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Nitesh Patel
Finance | Financial advice

By Nitesh Patel

While many know that life insurance is primarily something people count on to provide for their family when someone dies, it’s not as commonly known how life insurance companies are able to cover the claims of its policy owners. There are several factors that contribute to insurer’s financial strength. Along with other important aspects including the ability to control expenses, future claims experience, and retain and grow a strong customer base, the effective management of a company’s investments is vital.

Long-term, big-time investing

Throughout its more than 245-year history1, the American life insurance industry has fulfilled its commitments to policyholders in part, by investing carefully and managing its business conservatively with a keen eye on its long-term commitments.

The assets held by life insurers (which back the liabilities of the insurance lines of business) come from policy premiums and investment earnings. This money also provides the U.S. economy with an important source of investment capital. As reported in the American Council of Life Insurers 2004 Fact Book, according to the Federal Reserve, the life insurance industry is one of the largest institutional sources of funds, supplying 9 percent of the total capital in financial markets.

Investment strategy: art, science or regulatory requirement

While investment strategies vary from company to company, all insurance companies are highly regulated by state insurance departments and are restricted from taking on too much risk with their general account investments. Every company is subject to intensive financial examinations from state insurance departments and must comply with statutory requirements on the amounts and types of investments they can hold.

Each insurer must also submit an annual comprehensive statement of financial condition to the department of insurance in every state it does business. Other state laws require life insurers to file independently audited annual reports.

Most companies also subscribe to one or more major rating agencies such as Moody’s Investor Services, Fitch Ratings, Standard & Poor’s and/or A.M. Best. Each of these agencies performs an in-depth analysis of a company on an annual basis. Based on this analysis, the agency publishes a report assigning a “claims paying ability” rating and providing an overview of the company’s current strengths and weakness, business operations, management philosophy, etc.

A summary of the company’s investment strategy, strengths and weaknesses is a key component of these “third-party” ratings reports. If you are interested in learning about a particular company’s financials, this is a good place to start.

Where they invest

While bonds make up the majority of assets held by life insurers (56 percent at year end 2003) other holdings include corporate and government bonds, stocks, mortgages, real estate holdings and policy loans.2

Bonds. Life insurance companies invest in U.S. Government bonds and primarily high- quality foreign government bonds and corporate bonds with varying maturity dates. In fact, at year-end 20033, 93 percent of the industry’s bond investments were in the highest two categories of investment grade bonds. The higher the quality/category of the bond, the lower the investment default risk.

Mortgages, real estate, stocks, etc. Mortgages and real estate are generally considered riskier investments than bonds. While stocks and other investments are often used, their use is limited. It is important to note that while these asset classes are riskier, they do help provide an additional boost to investment performance over the long term when used prudently.

Stocks. While corporate stock holdings have historically represented a smaller percentage of the insurance industry’s total assets, the popularity of variable life insurance (where the policy owner chooses the underlying investment accounts) as well as several other factors has brought the percentage of total stock holdings up to 27 percent.3

Policy Loans. When life insurance companies loan money to their policy owners, they have to take these loans from funds that otherwise would have been invested. Since premiums are based in part on an anticipated investment return, interest must be charged on the loans. Accordingly, these accounts are included in a company’s assets.

Part of a company’s strategy is to ensure it has the appropriate mix of assets to pay the claims it expects. Whether or not a company has accomplished this will be reflected in its financial strength ratings and report provided by the third-party rating agencies.

The life insurance industry plays an important role in providing long-term financial security for millions of Americans. Through careful investment management, the industry will continue meeting future challenges and fulfilling its ultimate promise to policy owners.

3 Semi-Centennial History of The Northwestern Mutual Life Insurance Company, p. 26

2 American Council of Life Insurers, Life Insurers’ Fact Book, 2004

3 American Council of Life Insurers, Life Insurers’ Fact Book, 2004

2 American Council of Life Insurers, Life Insurers’ Fact Book, 2004

3 American Council of Life Insurers, Life Insurers’ Fact Book, 2004

Nitesh Patel is a financial representative with the Northwestern Mutual Financial Network based in Clearwater for The Northwestern Mutual Life Insurance Company, Milwaukee, Wisconsin). To reach Patel, call (727) 799-3007 or e-mail

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