NU Online News Service, April 6, 12:18 p.m.EDT

Property and casualty insurers could see a drop in the value intheir fixed-income-securities investments if interest rates climbas expected, says Moody's Investors Service.

In a report released this week, the ratings agency says abouttwo-thirds of the industry's $1.3 trillion in invested assets is infixed-income securities. Most of these are “conservativelypositioned” in U.S. government and agency securities, high-qualitymunicipal bonds, and investment-grade corporations.

While this investment strategy “served insurers well in recentyears,” interest rates are expected to increase, impacting thevalue of the bonds, Moody's says. Over the next year, interestrates are expected to rise “100 to 150 basis points” or 1 to 1.5percent and possibly as much as 300 basis points, or 3 percent,over the next two years.

“Interest-rate increases could result in a capital loss ofbetween $40 billion and $60 billion on the industry's $874 billionbond portfolio in 2012—7 percent to 11 percent of itsequity-capital base,” says Paul Bauer, Moody's vice president andauthor of the report in a statement. “This projection is based onour central economic scenario for theUnited States, which forecastsa 100 to 150 basis-point rise in rates over the next year.”

However, while the value may drop, it does not necessarily meaninsurers would see an actual loss, Bauer notes.

A study of bond duration indicates that many insurers haveinvested in short-term bonds with an average duration of around 4years. Unless they are subjected to a catastrophic loss and need toraise capital, P&C insurers typically hold onto their bondsuntil maturity.

It is only when they sell before maturity that they realize aloss because investors are not going to purchase a bond at a lowerinterest rate than the general marketplace unless they buy it at adiscount.

Realizing this, Bauer says many insurers' investment strategiesappear to have opted for short-term bonds.

“We believe companies have generally chosen to keep portfolioduration on the short side as a result of low-interest rates andexpected future rate increases, as well as an inability to generatesignificant additional returns by extending maturities out on theyield curve,” he says.

The report notes that while an interest-rate increase “wouldcause some short-term capital volatility (on GAAP financial),higher rates will generate higher investment income and, over time,boost profitability.”

While this roll-over to higher yielding bonds is taking place,“companies are raising insurance-premium rates, in part to offsetanemic investment income and to boost overall profitability.”