NU Online News Service, Nov. 22, 3:43 p.m. EST

Although municipal bonds make up 27 percent of the investmentportfolios of property and casualty insurers, even bond losses of$2 billion to $4 billion that could result from extreme stressscenarios are expected to be manageable, Moody's reported.

"In context, even these estimates from an extreme stress testwould be moderate given that we expect investment income of morethan $10 billion per year from the industry's sizable $370 billionmuni-bond portfolio," said Paul Bauer, an analyst for Moody's.

He said the investment income would more than offset the ratingagency's estimates of stress-case losses.

The New York-based rating agency detailed both stress andbaseline scenarios in a report released this morning, reachingconclusions very different from those presented in a Wall Street Journal article also published thismorning.

The Journal article, titled "State of Alert forInsurance Firms," compares muni values for several large p&cinsurers to shareholders equity, putting levels for W.R. Berkley,Travelers and Chubb over 100 percent. The article suggests theexposure could be "troublesome" or even disastrous, if a recentinvestor selloff of muni bonds does not reverse, or if currentproblems in the muni markets "mark the onset of structuraldeterioration" arising from deep fiscal problems.

The Moody's analysis focuses on default, or credit risk, ofinsurers' fixed income muni securities as the "most relevant"exposure for p&c insurers.

"We recognize, however, that p&c insurers are also exposedto market risk," Moody's said, noting that "investors could sour onthe muni market, or interest rates could rise broadly, causingmarket values to drop."

But Moody's added, "Generally, however, [insurance] companiesare able to hold their bonds to maturity, reducing the risk ofhaving to realize temporary market losses."

The Moody's report, prepared by insurance analysts, gives abrief description of challenges facing the municipal sector--makingnote of long-term structural issues and problems tied to arecessionary economy--while directing readers to more intensiveresearch of the sector from its public finance research team.

Moody's insurance analysts note the impacts of the recessionaryeconomy on three primary sources of tax revenue at the state andlocal level--income tax, sales tax and property tax. Thesechallenges, Moody's said, come in addition to long-term structuralproblems, which include growing unfunded pension liabilities, andstruggles among potential sources of secondary forms of support formunicipalities, such as financial guarantors, federal or stategovernments.

"In spite of these pressures, we believe potential credit lossesamong municipal bonds will not materially impair p&c insurancecompany capital, even in a stressed environment," Moody'sconcluded, citing the fact that insurers' muni-bond portfolios arewell diversified and of high quality.

Using information compiled from Highline Data, a data affiliateof National Underwriter, Moody's noted that 75 percent of themuni-bond investments of p&c companies are rated by Moody's as"Aaa" or "Aa."

Even individual p&c insurers with high muni exposuregenerally allocate less than 50 percent of their total investedassets to munis, Moody's noted, putting Travelers and AmericanInternational Group over half at 53 percent and 51 percent,respectively. Allocations for Chubb and W.R. Berkley are 42 percentand 37 percent, respectively, according to Moody's.

Focusing on potential credit losses, Moody's said that under a"baseline scenario for the U.S. economy, which assumes a slow andgradual recovery," it expects credit losses on the p&cindustry's muni-bond portfolio "to be modest, at less than $500million." An alternate, "severely stressed environment" couldproduce credit losses of $3 billion that would be more than offsetby interest income.

"An important caveat," Moody's said, is if insurers are, infact, exposed to market risk in addition to credit (default) risk,when they can't hold bonds to maturity--for example, when severecatastrophes, such as hurricanes, accompany market losses.

Catastrophic events could force insurers to sell investments ina depressed market in order to meet liquidity demands, resulting inrealized investment losses, Moody's said.