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Why Falling Bond Yields Are Raising Your Auto Insurance Premium: WSJ

Source: WSJ

Posted on 14 Aug 2012 by Neilson

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Auto premiums Caught between competing urges to chase yield and to flee volatility, investors around the globe are settling on high quality U.S. corporate debt as a safe — well, safe-enough — alternative to U.S. Treasurys.

The flood of capital is not only driving yields on blue-chip bonds to record lows and exposing buyers of the debt to risk down the road when interest rates rise, it is also sending ripple effects through the economy. Insurance premiums are rising for consumers and the hibernating animal spirits in corporate America – are starting to revive as companies boost dividends and buybacks for shareholders.

Falling yields are punishing the typical buyers of investment-grade bonds, insurers and pension funds. The result – insurers are charging customers more and buying more risky assets to offset the drop in bond returns.

Insurance companies operate by investing premiums they collect and using the proceeds to pay out future claims, pocketing the difference. In 2011, life insurers invested 40% of their capital in corporate and foreign bonds, making them the most popular asset class by a wide margin, according to the Insurance Information Institute, a trade group.

“High quality corporations financing at 2% yields is clearly not helpful to insurance companies struggling to meet investment targets,” said Thomas Mercein, global head of debt capital markets at Credit Suisse.

Property and casualty insurers have moved to protect profits hit by lower yields on their investments by charging their customers more, said Michael Siegel, head of insurer asset management at Goldman Sachs Asset Management. The cost of home and renters insurance rose 3.2% in June over the previous year compared to a 1.5% increase in 2011, according to the Bureau of Labor Statistics.

Insurers are also moving some of their capital into new asset classes to offset the decline in bond yields, which helps explain continued inflows into the hedge-fund industry despite average returns of negative 5.25% last year. Lincoln National Corp., for example, has traditionally allocated only 1% of its investments to alternative asset managers. On an earnings call August 2 the company announced it invested $1 billion – representing an additional 1% of its investments – to hedge funds as well as private equity and private placement funds.

Declining investment-grade bond yields are also starting to impact decisions in corporate boardrooms.

For the first time since 2009, leverage – a measure of debt relative to earnings – is rising among investment-grade companies, according to Barclays. “This suggests that corporations have stopped stockpiling cash … and are increasingly willing to put cash to work,” the bank said in a report.

The clearest sign of that shift is the jump in share buybacks and dividends by U.S. companies this year. Dividend payments by companies in the S&P 500 index are on pace to reach a record $275 billion in 2012, well above the previous high of $248 billion reached in 2008, said Standard & Poor’s analyst Howard Silverblatt.

It has become easier for companies to raise their dividens “as we go into a prolonged period where companies can borrow at lower yields than they pay on their dividends,” said Mr. Mercein. In 2012, Texas Instruments, PepsiCo, Sysco, IBM and McDonalds sold three-year debt at an average yield of 0.75%, which works out to just 30% of the average 2.53% dividend yield on their stocks.

Granted, buybacks and dividends don’t contribute directly to economic growth and companies often use them to boost ailing stock valuations. Most corporate chiefs are holding off on capital investments and transformative acquisitions until uncertainty about U.S. regulatory policy and the European crisis eases.

Nevertheless, “mergers and acquisition are going to pick up and so is capital expenditure because they’re going to be more cheaply financed,” said Andy O’Brien, global co-head of debt capital markets at J.P. Morgan Chase.

There are signs this is already happening. Investment-grade companies sold $44 billion of bonds backing acquisitions this year through July, almost twice the $24 billion they sold in all 2011, according to Thomson Reuters.