Firms that have losses are expected to sell tax-free securities and replace them with taxable securities since they can no longer benefit from tax savings. However, after the most recent financial crisis, firms’ decisions to rebalance their investment portfolios may have led to additional losses during a period of stressed financial performance and increased insurance regulation. This study examines portfolio allocation behaviour in the property and casualty insurance industry. The results show that investment limitations imposed by insurance regulators can inhibit desired investment allocation post the financial crisis.
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Approximately two-thirds of the insurance industry portfolio are held in the form of corporate or government bonds. In fact, insurers are among the largest holders of state and municipal government bonds (i.e., tax-free securities) that go directly towards the financing of public projects (American Insurance Association 2010).
Insurers derive their total income from two sources: underwriting and investing. Just like investment income, underwriting income can be volatile. Moreover, underwriting income has historically been negative (Fairley 1979).
Interest income on tax-free securities may not always be completely tax-free for P&C firms. However, the line item for tax-free securities is listed as entirely tax-free.
I would like to thank the authors for providing me with their data set to conduct my analysis.
Source: NAIC, used by permission. The NAIC does not endorse any analysis of its data or conclusions based on its use.
The primary users of the statutory financial statements are state or local regulators. In addition, SAP is focused on long-term liabilities of insurance companies and stresses the long-term claim-paying ability of the insurer, resulting in lower capital and income volatility, hence giving a more conservative measure of an insurer’s financial stability.
NAIC (2001) states, “One of the most difficult tasks facing insurance regulators is to make effective use of limited resources. All companies are required to file annual statements with all states in which they are licensed to operate. Obviously, no state is able to review thoroughly the financial condition of all licensed companies immediately upon receipt of the annual statements. IRIS helps to select those companies that merit highest priority in the allocation of the regulators' resources, thus directing those resources to the best possible use.”
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I would like to thank Joseph Comprix, Randell Elder, Susan Albring, Craig Nichols, William Horrace, Tyler Leverty, Norma Nielson, Dara Marshall, Lamont Black, Stephani Mason, Phebian L. Davis-Culler, Noelle Butski and Menna Bizuneh and worship participants at West Virginia University, New Mexico State University, DePaul University, Miami University. Funds were provided by DePaul University, Syracuse University and the Hagan Family Foundation Fund. Data Source: National Association of Insurance Commission (NAIC), by permission. The NAIC does not endorse any analysis or conclusions based upon the use of its data. I bear full responsibility for any remaining errors in the text.
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Reddic, W.D. Under pressure: investment behaviour of insurers under different financial and regulatory conditions. Geneva Pap Risk Insur Issues Pract 46, 1–20 (2021). https://doi.org/10.1057/s41288-020-00174-7
- Statutory accounting principles
- Tax-free and taxable securities
- Portfolio rebalance