"For the industry as a whole, there could be losses of $500 million under the current credit conditions," Bauer said. "Under the stress tests we are coming out with there could be a $3 billion credit loss that could happen if there were more deterioration in the market".
Those numbers are offset by the $10 billion per year in interest income that insurers to earn on their muni portfolios.
The municipal bond sector has taken a beating due to the weak U.S. economy and depleted local tax revenues. Not surprisingly, demand for municipals bonds plummeted as well. However, the property and casualty insurers are highly invested in the sector and could face further losses.
Bauer says that 70 percent of total insurance company equity is invested in the muni sector throughout the insurance industry. Total muni investments in the industry make up about $370 billion, according to his report.
"Losses are still reasonably modest in terms of expected investment income and their total investments in the portfolios. We think insurers will be able to manage," said Bauer.
Still, some of insurers have larger muni portfolios than others and they are likely to be hit the hardest by exposure. Those insurers are Horace Man Group, Delphi Financial, Mercury General Group, Markel Corp, American International Group, Travelers, Chubb and Allstate.