|
99230 |
Prepared by the North Dakota Legislative Council
staff for the Budget Committee on Government Finance |
BONDING FUND AND FIRE AND TORNADO FUND - INVESTMENT POLICIES
This memorandum reviews previous and current investment policies of the bonding fund and fire and tornado fund and includes projected returns based on alternative policies.
1995-97 INVESTMENT POLICY
Prior to July 1, 1997, the asset allocation policy of the bonding fund and fire and tornado fund provided that 90 percent of the moneys in each of the funds be invested in either fixed income or cash equivalent type investments. The asset allocation for the 1995-97 biennium was:
| Asset Class | Fire and Tornado Fund | Bonding Fund |
|
Equities |
10% | 10% |
|
Fixed income |
30% | 20% |
|
Cash equivalents |
60% | 70% |
|
Total |
100% | 100% |
Total returns for each of the funds for the 1995-97 biennium are listed below:
| Total Return | Fire and Tornado Fund | Bonding Fund |
|
Fiscal year 1996 |
6.45% | 6.98% |
|
Fiscal year 1997 |
9.67% | 9.49% |
1997-99 INVESTMENT POLICY
Beginning July 1, 1997, after discussions with the Insurance Department, the Retirement and Investment Office changed the asset allocation policy of the bonding fund and fire and tornado fund.
| Asset Class | Percentage |
|
Large capital domestic equity |
15 |
|
Small capital domestic equity |
5 |
|
Convertible bonds |
10 |
|
International equity |
10 |
|
Fixed income |
50 |
|
Cash equivalents |
10 |
|
Total |
100 |
The Retirement and Investment Office also established an insurance trust consisting of the commingled moneys of the insurance-related funds which the Retirement and Investment Office is responsible for investing. These funds include the fire and tornado fund, bonding fund, insurance regulatory trust fund, petroleum tank release compensation fund, risk management fund, National Guard tuition trust fund, and the workers' compensation fund. The value of the insurance trust as of November 30, 1997, totaled $637.2 million, $30 million of which is in cash equivalent investments.
Based on bonding fund and fire and tornado fund investment returns for July 1, 1997, through October 31, 1997, the projected fiscal year 1998 annualized returns for these funds would be 13.4 percent.
If bonding fund and fire and tornado fund moneys would have been invested using the 1997-99 asset allocation policy during the 1995-97 biennium, based on benchmark returns for each asset class for that period, the bonding fund and fire and tornado fund would have realized a fiscal year 1996 return of 11.01 percent and a fiscal year 1997 return of 13.32 percent, an increase of 4 to 4.5 percent compared to actual fiscal year 1996 returns and an increase of approximately 3.75 percent compared to actual fiscal year 1997 returns.
SHORT-TERM LOAN OPTION
At its last meeting, the committee considered an option to potentially increase the investment returns of the bonding fund and fire and tornado fund. The option involved authorizing the Insurance Commissioner to obtain a short-term loan from the Bank of North Dakota to meet cash flow needs of these funds in order to allow more longer term investments.
Based on the current investment policy of these funds, it appears the loan option would not lead to improved investment returns. Because the bonding fund and fire and tornado fund are a part of the Retirement and Investment Office's insurance trust, the moneys of these funds are commingled with other insurance-related funds for investment purposes. Due to this commingled structure and the positive cash flow into the insurance trust, the Retirement and Investment Office is easily able to make cash available for required distributions from the bonding fund or the fire and tornado fund. Even very large distributions from these funds would unlikely cause the need for security liquidations because the current cash equivalent amount in the insurance trust is $30 million. The required distribution amount would be withdrawn from the cash pool and a prorated portion of the fund's investments would be redistributed administratively to the other participating funds. The effect of this would be that the fund paying the distribution would maintain its asset allocation structure but shrink in size by the amount of the cash outflow.
LOWER STATUTORY MINIMUM BALANCES
Current law provides that if the balance in the bonding fund is less than $2.5 million, premiums must be charged to bonding fund policyholders. If the fire and tornado fund balance is less than $12 million, an assessment must be levied against every policy in effect in order to return the balance to $12 million.
By lowering these minimum balances, more aggressive investment strategies could be considered for the bonding fund and fire and tornado fund which could potentially increase returns beyond those projected in the current investment strategy; however, potential for greater losses also increases. The following chart shows three investment scenarios. Scenario 1 is the current investment policy, scenario 2 would be somewhat more aggressive, and scenario 3 would be yet more aggressive.
| Asset Class | Asset Allocation | ||
| Scenario 1 | Scenario 2 | Scenario 3 | |
|
Large capital United States equity |
15% | 30% | 35% |
|
Small capital United States equity |
5% | 15% | 20% |
|
Convertible bonds |
10% | 10% | 10% |
|
International equity |
10% | 15% | 15% |
|
Fixed income |
50% | 20% | 15% |
|
Cash equivalents |
10% | 10% | 5% |
|
Total |
100% | 100% | 100% |
The schedules below present projected fund balances based on the scenarios over a two-year period for a normal investment environment, a pessimistic investment environment, and an optimistic investment environment. In these scenarios, the fire and tornado fund begins with a balance of $16,162,000 while the bonding fund begins with a balance of $4,038,000.
| Environment | Years | Fire and Tornado Fund | ||
| Scenario 1 | Scenario 2 | Scenario 3 | ||
|
Normal |
1 | $17,422,636 | $17,551,932 | $17,600,418 |
| 2 | $18,796,406 | $19,054,998 | $19,184,294 | |
|
Pessimistic |
1 | $14,691,258 | $14,044,778 | $13,753,862 |
| 2 | $13,576,080 | $12,396,254 | $11,814,422 | |
|
Optimistic |
1 | $18,521,652 | $18,861,054 | $19,038,836 |
| 2 | $21,253,030 | $22,044,968 | $22,465,180 | |
| Environment | Years | Bonding Fund | ||
| Scenario 1 | Scenario 2 | Scenario 3 | ||
|
Normal |
1 | $4,352,964 | $4,385,268 | $4,397,382 |
| 2 | $4,696,194 | $4,760,802 | $4,793,106 | |
|
Pessimistic |
1 | $3,670,542 | $3,509,022 | $3,436,338 |
| 2 | $3,391,920 | $3,097,146 | $2,951,778 | |
|
Optimistic |
1 | $4,627,548 | $4,712,346 | $4,756,764 |
| 2 | $5,309,970 | $5,507,832 | $5,612,820 | |
