bsrsharma, you’re right, I think there’s some confusion. I don’t think you have a good understanding of how insurance companies operate. I’ll try to explain without getting into too many gory details. (I analyzed insurance companies for a hedge fund several years back – not particularly well, I might add.)
Of course the insurance company WANTS to make a profit in its “insurance business,” as you call it – this is known as an “underwriting profit.” The measure of that profit is the “combined ratio.” A combined ratio of above 100 means that the company isn’t generating an underwriting profit; that is, its insurable losses exceed its premium revenues. A combined ratio of below 100 means there’s an underwriting profit.
Unfortunately (for them), in a normal year, in aggregate, P&C companies don’t generate an underwriting profit. My guess is the average combined ratio for the industry is 105 or so for the last 25 years. They stay in business by generating a profit on their investments that exceeds their underwriting losses. Add in a little leverage and – voila – you can still make a little bit of money. Therefore, your statement, “They have enough risk to manage in insurance business and would probably do a bad job if they try to manage money risk” is incorrect. Most P&C companies pay big money to their in-house and external asset managers to maximize the returns on the investment portfolio (that is, “to manage money risk” in your words) because that’s generally the sole source of profit. Where do you think the lion’s share of Berkshire Hathaway’s equities are held? By Geico, GenRe and Berkshire’s supercat business – Berkshire’s insurance companies.
Now, insurance companies need liquidity, they’re regulated and they also get rated by AM Best (among others), so they can’t go totally crazy with their investment portfolio without some repercussions. So there’s plenty of conservative stuff in their investment portfolios (treasuries, corporate bonds, etc.). But there’s plenty of risky stuff as well – equities, hedge funds, private equity, real estate, etc. It’s typically the returns on the risky investments that makes the difference between overall insurance company returns.
If you want to understand more about this I’d suggest reading all the Berkshire Hathaway annual reports dating back to the 70s. They are a great primer on P&C insurance.
Life insurance companies tend to generate a small underwriting profit and therefore take less risk in the investment portfolio. Life insurance is a more predictable business than P&C insurance due to far better actuarial data (it’s much easier to determine how many people are likely to die in a particular age cohort in a given year than it is to predict how many hurricanes will hit the North Atlantic in a given year). But, even so, all life insurers invest in riskier investments as well – equities, hedge funds, etc. But they do so less than the average P&C insurance company.
The point is that taking and managing investment risk is a CRITICAL part of running an insurance company. They don’t just stick the money in treasuries and pray that the competition will be rational enough for everyone to enjoy an underwriting profit. The insurance markets just don’t work that way.
