With the breakneck pace of earnings growth for the municipal bond insurers ended, company officials are scouring the horizon for ways to keep antsy equity investors from jumping ship.

"The dilemma facing the insurers is that shareholders do not appear to be sanguine about growth and returns on equity below 15%," Standard & Poor's Corp. said in a recent report on the state of the industry.

Although in the past bond insurers have continued serving up healthy portions of both profits and volume to meet the growing expectations of investors, "it seems unlikely that the basic insurance business will be able to provide sufficient growth opportunities to match these expectations in the current market environment." Standard & Poor's said.

For the past five years, profits in the industry have soared at an average rate of 25%, according to Fitch Investors Service. Stock prices marched higher throughout the period as record earnings reports followed one quarter after another.

But beginning at the end of last year and so far in 1994, profits for the major bond insurers have come back down to earth. Though that came as no surprise, given the inevitable end of the refunding boom, some equity investors are taking the cool-off as a cue to pull up stakes and search out the next hot industry. As a result, stock prices have sunk to nearly two-year lows.

While several options for dealing with the problem are available, analysts and even company officials themselves are arguing that caution must be exercised so as not to tarnish the sterling credit ratings upon which the industry's core business is based.

Diversification, the industry watchword over the next several years, can mean diluting resources devoted to insuring municipal bonds. But a prudent course of expansion into peripheral lines of business can help modestly to bolster bottom lines without threatening ratings, industry watchers agree.

In addition, insurers can rejigger their internal expense and pricing mechanisms with the aim of maximizing returns on insurance work. While that idea may be "theoretically promising," as Standard & Poor's put it, certain strategies "hold little practical or near-term reward."

Raising prices or attempting to trim losses through tougher underwriting standards, for example, offers little hope of higher returns for the industry. The competitive market environment will work to prevent price increases from taking hold, and tougher underwriting criteria would have little short-term effect since most losses over the next several years will come from bonds already insured.

Growth Strategies

According to Standard & Poor's, there are several strategies that might have a positive effect on earnings:

* Controlling expenses;

* Expanding operating leverage;

* Diversifying and expanding globally;

* Increasing investment income;

* Improving risk profiles.

"S&P believes the decline [in earnings growth] will be temporary and expects the insurers to resume solid earnings growth beginning in 1995, though not at the same rate as the last five years," the agency said in its report.

In the current market environment, which features moderately higher interest rates, increasing investment income stands out as an option.

According to Standard & Poor's, the industry has about $3.8 billion in its combined unearned premium reserve, which represents premiums collected but not yet counted as earnings because of the industry's method of accounting.

That pile of cash represents a significant and secure stream of future earnings that is expected to grow by about 8%-10% annually -- faster if interest rates continue to rise.

Another cost-control method involves improving risk profiles, Several companies, most recently Financial Security Assurance, suffered huge losses when commercial real estate transactions defaulted and bond insurance policies were called upon to pay up.

In response, FSA and others have stopped underwriting commercial real estate and refocused their efforts on such low-risk sectors as general obligation, tax-backed, and utility bonds, Standard & Poor's said.

"The improvement in risk profile, as evidenced by declining capital charges, portends a continued low to moderate loss environment for the industry,' the agency's report says.

On other fronts, several companies are expanding into new markets and developing new products to take up the earnings slack created by the slower municipal bond market.

Most of the diversification is being implemented at holding companies, in an attempt to insulate the municipal bond insurance subsidiaries from credit erosion, but the new ventures all seek to leverage the expertise and skill base developed in core business operations.

MBIA Inc., Financial Guaranty Insurance Co., and AMBAC Inc., for example, all have opened new money-management subsidiaries that offer investment services to municipal issuers.

Standard & Poor's estimated the market for such services could be between $20 billion and $30 billion annually, and "the insurers' existing relationships with municipal issuers, coupled with their superior claims-paying ability ratings, should help them capture a significant share of this market."

In general, the rating agency's report said that the bond insurers have been conservative in expanding into complementary businesses.

"S&P expects they will continue to follow conservatives policies when diversifying, thus limiting the risks to their core operations," the report says.

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