American P&C insurers face risk regardless of interest rate direction: Moody’s

Insurers in the United States are facing a risk regardless of which way interest rates are moving, Moody’s Investors Service said Thursday.

 The recent rise in rates in the U.S. has highlighted a key risk for the property and casualty industry there, Moody’s said in an announcement of its new special comment on interest rate challenges.

The P&C insurance sector holds about $900 billion of bonds, which leaves it highly exposed to fixed income market developments, according to Moody’s.

“In the current environment, P&C companies face investment risk regardless of interest rate direction,” noted Paul Bauer, vice president – senior credit officer and author of the Moody’s report.

“If rates continue moving up, which we believe is the more likely scenario; companies will face capital volatility as bond prices decline. If rates stay low, or resume their long term downward trend, earnings will be pressured by weak investment income,” he added.

For each 100 basis point rise in interest rates, the value of bonds held by the industry will decline by about $40 billion, or about 7% of industry capital, the firm predicts.

A sudden rate increase of 300 basis points in the next 12 to 18 months could mean unrealized losses of about $120 billion, or 20% of policyholder’s surplus, Moody’s added.

On an individual company basis, for each 100 basis point rise in rates, Moody’s expects market losses of 2% to 7% on company fixed income investment portfolios.

“Rising interest rates, combined with higher than expected claims inflation, could be especially problematic for P&C insurance companies given that lower asset valuations would be accompanied by increases in loss reserve liabilities,” the ratings agency said,

“However, the risk of market value declines is moderated by strong liquidity at insurance operating companies, the industry practice of holding bonds long term, and the unlikely need to liquidate investment portfolios,” it added.

Continued low rates, on the other hand,  would be a challenge for the P&C industry’s profitability, given the difficulty of generating investment income in a low yield environment, Moody’s noted.

“If yields were to return to the low levels seen in the first quarter of 2013 and remain there for several years, Moody’s said the industry would face a decline in its total investment income of about $3 billion annually over the next five years.”