NU Online News Service, April 6, 12:18 p.m. EDT
Property and casualty insurers could see a drop in the value in their fixed-income-securities investments if interest rates climb as expected, says Moody’s Investors Service.
In a report released this week, the ratings agency says about two-thirds of the industry’s $1.3 trillion in invested assets is in fixed-income securities. Most of these are “conservatively positioned” in U.S. government and agency securities, high-quality municipal bonds, and investment-grade corporations.
While this investment strategy “served insurers well in recent years,” interest rates are expected to increase, impacting the value of the bonds, Moody’s says. Over the next year, interest rates are expected to rise “100 to 150 basis points” or 1 to 1.5 percent 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 of between $40 billion and $60 billion on the industry’s $874 billion bond portfolio in 2012—7 percent to 11 percent of its equity-capital base,” says Paul Bauer, Moody’s vice president and author of the report in a statement. “This projection is based on our central economic scenario for theUnited States, which forecasts a 100 to 150 basis-point rise in rates over the next year.”
However, while the value may drop, it does not necessarily mean insurers would see an actual loss, Bauer notes.
A study of bond duration indicates that many insurers have invested in short-term bonds with an average duration of around 4 years. Unless they are subjected to a catastrophic loss and need to raise capital, P&C insurers typically hold onto their bonds until maturity.
It is only when they sell before maturity that they realize a loss because investors are not going to purchase a bond at a lower interest rate than the general marketplace unless they buy it at a discount.
Realizing this, Bauer says many insurers’ investment strategies appear to have opted for short-term bonds.
“We believe companies have generally chosen to keep portfolio duration on the short side as a result of low-interest rates and expected future rate increases, as well as an inability to generate significant additional returns by extending maturities out on the yield curve,” he says.
The report notes that while an interest-rate increase “would cause 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 offset anemic investment income and to boost overall profitability.”