Throwing Risk To The Wind

Daniel P. Kearney, former head of the Resolution Trust Corp., recently joined Aetna Life and Casualty Co., which seemed to offer a less stressful life. Yet as head of Aetna's investment operations, he faces some of the same problems that plagued him at the federal thrift-bailout agency, notably what to do with a lot of bum investments. In 1990, Aetna booked losses of $ 35 million on its bonds and took a $297 million hit in write-downs and reserves to cover losses in real estate.

No surprise, then, that Kearney is changing Aetna's investment strategy. He's passing up real estate and junk bonds in favor of less risky investments such as Treasuries and mortgage-backed securities. While one can sympathize with him, his new preferences could damage Aetna's investment results and undermine its competitive position.

Kearney has plenty of company (chart). Such other wounded insurers as Equitable, Kemper, and Travelers are also pushing prudence. These companies are in no danger of folding, but they've been roundly criticized for their risky holdings. And they know that a conservative portfolio is in demand nowadays by skittish customers. Some 22% of life insurers' $1.4 trillion in assets is in real estate and mortgages, and 6% is in junk. Customers' fears intensified following the mammoth failures of First Executive Corp.'s and First Capital Holdings Corp.'s junk-heavy insurance units.

'DIFFICULT CORNER.' Insurers aren't heartened by the recent upturn in the moribund junk market or by hints that real estate may be bottoming out. Standard & Poor's Corp. forecasts that junk defaults will surge as high as 15% this year, vs. 8% in 1990. Real estate reserves and write-offs by the top 25 life insurers, says S&P, will total $1.1 billion annually for the next three years. "These days, you can't be too safe," says Kearney.

Not necessarily true. Less risk usually means lower returns. If insurers move too heavily into safer investments, analysts say, returns on their annuities (now around 8%), whole-life policies (currently 6%), and other life-insurance products will fall by about two percentage points over the next year. That would be good news for insurers' competitors--mutual funds and others able to flaunt higher yields. Insurers "could box themselves into a difficult corner by being too conservative," says John B. Kleiman, vice-president at insurance-research firm Conning & Co. Adds Northington Partners Inc. analyst William D. Bitterli: "They will lose business."

Analysts predict that insurers' returns on equity, now averaging 15%, could plunge by a third over the next three years. Ironically, the main reason insurers got into riskier investments in the 1980s was pressure from competitors.

A further irony is that the safe havens targeted by insurers may not be that safe after all. Unlike real estate, bonds and mortgage-backed securities are acutely vulnerable to interest-rate fluctuations. Insurers claim they have sufficient computer-aided investing savvy to insulate them from that.

Such confidence about highly interest-sensitive products worries some analysts. Says Michael A. Smith, analyst at Shearson Lehman Brothers Inc.: "There aren't too many companies that are so adroit that they can maneuver successfully around a yield curve that's moving constantly."

GRADUAL SHIFT. In their flight to safety, some analysts argue, insurance companies may be passing up real bargains in the depressed junk and real estate markets, where not everything is a turkey. Analysts say insurers must be bolder now if they are to earn competitive returns. "Unless they do something within the next six months, the outlook for 1992 is poor," says Udayan Ghose, a partner at money-management firm Weiss, Peck & Greer.

So far, insurers are not persuaded. Eliot P. Williams, Travelers Corp. vice-president for investments, concedes that lower returns could hinder growth. But he insists that beefed-up service and marketing will keep customers from straying. The extra risk of high-octane investments isn't worth scaring customers away, insurers contend. "It doesn't do you a lot of good to make just a little extra for a lot fewer customers," says David E. McPherson, executive vice-president at Allstate Insurance Co.

The industry's movement toward more cautious investments, to be sure, is gradual. A sudden selling of huge blocks of assets would only aggravate the situation by sinking prices further. The slow shift may allow insurers to change their minds before too much damage is done. An economic recovery that brought a rebound in junk and real estate may convince them that being too safe could make them very sorry.