U.S. property-casualty insurers, a group including American International Group Inc. (AIG) and Travelers Cos., will struggle to post a 10 percent return on equity as low interest rates weigh on investments, Citigroup Inc. said.
“The sector has let investment income be a subsidy for too long,” counting on fixed-income returns while results from underwriting insurance coverage were pressured, Keith Walsh, a Citigroup analyst, said today at a conference sponsored by Reactions Magazine in New York. A 10 percent return on equity for the industry is a “best-case scenario” amid low yields for new investments.
AIG, which counts the U.S. as its largest investor after a 2008 bailout, has increased its focus on emerging markets and worked to reduce business in areas that require the company to hold large amounts of capital. Travelers, the lone insurer in the Dow Jones Industrial Average, is charging commercial clients more for coverage as it copes with falling bond returns.
Lower bond yields have “imposed somewhat of a discipline” on companies in managing their insurance liabilities, Walsh said. New York-based AIG spent $1.09 on claims and expenses for every premium dollar at its Chartis property and casualty operation in 2011, better than $1.17 a year earlier. The figure improved to $1.02 in the second quarter.
Chartis is targeting return on equity of 10 percent to 12 percent in 2015 compared with a “normalized” return of 6 percent in 2010, Peter Hancock, the unit’s chief executive officer, said in May.
Travelers’s goal of mid-teens return on equity isn’t realistic in the near term as natural disasters fuel claims costs, CEO Jay Fishman said in July. The figure was 11.8 percent for the first half at the New York-based company.
“The whole industry and beyond needs to be more realistic about its return expectations” from investment portfolios, Jason Pratt, chief investment officer of Bermuda-based reinsurer Montpelier Re Holdings Ltd. (MRH), said at the conference.
The U.S. Federal Reserve pledged last week to maintain interest rates near record lows until at least mid-2015 and purchase mortgage debt to stimulate the economy. The yield on the 10-year Treasury is about 1.78 percent, compared with 3.29 percent at the end of 2010.
Pratt said derivatives and short positions, in which investors bet on a decline in securities prices, are necessary tools and that portfolio managers need to convince corporate boards of their effectiveness.
Children With Guns
“If you think you’re going to operate in a long-only environment in fixed income, you’re going to die,” Pratt said. “But you also can’t give guns to children.”
Fishman, who kept Travelers profitable in the credit crisis by sidestepping losses on mortgage-backed securities, has shunned adding risk in the bond portfolio this year.
“People say, ‘Where are you going for yield?’ and the answer is ‘Nowhere,’” Fishman said at a conference last week. “If we thought that there was a place where, on a risk-adjusted basis, yield was better than where we are today, we would move in that direction. But we don’t see it, we don’t perceive that there is such a place. So we continue to be invested in the same asset classes that we have been before and accept the premise of lower returns prospectively.”
AIG, which almost collapsed in 2008 before it was rescued by taxpayers, has been increasing bets on lower-rated mortgage bonds. The company has surged 49 percent this year in New York trading as the company bought back about $13 billion in stock, helping to cut the government’s stake below 50 percent.
“The investment community is OK with companies taking a little more risk,” Citigroup’s Walsh said today.
Travelers had advanced 16 percent this year as Fishman raised rates for insurance coverage, beating the 11 percent gain in the 30-company Dow Average. Montpelier climbed 27 percent.
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