One of the best features of insurance businesses is that they generate float by taking in premiums before losses are paid out. This gives insurance companies the ability to invest the dollars their customers hand them and collect interest, dividends, and capital gains from trillion-dollar investment portfolios.
But what they invest in will vary by insurer. Companies like Progressive (NYSE:PGR), which primarily underwrites car insurance, will invest very differently than a life insurer like MetLife (NYSE:MET).
In this Industry Focus: Financials segment, host Gaby Lapera and contributor Jordan Wathen discuss how insurance companies decide what to invest in, and how much risk to take with their customers' money.
A full transcript follows the video.
This video was recorded on May 22, 2017.
Gaby Lapera: What is the float typically invested in?
Jordan Wathen: That depends. The whole idea -- most insurance companies really want to build an investment portfolio so that the duration of their assets matches that of their liabilities. A car insurance company writes short-term contracts, so it's going to primarily invest in short-term bonds. On the other hand, a company that writes life insurance or annuities, for example, is going to invest in longer-term assets. To give you an example of that, let's use Progressive. As a car insurance company, 80% of its investment portfolio, its fixed-income portfolio, at least, is in short-term bonds that mature in less than five years. On the other hand, MetLife -- which does life and annuity insurance, long-term insurance contracts -- 70% of its portfolio is invested in bonds that mature in more than five years. So the whole idea is, depending on how long it will take you to pay out your claims, generally speaking, the longer you can invest your capital, so the longer you can invest in longer-term bonds or even stocks.
Lapera: Yeah, that makes sense to me. I think a question that people will probably also have is, you talked a lot about bonds... what about stocks?
Wathen: Generally speaking, Progressive, for example, only has about 10% of its capital invested in stocks, because stocks gyrate so much more. If they need to go sell stocks, and something like 2009 happens, you don't want to be in the scenario where you're selling stocks at a loss to pay out claims. So generally speaking, these insurers try to keep into super-safe investments -- 90% or more of their portfolio in bonds.
Lapera: Yeah, that makes sense to me. That's what I would do if I were an insurer. But insurance companies typically are kind of conservative animals, because they have to be. OK. Second-to-last question: What percentage of premiums paid make up the float for most insurance companies?
Wathen: Ultimately, premiums are the source of float. The question is, really, how much in unearned premiums, or premiums that are paid in advance of the contract? If you pay on March 30th your insurance premium for April, May, and June, that's an unearned premium for the insurance company. That period hasn't come yet. So Progressive, for instance, its unearned premiums on its balance sheet when it last reported it was about $8 billion. So there's $8 billion of capital there. Then, if you look a little bit further, you'll see their loss and loss-adjustment reserves, which is how much they expect to lose that they haven't paid out yet. That was $11.6 billion. So for Progressive, the big generator of the float really isn't so much premiums they've taken in in advance of the contract. It's really the amount of time it takes for them to pay out on losses, if that makes any sense.
Lapera: That makes a ton of sense. Thank you so much for answering that. Listeners, we also have a really old article -- I don't want to mislead you, it's from 2006 -- but it helped also answer this question. If you want it, email me at email@example.com. The information in it is still relevant, it's just very old. It's over 10 years old at this point.
Gaby Lapera has no position in any stocks mentioned. Jordan Wathen has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.