Moody’s: P/C Insurers’ Losses Under Municipal Bonds Manageable

November 22, 2010

U.S. property/casualty insurers are not likely to sustain substantial losses on municipal bonds, Moody’s Investors Service says in a new report.

While muni bonds make up a high 27 percent of P/C insurers’ invested assets, credit losses would be manageable even under a severe stress scenario, Moody’s says. Also, the rating agency believes municipal credit quality will remain generally resilient even through a period of economic stress.

“Numerous concerns have been raised about U.S. municipal bonds, and the potential impact that disruptions in the muni sector could have on P/C insurance company investment portfolios,” says analyst and author of the report, Paul Bauer. “While recognizing that public finance in the United States is under strain, we nevertheless view P/C insurers’ muni bond exposure as manageable.”

Even under a baseline scenario that assumes a slow and gradual economic recovery, Bauer says Moody’s expects “very minimal credit losses, given the high credit quality of the sector.”

In a severely stressed environment, Moody’s believes the P/C industry’s muni bonds losses could be in the $2 billion to $4 billion range, however, Bauer said that even these estimates from an extreme stress test would be moderate given that “we expect investment income of more than $10 billion per year from the industry’s sizable $370 billion muni bond portfolio, more than offsetting our stress case losses.”

P/C insurers’ high allocation to municipal bonds stems from their preference for fixed-income securities, and their desire to minimize fixed-income credit risk and take advantage of the tax benefits the bonds offer. Bauer notes that despite the large amount of muni bonds held by P/C insurers, these holdings are well diversified by both bond and obligor type, as well as geographically. Additionally, approximately 75 percent of the securities are of the highest quality, which is reflected in their Aaa or Aa ratings.

Moody’s analysis of P/C insurers’ investment portfolios focused on the default risk of fixed-income securities. “While recognizing that these insurers are not immune to market risk, they are nevertheless generally able to hold their bonds to maturity,” Bauer says.

However, he adds, an important caveat is a scenario in which losses resulting from a catastrophe such as a major hurricane or earthquake force insurers to sell investments in a depressed market in order to satisfy claims, resulting in realized investment losses.

The report is titled “U.S. P&C Insurers Face Manageable Credit Risks in their Muni Bond Portfolios.”

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