Magazine article Risk Management

Mutual Understanding

Magazine article Risk Management

Mutual Understanding

Article excerpt

Currently, all insurers are experiencing lower investment returns or losses on the back of a global economic slowdown. This has been compounded by increased volatility in the capital markets, stemming from a tight credit environment. Myopia has set in for investment managers at insurance companies as nobody can see when the recessionary landscape will end or when it is safe to return to previous allocation strategies.

Mutual insurers have historically had higher allocation of equities in their investment portfolios than the commercial markets (20%-60% compared to less than 10% in typical commercial carrier investments). The equity allocation of the mutual insurers in the United States has caused them to benefit from higher investment returns during strong equity markets when compared to their competitors and lower returns during bear markets.

Over the years, this allocation position has contributed to increases in company surplus as equity markets have enhanced returns beyond fixed income returns in mutual insurers' portfolios. In years when there were high underwriting losses, investment returns could be used to offset volatility in the underwriting book and provide policyholder benefits, in the form of compensation at the end of the year through dividends or member credits, thereby reducing members' long-term cost of risk.

Fixed income returns, which form the basis for most insurance companies' investment allocation strategies, are also slim, anchored by a Federal Funds Rate of less than 1%, the lowest in decades. The difference between now and 10 or 20 years ago, however, is that rises in the stock markets (S&P annual return of 5%-10% or more) allowed for those risk takers with high equity allocations to benefit in low underwriting loss years. Likewise, it allowed mutual insurers to offset large parts of the losses during years of high claims activity. This is no surprise as mutual insurers typically maintain higher combined loss ratios than the commercial market; their goal being to lower the policyholder's long-term cost of risk, not to maximize profit.

Mutual insurers, some of which are devoted to niche industries, are prone to uniquely high incurred underwriting losses. Due to their risk concentrations, they are exposed to decreases in surplus that are often large relative to general insurers with greater risk diversifications. …

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