Travelers 2009 Annual Report Download - page 119

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 invest in other types of CMO tranches if a careful assessment indicates a favorable
risk/return tradeoff. The Company does not purchase residual interests in CMOs.
At December 31, 2009 and 2008, the Company held CMOs classified as available for sale with a
fair value of $2.58 billion and $2.84 billion, respectively (in addition to the CMBS securities of
$714 million and $766 million, respectively, described above). Approximately 37% and 35% of the
Company’s CMO holdings are guaranteed by or fully collateralized by securities issued by GNMA,
FNMA or FHLMC at December 31, 2009 and 2008, respectively. In addition, at December 31, 2009
and 2008, the Company held $2.63 billion and $3.22 billion, respectively, of GNMA, FNMA, FHLMC
(excluding FHA project loans which are included with CMBS) mortgage-backed pass-through securities
classified as available for sale. The average credit rating of all of the above securities was ‘‘Aa1’’ at
December 31, 2009, and ‘‘Aaa’’ at December 31, 2008.
The Company’s fixed maturity investment portfolio at December 31, 2009 and 2008 included asset-
backed securities collateralized by sub-prime mortgages and collateralized mortgage obligations backed
by alternative documentation mortgages with a collective fair value of $270 million and $206 million,
respectively (comprising approximately 0.4% and 0.3% of the Company’s total fixed maturity
investments at December 31, 2009 and 2008, respectively). The disruption in secondary investment
markets for mortgage-backed securities provided the Company with the opportunity to selectively
acquire additional asset-backed securities collateralized by sub-prime mortgages at discounted prices.
The Company purchased $74 million and $47 million of such securities in the years ended
December 31, 2009 and 2008, respectively. The Company defines sub-prime mortgage-backed securities
as investments in which the underlying loans primarily exhibit one or more of the following
characteristics: low FICO scores, above-prime interest rates, high loan-to-value ratios or high
debt-to-income ratios. Alternative documentation securitizations are those in which the underlying loans
primarily meet the government-sponsored entity’s requirements for credit score but do not meet the
government-sponsored entity’s guidelines for documentation, property type, debt and loan-to-value
ratios. The average credit rating on these securities and obligations held by the Company was ‘‘A3’’ and
‘‘Aa2’’ at December 31, 2009 and 2008, respectively. Approximately $114 million of the Company’s
asset-backed securities collateralized by sub-prime and alternative documentation mortgages were
downgraded in 2009. An additional $39 million of such securities were placed on credit watch during
2009. Approximately $81 million of the Company’s asset-backed securities collateralized by sub-prime
and alternative documentation mortgages were downgraded in 2008.
The Company’s real estate investments include warehouses and office buildings and other
commercial land and properties that are directly owned. The Company’s other investments are
primarily comprised of private equity limited partnerships, hedge funds, real estate partnerships, joint
ventures, mortgage loans, venture capital (through direct ownership and limited partnerships) and
trading securities, which are subject to more volatility than the Company’s fixed maturity investments.
While these asset classes have historically provided a higher return than fixed maturities, in 2009 and
2008 the returns were significantly lower than in prior periods and, in the aggregate, produced negative
investment income, reflecting market conditions. At December 31, 2009 and 2008, the carrying value of
the Company’s other investments was $2.95 billion and $3.04 billion, respectively.
The Company has engaged in securities lending activities from which it generates net investment
income from the lending of certain of its investments to other institutions for short periods of time.
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