Lower Costs Help Cushion Falling Returns For Insurers: Conning

"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.