Travelers 2007 Annual Report Download - page 111

The Company makes investments in residential collateralized mortgage obligations (CMOs) that
typically have high credit quality, offer good liquidity and are expected to provide an advantage in yield
compared to U.S. Treasury securities. The Company’s investment strategy is to purchase CMO tranches
which offer the most favorable return given the risks involved. One significant risk evaluated is
prepayment sensitivity. While prepayment risk (either shortening or lengthening of duration) and its
effect on total return cannot be fully controlled, particularly when interest rates move dramatically, the
investment process generally favors securities that control this risk within expected interest rate ranges.
The Company does not purchase residual interests in CMOs.
At December 31, 2007 and 2006, the Company held CMOs classified as available for sale with a
fair value of $3.59 billion and $3.56 billion, respectively. Approximately 31% and 36% of the
Company’s CMO holdings are guaranteed by or fully collateralized by securities issued by GNMA,
FNMA or FHLMC at December 31, 2007 and 2006, respectively. In addition, the Company held
$3.79 billion and $4.36 billion of GNMA, FNMA, FHLMC or FHA mortgage-backed pass-through
securities classified as available for sale at December 31, 2007 and 2006, respectively. Virtually all of
these securities are rated Aaa.
At December 31, 2007 and 2006, the Company held commercial mortgage-backed securities
(CMBS) of $935 million and $1.07 billion, respectively. At December 31, 2007, approximately
$302 million of these securities, or the loans backing such securities, contain guarantees by the United
States Government or a government-sponsored enterprise and $26 million were comprised of Canadian
non-guaranteed securities. The remaining $607 million at December 31, 2007, were comprised of U.S.
non-guaranteed securities, issued in 2004 and prior years. The average credit rating of these securities
was ‘‘Aaa.’’ The CMBS portfolio is supported by loans that are diversified across economic sectors and
geographical areas. The Company does not believe this portfolio exposes it to a material adverse
impact on its results of operations, financial position or liquidity, due to the underlying credit strength
of these securities.
The Company’s fixed maturity investment portfolio at December 31, 2007 included asset-backed
securities collateralized by sub-prime mortgages and collateralized mortgage obligations backed by
alternative documentation mortgages with a collective market value of $286 million (comprising
approximately 0.4% of the Company’s total fixed maturity investments). The Company defines
sub-prime mortgage-backed securities as investments which contain loans to borrowers that exhibit one
or more of the following characteristics: low FICO scores, above-prime interest rates, high loan-to-value
ratios, high debt-to-income ratios, low loan documentation (e.g., limited or no verification of income
and assets), or other characteristics that are inconsistent with conventional underwriting standards
employed by government-sponsored mortgage entities. Alternative documentation mortgages are
mortgage loans with low loan documentation as described above. The average credit rating on all of
these securities and obligations held by the Company was ‘‘Aaa’’ at December 31, 2007. No securities in
the residential mortgage portfolio were downgraded in 2007.
The Company’s fixed maturity investment portfolio at December 31, 2007 included securities issued
by numerous municipalities with a total carrying value of $38.82 billion. Approximately $14.10 billion,
or 36%, of the securities were enhanced by third-party insurance for the payment of principal and
interest in the event of an issuer default. Such insurance generally results in a rating of ‘‘Aaa’’ being
assigned by independent ratings agencies to those securities. The downgrade of credit ratings of
insurers of these securities could result in a corresponding downgrade in the ratings of the securities
from ‘‘Aaa’’ to the underlying rating of the respective security without giving effect to the benefit of
insurance. Of the total $14.10 billion of insured municipal securities in the Company’s investment
portfolio, approximately 96% were rated at A3 or above, and approximately 76% were rated at Aa3 or
above, without the benefit of insurance. The Company believes that a loss of the benefit of insurance
would not result in a material adverse impact on the Company’s results of operations, financial position
or liquidity, due to the underlying credit strength of the issuers of the securities, as well as the
Company’s ability and intent to hold the securities.
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