By Alton Cogert
Who doesn’t want to know how they compare to their peers?
From ‘keeping up with the Joneses’ to ‘I’m better than you,’ there are many ways of expressing this sentiment in everyday life.
Of course, insurers are known as long term, conservative investors who have less need for sentiments such as those. Nonetheless, insurers are incessantly compared to peers by regulators, rating agencies and the press, to say the least.
The problem is that many of those peer comparisons are riddled with problems, starting with three important questions that need to be answered:
- Do we have adequate data to make the comparison?
- Are we comparing the correct information?
- Are we comparing to the right peers?
We have viewed many different peer analyses that attempt to address these issues, and then expand the peer analysis to unnecessary levels of detail. This is undoubtedly due to the myriad of questions that hound peer group analysis, such as, “What about x characteristics, or y information, or z related data?”
At Strategic Asset Alliance, we have tackled these problems and developed a focused peer analysis to help answer a very specific question: “What can we do to improve investment results?”
In this incessant low rate environment, it is increasingly important to consider assets outside of traditional investment grade core fixed income to improve those results. But, we all know that stepping too far outside the bounds of propriety (as seen by the regulators and ratings agencies) is probably not a very good idea, no matter how compelling an asset class may appear to be.
But, simply comparing to competitors is not a very good idea, as many times those competitors are of significantly different size than your company. And, there is no getting around the fact that rating agencies have a large company bias, coupled with the other fact that larger companies typically have more investment flexibility than smaller companies. (This should not, however, rule out inspecting the public filings of those large company competitors.)
With these issues in mind, we have established proprietary SAA Structured Peer Groups, using data provided by SNL Securities, which are grouped by asset range, within a similar business line focus. Thus, Structured Peer Groups allow us to compare what are, in essence, ‘investment competitors,’ companies that may not even write business in your geographic area but do compete with you more directly in the investment marketplace.
Within each Structured Peer Group, we focus on key indicators that might shed some light on the relative levels of investment risk being taken by companies similar in size and line of business. These indicators are not designed to identify all kinds of investment risk – publicly available information is neither broad nor deep enough to allow such analyses without making spurious assumptions. However, these indicators are designed to focus on the types of investment risk which is readily understandable from the data. (Thus, we have excluded interest rate risk for this analysis due to lack of adequate data.)
Within the SAA Structured Peer Groups, we compare four major investment ratios and two major financial ratios, assigning peer companies into quartiles. The investment ratios are:
1) BBB Bonds/Surplus – While BBB bonds are still part of the core fixed income portfolio, they do inhabit the bottom tier of investment grade. With rates having fallen to historic lows and the shrewdness of corporate treasurers having risen to historic highs, many issuers have decided that they can operate better outside the financial constraints posed by ratings above BBB. Thus, BBB’s have become a larger part of corporate bond indices and of insurer portfolios over time. Nonetheless, they do cover a higher probability of loss than other ratings within investment grade, so understanding peer investment in this rating class is important.
2) Common Stock/Surplus – As common stock is marked to market and impact surplus immediately, the amount of surplus being risked is important and measure of market risk.
3) High Yield/Surplus – P/C and L/H companies play by different accounting rules when it comes to these bonds, which typically perform somewhere between investment grade bonds and common stock. However, it is their imbedded credit risk which, should losses occur, impacts the bottom line and, concurrently, surplus.
4) Risky Assets/Surplus – Because insurers can creatively place some rather interesting investments in their portfolio and they can find their way onto Schedule BA, we have attempted to sum all Common Stock, Preferred Stock, High Yield and Schedule BA assets and compare to surplus. This is an attempt to measure overall market risk (including credit risk) from these non-core fixed income assets versus surplus levels.
In addition, because insurers are levered institutions, they consider operating and financial leverage when deciding where to take risk. With that in mind, we decided to include those two ratios in the peer comparison.
You can see a preview of what these measures look like for your entire industry by choosing one of the following links. However, please remember that this does not take into account the more appropriate peer analysis possible with a SAA Structured Peer Group.:
Peer group analysis is a good initial step in comparing to similar companies in similar lines of business. By focusing on some key measures of how companies are taking on investment related risk, we can take the first step in answering the question, “What can we do to improve investment results?”
After all, “a journey of a thousand miles begins with a single step.”