Finding, pricing, and managing the risks of the insured aren't all that insurance companies do. Insurance companies also have to manage their investment risks they take when they make investments using the premiums they receive from their customers to generate additional returns.
In this clip from the Industry Focus: Financials podcast, The Motley Fool's Gaby Lapera and Jordan Wathen discuss ways that investors can look to an insurance company's financial reports to understand just how much risk it is taking with its customers' (and stockholders') money.
A transcript follows the video.
This podcast was recorded on April 4, 2016.
Gaby Lapera: How would we evaluate whether or not a company is doing well on the investment side of their business model?
Jordan Wathen: If you go to the financial statements and you look at the investments, I like to look at that especially because you can really find out how much risk they're taking. One think they'll always show is the percentage ... Most insurers invest mostly in bonds, so you look and you can see for example by credit rating, they'll show percentage of investments that are held in government securities, percentages that are held in AA corporate bonds. That gives you a good idea of how risky an insurance company is. There was one very small insurer that was run by some very interesting people. For a long time it had a lot of its money invest in gold stocks and gold and silver, which if you think about it is a pretty terrible way to run an insurance balance sheet, because if at the same time gold goes down a huge hurricane through, you're in a world of hurt.
Lapera: That is really interesting. Gold is whole another issue we could do an entire podcast on. There are definitely issue some gold bugs out there, I think one of my colleagues called them the other day. Which is crazy because ever since, what's his name, William Jennings Bryan I didn't realize that this was still a thing that people were so obsessed with.
Wathen: Right, yeah. If you ever have some survivalist friend, your insurance company might want to double think it. That's one of the biggest risks, but for the most part most major insurance companies are pretty plain vanilla in how they invest their money. It's say 95% fixed income or bonds and 5% stocks. They're not interested in taking too much risk on that, because they know a lot of the money they take in in premiums will have to be paid out in losses and expense relatively soon.
Lapera: Yeah. Okay, here's a thing right, is that we're doing an episode about something that a lot of people think is super boring, so I asked Jordan Wathen to come up with some fun facts about insurers. I think it might be time after talking about some very boring bonds, to come up with a fun fact. Do you want to go for it?
Wathen: Yeah. We can go with some fun facts. Way back in the day ... Actually first I should give a shout out to this book which is called The Invisible Bankers. Actually it was interesting that we talked about insurance companies being like banks. The book is called, Invisible Bankers, I would highly recommend you read it. You can get it on Amazon for all of a dollar, so it's worth checking out. One of the few of the fun things they had in there was one about in the hay day of air travel, insurance companies made a fortune selling life insurance to air travelers. They basically pitched it as this huge risk, that getting on a plane was basically taking a huge risk with your life. But all the same time, while they're selling travelers life insurance on the plane, they're underwriting pilots at the standard rate. Basically they're telling travelers that traveling is so dangerous, but the people who fly for a living, they're just standard risks.
Lapera: That is super sneaky. Again, why maybe people think that people who work in financial services are villains. Take note in case you want to change your perception, insurance companies.