Insurance Company Investment Strategies: Where Does The Money Go?

Insurance companies make money in two main ways: charging premiums to customers for insurance coverage and investing these premium payments. The former is known as underwriting profit, while the latter is known as investment income.

Insurance companies invest in many areas, including stocks, bonds, mortgages, liquid short-term investments, real estate, and derivatives. However, they invest most heavily in bonds, as these are the safest of all investment categories.

Bonds

Insurance companies invest in many areas, but they invest most heavily in bonds. This is because bonds are perhaps the safest of all investment categories, and insurance companies are in the business of risk assessment.

Additionally, bonds have a weak correlation with other investment classes, such as stocks and mortgages. This means that their returns are relatively independent, providing diversification to an insurance company's investment portfolio.

Stocks

Life insurance companies typically invest around 5% of their total holdings in the stock market, while property and casualty insurance companies invest around 30% of their holdings in common stocks. This is because stocks can provide a way for insurance companies to boost their returns without taking on the full risk of the stock market.

Some insurance companies are more adventurous with their investments and choose to invest a significant portion of their assets in stocks. For example, Markel, a specialty insurer, invests about one-third of its assets in publicly traded stocks.

When investing in stocks, insurance companies seek to balance risk and return. They tend to invest in stable, blue-chip stocks to minimise risk while still benefiting from the higher returns that stocks can offer compared to bonds.

Mortgages

Insurance companies invest in many areas, but they tend to invest the most in bonds. However, they also invest in stocks, mortgages, and liquid short-term investments.

The life insurance sector of the insurance market invests about 15% of its premiums in mortgages and first liens. These three asset classes – bonds, stocks, and mortgage instruments – comprise about 90% of investments for life insurance companies and over 80% of investments for property and casualty insurers.

In addition to investing in mortgages directly, insurance companies also invest in derivatives, which are contracts with values dependent on other assets, often mortgages.

Short-term investments

Insurance companies are big investors in the bond market, and they tend to invest the most money in bonds. However, they also invest in stocks, mortgages, and liquid short-term investments.

• CDs: These are offered by banks and typically pay a higher interest rate because they lock up cash for a given period, usually ranging from several months up to five years.
• Money market accounts: These accounts offer higher returns than savings accounts but require a minimum investment.
• Treasuries: These are government-issued bonds, such as notes, bills, floating-rate notes, and Treasury Inflation-Protected Securities (TIPS).
• Bond funds: These are offered by professional asset managers/investment companies and are better for shorter time frames, offering better-than-average returns for the risk.
• Municipal bonds: These bonds are issued by local, state, or non-federal government agencies and can offer higher yields and tax advantages since they are often exempt from income taxes.

Real estate

Insurance companies have long been significant investors in real estate, particularly in the United States and Europe. They invest the premiums collected from policyholders into real estate, including commercial, residential, and agricultural properties. For instance, MetLife, a prominent US insurance company, holds a real estate portfolio worth over $55 billion, with other major companies like Prudential and Farmers following closely behind.

The insurance industry's interest in real estate stems from its unique business model, which involves mutualizing and managing risks. This model aligns with the characteristics of real estate as a lower-risk, long-duration investment that corresponds with their long-term liabilities. The ability to hold real estate over extended periods while collecting liquid premiums enables insurance companies to invest directly in specific assets and open-ended funds. Many large insurers have established dedicated real estate divisions to acquire and develop physical real estate assets, including commercial offices, retail spaces, industrial buildings, and housing.

In addition to direct investments, insurance companies actively participate in fund investing, such as real estate investment trusts (REITs). This approach provides them with greater access to the real estate market and the advantage of a diversified portfolio. By investing in REITs, insurers can benefit from professional management, reduced risk, and increased liquidity compared to direct property ownership.

The insurance sector's involvement in real estate has had a positive impact on municipal infrastructure improvements and the development of various property types. However, it is important to note that insurance companies have been criticised for their hypocrisy in persuading consumers to buy policies as valuable investments while using the premiums from these policies to invest in real estate themselves.

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