State Farm Insurance CompaniesState Farm Insurance Companies
Agenda
• State Farm Overview
• State Farm Investment Department
• State Farm Fixed Income
State Farm Overview
Company Evolution
George J. Mecherle
Auto Health
Life Fire
SF Bank &Mutual Funds
“About State Farm”
State Farm’s mission is to: •help people manage the risks of everyday life,
•recover from the unexpected, •and realize their dreams.
State Farm Data
• 23 Affiliated Companies• 16,900 Agents• 68,000 Employees• 76.2 Million Policies & Accounts• $ 59.2 Billion Revenue (12/31/05)• $159.7 Billion in Assets (12/31/05)• $ 50.2 Billion Net Worth (12/31/05)• Ranked #22 within Fortune 500 • Ranked #1 in Illinois
Industry Positions
• #1 U.S. Auto insurer since 1942• 17.7% Market Share at end of 2005• Over 40 million Auto policies
• #1 U.S. Home insurer since 1964• 22.2% Market Share at end of 2005• Over 25 million Fire policies
•SF Bank•$12.2 billion in total assets (12/2005)•Top 5% of banks nationwide
•Mutual Funds•$2.8 billion in assets (12/2005)
State Farm Investment Department
Investment Department Invested Assets* ($ Billions)
Cash & equivalent xxx
Bonds xxx
Stocks xxx
Mortgages & Real Estate xxx
Total $ xxx
* (12/31/2006)
Why does State Farm have an Investment Department?
• Amount of “float” the business generates– Premiums – Reserves
• Cost of the float – Claims – Operating expenses
• Long-term outlook for both these factors – Write more policies
Property/Casualty Company Change in Adjusted Surplus
Underwriting Losses including Policyholders’ Dividends (25.0) %
Stock Portfolio Appreciation 30.0 %
Net Investment Income 55.0 %
Other (3.0) %
Net Increase to Surplus 57.0 %
Example: XYZ Property Casualty Company (5-year period)
Structure Investment Policy to Withstand Worse Case Scenario
• Major underwriting losses
• Discovery of gross underestimation of cost of unpaid claims
• Collapse in stock and long-term bond prices
Insurance Company Financial Adequacy Ratios
• Premiums / surplus – tests adequacy of capital to prolonged poor underwriting results
• Loss reserves / surplus – tests potential for estimation error relative to capital
• Equities / surplus – tests potential for stock market declines to reduce capital
State Farm’s Top 10 Catastrophe Pay-outs (Auto & Fire Combined)
Investment Department Goals
• Support insurance & financial service operations
• Invest long-term
Support Insurance and Financial Service Operations
• State Farm Companies are first and foremost insurance companies with growing financial service operations
• Make investment decisions for investment reasons first
Long Term Investing
Long-term investors have earned higher returns over the years from equity investments versus any other asset class
Equities: Goal: Maximize shareholder value Return: Potentially unlimited
Fixed Income: Goal: Capital preservation Return: Generally limited to coupon or yield
Risk vs. Return, 1926 – 2005 (nominal returns)
Asset Class
Compound
Return %
Holding
Period
Simple
Average Max Min Range
Small
Company
Stocks
12.6
5
10
20
13.7
14.2
14.7
45.9
30.4
21.1
-27.5
-5.7
5.7
73.4
36.1
15.4
Large
Company
Stocks
10.4
5
10
20
10.5
11.2
11.4
28.6
20.0
17.9
-12.5
-0.9
3.1
41.0
21.0
14.8
Long-Term
Corporate
Bonds
5.9
5
10
20
6.0
5.9
5.5
22.5
16.3
12.1
-2.2
1.0
1.3
24.7
15.3
10.8
Long-Term
Government
Bonds
5.5
5
10
20
5.5
5.4
5.1
21.6
15.6
12.1
-2.1
-0.1
0.7
23.8
15.6
11.4
Treasury
Bills 3.7
5
10
20
3.8
3.9
4.0
11.1
9.2
7.7
0.1
0.1
0.4
11.0
9.0
7.3
Consumer
Price
Index
3.0
5
10
20
3.2
3.5
3.8
10.1
8.7
6.4
-5.4
-2.6
0.1
15.5
11.2
6.3
Data Source: Stocks, Bonds, Bills and Inflation 2006 Yearbook, Ibbotson Associates, Inc., Chicago, Illinois
State Farm Fixed Income
Global Major Marketsmarket value of invested assets
$ 43.6 trillion
$ 58.4 trillion
Stocks Bonds
Corporate Bonds
$ 6.7 trillion
$ 17.0 trillion
$ 24.1 trillion
Stocks, U.S. Bonds, U.S.
Corporate Bonds
$ 3.1 trillion
U.S. Major Marketsmarket value of invested assets
Major Market Indices
• $ 13.1 trillion market value
• Capitalization-weighted Index
S&P 500 Index stocks
Lehman Aggregate Index bonds
• 994 issuers• 7,158 issues• $ 8.8 trillion par outstanding• Asset Classes
– U.S. Government (35.7%)• Treasury bonds• Agencies
– Corporate Bonds (23.1%) – Mortgage-Backed (35.1%)– Asset-Backed (1.2%)– Commercial Mortgage-Backed
(5.0%) – Taxable Municipals
(new as of Oct. 1, 2003)
Bonds* – 12/31/2006
U.S. Treasuries
Other U.S.-Government-Backed
Agencies
Mortgage-Backed Securities
Asset-Backed Securities
Corporate Bonds
Canadian Pay Bonds
Taxable Municipal Bonds
Municipal Bonds (Tax-Advantaged)
Community Investments
Total
* Insurance Company Portfolios
State Farm Investment Philosophies and Disciplines:
• Buy and Hold
• Dollar-Cost Average
• Portfolio Ladder
• Duration Target
Corporate Bonds
• Private vs. Public
• Analyzing and investing in corporate bonds
• Pricing corporate bonds
Fundamental Credit Analysis
• Industry Analysis – Porter’s 5 Forces
• Business Risk Analysis
• Financial Risk Analysis
Porter’s Five Forces of Competition
• Barriers to Entry
• Threat of Substitute Products
• Power of Suppliers
• Power of Buyers
• Rivalry among Existing Competitors
Source: Michael Porter, Competitive Strategy
Business Risk Analysis
• Industry Characteristics
• Competitive Position
• Management
Financial Risk Analysis
• Financial Characteristics
• Financial Policy
• Profitability
• Capital Structure
• Cash Flow Protection
• Financial Flexibility
Common Financial Ratios
• EBIT / Interest – tests the adequacy of operations to meet interest payments
• CA / CL – tests liquidity• Debt / Cap – tests leverage (loan to
value)• Funds from Operations / Debt – tests
cash flow adequacy to repay debt
Idiosyncratic
Risk
Systematic Credit
Risk
Yield Curve
T-Bill
Credit Spread
Risk-Free Rate
{{
= Yield
Corporate Bond Pricing
Why can’t I find a quote for Duke Energy bonds –
herein lies the answer:
Trace Data:
This is how we keep track of bond prices:
Example of 10-Year AT&T bond yield:
Idiosyncratic
Risk
Systematic Credit
Risk *
Yield Curve
T-Bill
10-year Credit Spread
10-yr Risk-Free Rate
{
{ = Yield7.40%
1.70 %
0.70 %
3.00 %
2.00 %
2.40 %
5.00 %
* Swap Spreads or Agencies
Example of 10-Year AT&T bond prices:
• 6% coupon 10-year AT&T corporate bond trading at a yield of 7.4% = $90.23 (discount)
• 8% coupon 10-year AT&T corporate bond trading at a yield of 7.4% = $104.19 (premium)
The coupons are different but both bonds trade at the same yield, 7.4%.
Example of 10-Year AT&T bond bid/ask yields:
Bid (yield at which you can sell)
Assume 10-Year Treasury is 5.00%
2.45%
Yield on Bid Side 7.45%
Offer (yield at which you can buy)
Assume 10-Year Treasury is 5.00%
2.40%
Yield on Offer Side 7.40%
Remember from finance class – bond prices and yields are inversely related – a lower yield means a higher price.
Think of bid/ask spread for stocks. You have to buy at a higher price than you can sell. The same holds true for bonds.
Investing in a New Public Corporate Bond Issue
New deal isannounced
Perform fundamental credit analysis
Road shows, Conference calls, Red-herring prospectus
Price guidance Determine relative value
Submit order
Deal goes “subject”
Receive allocation and final spread
Price the deal, bill & deliver
Questions?
Contact Information
State Farm Insurance
Human Resources
Three State Farm Plaza South, K-1
Bloomington, IL 61791
Need more information? Visit our website!
www.statefarm.com
E-mail: [email protected]