State 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
Bonds
Stocks
Mortgages & Real Estate
Total
xxx
xxx
xxx
xxx
$ 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
Example: XYZ Property Casualty Company (5-year period)
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 %
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
Asset Class
Small
Company
Stocks
Large
Company
Stocks
Long-Term
Corporate
Bonds
Long-Term
Government
Bonds
Treasury
Bills
Consumer
Price
Index
(nominal returns)
Compound
Return %
Holding
Period
Simple
Average
Max
Min
Range
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
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
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
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
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
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 Markets
market value of invested assets
Stocks
Bonds
$ 58.4
trillion
$ 43.6
trillion
Corporate
Bonds
$ 6.7 trillion
U.S. Major Markets
market value of invested assets
Stocks, U.S.
Bonds, U.S.
$ 24.1
trillion
$ 17.0
trillion
Corporate
Bonds
$ 3.1 trillion
Major Market Indices
Lehman Aggregate Index
bonds
S&P 500 Index
stocks
• $ 13.1 trillion market
value
• Capitalization-weighted
Index
•
•
•
•
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
Corporate Bond Pricing
Credit Spread
Risk-Free Rate
{
{
Idiosyncratic
Risk
Systematic Credit
Risk
Yield Curve
T-Bill
= Yield
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:
10-year Credit Spread
2.40 %
{
Idiosyncratic
Risk
Systematic Credit
1.70 %
0.70 %
Risk *
Yield Curve
3.00 %
10-yr Risk-Free Rate
5.00 %
T-Bill
* Swap Spreads or Agencies
2.00 %
7.40%
= Yield
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
Remember from
finance class – bond
prices and yields are
inversely related – a
lower yield means a
higher price.
7.40%
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 is
announced
Perform
fundamental
credit analysis
Price guidance
Determine
relative value
Deal goes
“subject”
Receive
allocation and
final spread
Road shows,
Conference calls,
Red-herring prospectus
Submit
order
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: jobopps.corpsouth@statefarm.com