The U.S. property/casualty insurance industry, which has about 60 percent of its equity capital base or — $355 billion– in municipal bonds remains exposed to disruptions in this asset class, but the overall level of risk continues to be manageable, according to Moody’s Investors Service.
“In spite of pressures in the public finance sector, P/C insurers’ muni portfolios remain sound,” said Paul Bauer, Moody’s vice president and author of the firm’s report on the sector.
Moody’s estimates that muni bond credit losses will be low, at $500 million for the entire P/C industry, or the equivalent of a little more than 1 percent of last year’s net income.
Even under a downside economic scenario Moody’s estimates credit losses in the range of $3 billion to $4 billion, which would still be moderate in relation to the more than $10 billion a year insurers earn in investment income on their muni portfolios. Also helping to moderate the risk embedded in municipal bond holdings is the fact that insurers’ muni bonds are of high credit quality, and muni portfolios are well diversified both geographically and by bond type.
There are a few areas in which the rating agency remains cautious, however. Though insurers’ muni exposure has come down in the past year, it is still very high, Bauer said. He also said that P/C insurers have material exposure to state and local general obligation bonds originating from the highest risk states, including 17 percent of the industry total stemming from California and Illinois. Additionally, with an average duration on the long side at six years, muni bond holdings expose companies to interest rate risk and greater market volatility.
U.S. P/C insurers exhibit a wide range of exposure to muni bonds, ranging from almost zero to more than 200 percent of regulatory surplus. For a substantial majority of firms muni bond exposure is over half of surplus, while for about a third of the insurers it exceeds 100% of surplus, according to Moody’s.
“Nonetheless, we continue to believe that U.S. P&C insurers will remain resilient,” Bauer said, “though the municipal bond sector itself remains under stress due to macroeconomic pressures and attendant budget strains, and this year we again expect more muni bond rating downgrades than upgrades.”
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