Insurers roared back to profitability in the third quarter, possibly bolstering a pillar of buy-side support for tax-exempt municipal bonds.
The property and casualty insurance industry reported $11.47 billion in pretax operating income in the third quarter, the Property Casualty Insurers Association of America said in a report yesterday. The industry lost $1.48 billion in the third quarter last year, according to the group.
The PCIAA attributed the improvement to placid weather. Property insurers endured billions of dollars in claims from hurricanes Ike and Gustav in the third quarter of 2008.
Insurers in the third quarter suffered $2.6 billion in losses from catastrophes, compared with $16.1 billion in such losses in the third quarter of 2008.
The industry’s return to profitability is potentially good news for tax-exempt municipals.
Property and casualty insurers are one of the biggest buyers of state and local government debt. The P&C industry owned $394 billion in municipals at the end of the third quarter, according to the Federal Reserve, or 14.2% of municipalities’ outstanding debt.
Insurers collect premiums in exchange for covering losses arising from a given event. Because they need to keep a certain amount of money available to pay would-be claims on their policies, insurers typically manage big, liquid investment portfolios.
Insurers generally do not make money on insurance policies. According to A.M. Best, the industry spends more paying claims than it collects in premiums most years.
Most of the industry’s profit comes from investing customers’ premiums before they are paid out as claims. Profitability is a key determinant of whether an insurer invests in tax-exempt munis.
An insurer that is losing money has no reason to accept the lower yields on tax-exempt securities. An insurer with pretax operating income, though, can shelter the income from taxes by investing it in municipals.
The industry’s third-quarter profit did not lead to much buying. Insurers added just over $2 billion to their municipal holdings during the quarter, according to Fed data. With the exception of the third quarter of last year, insurers last quarter added municipals to their portfolios at the slowest rate since 2002, according to the Fed.
Municipals constitute 29.3% of P&C insurers’ assets, compared with 28% at the end of the third quarter last year.
The modest accumulation shows that while profitability might be a primary determinant of insurers’ appetite for municipals, it is not the only one.
Allstate Corp., which reported operating income of $538 million in the third quarter, decided to pare down its tax-exempt municipal holdings anyway because of concerns about state and local government credit as well as the risk of a spike in interest rates.
In the company’s third-quarter conference call, chief executive officer Thomas Wilson said Allstate planned to “slightly reduce exposure to municipal debt” because “the financial wherewithal of state and local governments has a negative focus on it.”
The Northbrook, Ill.-based company sold $4 billion in municipals during the first three quarters of 2009, bringing its holdings down to $23 billion. Allstate expects to continue selling munis.
Then of course there’s American International Group Inc., the felled insurance giant whose entire $54.6 billion municipal portfolio is for sale. The company has sold at least $10 billion in municipals in the last year.
Meanwhile, the federal government threw a wrinkle into the bond math for insurers this year.
Enacted through the American Recovery and Reinvestment Act in February, the Build America Bonds program enables state and local governments to forego the customary tax exemption on their debt and instead issue taxable debt and collect a federal subsidy equal to 35% of the interest cost.
The program triggered an explosion in taxable issuance. Municipalities have sold more than $64 billion of BABs this year, shattering the record for most taxable municipal debt sold in a year.
The taxable bonds created through the BAB program means insurers can park their cash in state and local government debt even if they have no taxable income to report.
Insurers in an unprofitable period can enjoy the higher yields on taxable municipal bonds without paying taxes on them.
Allstate in its third-quarter conference call said even as it sheds munis overall it is buying BABs.
Disclosures of BABs holdings by institutional investors show life insurers as buyers.
According to Ipreo’s Muni Analytics service, the top holders of BABs at the end of the third quarter include names like Protective Life Corp., John Hancock Life Insurance Co., and Aetna Inc.
“BABs allow us to gain municipal credit exposure in portfolios that aren’t otherwise suitable for traditional tax-exempt bonds,” Cincinnati Financial Corp., which owned $15.8 million in BABs at the end of the third quarter, said in a statement.
Life insurance companies have historically invested far less in municipal bonds than property insurers. The life insurance industry owned $50 billion in municipals at the end of the third quarter.