How Do Insurance Companies Invest Money?

Insurance is a big business. In the United States approximately 1,800 insurance companies offer a range of product lines from property and casualty protection, such as homeowners and auto insurance, to life and health insurance. In exchange for regular payments, or premiums, insurers indemnify individuals, businesses and governments against losses. To operate profitably, insurers must earn more from premiums, which are invested across a range of asset classes, than they pay out in claims.

Internal vs. External Managers

Insurance companies face a choice when it comes to investing policyholders' premiums. The first option is to build a team of in-house investment professionals assembled from existing or new staff. This approach is often taken by larger insurance companies with multibillion dollar balance sheets. In contrast, smaller insurance companies usually find it more economical to appoint external investment managers. In some cases, insurers may adopt a hybrid model, keeping some investment functions in house while outsourcing others.

Asset Classes

The insurance industry invests colossal amounts across a range of asset classes. In 2012, U.S. insurers held $5.4 trillion in assets, a 2.3 percent increase from the previous year. The largest asset type is bonds, totaling $3.7 trillion, or 68.4 percent of total assets. The next two largest asset types are common stock ($589 billion) and first-lien mortgages ($351 billion). Other investments include preferred stock, real estate, derivatives and contract loans.

Bond Investments by Type

Bonds are attractive to insurance companies because regular principal and interest payments can be matched against expected claims. Corporate bonds represent the lion's share of the industry's bond investments, amounting to $1.9 trillion, or 51.6 percent of bond holdings. Municipal bonds represent the second-largest bond type, amounting to $524 billion, or 14.3 percent of bond holdings. Other fixed-income investments include U.S. Treasury bonds as well as agency-backed and private label mortgage-backed securities.

Bond Investments by Rating and Industry

Insurance companies are inherently conservative, with 94 percent of their bond holdings funneled into investment-grade securities -- those bonds carrying credit ratings of at least BBB- by Standard & Poor's and Baa3 by Moody's. Bonds from financial services companies represent the largest portion: $447 billion, or 23.7 percent of total bond holdings. Other significant industry exposures include utilities ($264 billion), energy ($223 billion) and industrials ($172 billion).

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About the Author

Giulio Rocca's background is in investment banking and management consulting, including advising Fortune 500 companies on mergers and acquisitions and corporate strategy. He also founded GradSchoolHeaven.com, an online resource for graduate school applicants. He holds a Bachelor of Science in economics from the University of Pennsylvania, a Master of Arts in English from the University of Hawaii at Manoa, and a Master of Business Administration from Harvard University.

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