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1 NAIC 'IRIS ratio' rendered irrelevant by challenging investing environment

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1 NAIC 'IRIS ratio' rendered irrelevant by challenging investing environment

Rising interest rates have yet to translate into improved investment results for the entire U.S. property and casualty industry, though the combination of that macroeconomic trend and a lower U.S. corporate tax rate should eventually provide tailwinds.

The industry's net yield on invested assets dipped by 1 basis point on a year-over-year basis to a 3.03% in 2017, and slid by 13 basis points year over year to 2.92% in the first quarter of 2018.

The industry's investment yield in 2017 was so anemic that the vast majority of P&C companies once again fell short of the low end of what the National Association of Insurance Commissioners considers the "usual" range of investment yields as part of its Insurance Regulatory Information System, or IRIS, ratios. While the 13 ratios that pertain to P&C companies are intended to offer individual regulators with an integrated approach to screening and analyzing the financial condition of insurers operating within their respective states, the low-for-long rate environment has rendered much of the "usual" range of investment yields of between 3% and 6.5% an aspirational result, as opposed to an achievable target for the conservative, liquid portfolios that are prevalent across the industry.

Based on a "usual" range for the IRIS ratio of investment yields of about 3% to 6.5%, 87% of the 2,635 individual U.S. P&C insurers under S&P Global Market Intelligence coverage produced "unusual" results in 2017, up from 84.2% in 2016.

No more than 19.2% of the individual P&C companies produced "unusual" results for any of the other 12 IRIS ratios in 2017. And fewer than 5% of those companies produced "unusual" results for 6 of the 13 ratios, including the three that pertain to loss reserves.

When excluding investment yields, just over half of the companies under current coverage reported no "unusual" values in 2017, well above the 7.7% that did so when including all 13 ratios.

The IRIS ratio manual indicates that low yields may be indicative of factors including speculative investments that sometimes produce large capital gains in the long run but little interim income, outsized investments in home office facilities, large investments in tax-exempt bonds, significant interest payments or very high investment expenses. Though there might be some isolated examples of those factors, the low-for-long rate environment is a much more likely culprit of the prevalence of "unusual" values in the last number of years.

The manual allocates less space to a discussion of yields above the "usual" range, suggesting that they may be indicative of investments in high-risk instruments or evidence of extraordinary upstream dividend payments. Given the challenging environment, however, they likely merit additional scrutiny.

Of the 2,293 individual P&C entities with "unusual" investment yield IRIS ratios in 2017, only 24 of them produced results above the "usual" range. Half of them paid some amount of dividend to their stockholders during the year. Among the remaining 12 entities, items such as dividends paid on affiliated common stock, dividends receivable and unrealized gains on unaffiliated stock recorded in net investment income led to investment yields of 6.5% or higher.

Some companies have seen the light at the end of the interest rate tunnel.

Travelers Cos. Inc. executives during an April conference call noted that pretax income from the company's fixed-income investment portfolio increased on a year-over-year basis in the first quarter for the first time since 2008. The $500 million in gross investment income from fixed maturities and short-term securities marked an increase from $488 million in the first quarter of 2017. Officials cited the benefits of a more favorable interest rate environment, especially as it pertains to short-term rates, as well as a higher amount of average invested assets, as reasons for the increase.

The effective tax rate on Travelers' investment income declined to 14.9% in the first quarter from more than 21% in each of the previous four quarters. Officials projected that the after-tax investment income from the fixed income book would rise by between $40 million and $45 million per quarter through the remainder of 2018. The positive after-tax variance in the first quarter was $36 million.

At Federated Mutual Insurance Co., which has consistently produced investment yields within the "usual" range, the company said it has taken a variety of actions to respond to the low-rate environment. Among them, it has reduced its new-money allocation to tax-exempt municipal bonds and focused instead on assets such as private placements and equities. It boosted its allowed allocation by 50% to as much as 12% of invested assets and said that it would consider raising that limit again to 15%.

The company said that it has not been immune to the investment challenges the industry has faced. But the data show it has fared better than most.