% from 1999 to 2003, from around $1.6 trillion to $2.2 trillion. Conning defines investable assets as assets over which the companies portfolio managers have direct control. They include cash as well as invested assets.

Income earned from the industrys investable assets increased from $122 billion to $144 billion from 1999 to 2003, an annual growth rate of 3.7%. But the values of the assets grew at a much faster rate of 8.3% in that time. (See chart.)

Income earned by the industry on invested assets grew from $136 billion to $154 billion between 1999 and 2003, while net investment income grew from around $130 billion to a bit more than $144 billion in the period, Conning says in its study, “Investment Profile of the Life Insurance Industry-2004 Edition.”

At the same time, investment expenses increased from $9.2 billion to $9.7 billion.

However, as a percentage of average invested assets, the expense ratio actually fell from 52 basis points in 1999 to 40 basis points in 2003, Conning found.

“Over the past 5 years, 54 cents of each $1 spent on investment expenses was categorized as general expenses, 18 cents was used for interest expense and 28 cents went toward expenses such as taxes, depreciation on real estate and other miscellaneous write-in expenses,” Conning says.

Roughly 94% of insurers gross income from investments is net income, while around 6% is eaten by expenses, says Jim Smith, a Conning analyst and author of the report.

Reduced investment costs are “consistent with insurers flight to bonds, because they are much less expensive for insurers to hold,” says Smith. “Bonds also have a lower risk-based capital requirement, so the NAIC requires less surplus for bonds, particularly high grade bonds.”

Both long- and short-term bonds in total grew from around 80% of life insurers investable assets to 84% over the 5 years, Conning found.

Mortgages, the industrys 2nd largest type of investable asset, declined from around 14% to 11% during the period.

The remaining investments were in stock, real estate and other assets.

The big reason for the decline in insurer ownership of actual mortgages is that mortgage-backed securities became more accepted by insurers portfolio managers.

“They are actually classified as bonds,” notes Smith. “The life insurer can still invest in the mortgage market, but these give it a more diversified risk.”

Conning expects insurer investment returns to continue to fall slightly over the next 2 years, followed by a slow improvement.

Returns could decline into the low 6-point range before beginning to improve, Smith predicts. But Conning doesnt see any significant improvement in 2004 and 2005, he says.

“As the equity markets improve and interest rates go up, we expect returns will go up as well,” he says. “But usually we see a 2- to 3-year lag. Thats because insurance companies have bond investments of different duration, so a lot of older bonds will be replaced with much lower yielding bonds.”


Reproduced from National Underwriter Edition, September 9, 2004. Copyright 2004 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.