U.S. Government Bonds In P/C Insurer Portfolios
Property/Casualty insurers held $860 billion in bonds at year-end 2010. U.S. government bonds—but not state and local governments—constituted about $80 billion of the bond holdings. Total invested assets (including cash) held by P/C insurers exceeded $1.3 trillion at year-end 2010, meaning that holdings of U.S. Treasury bonds accounted for roughly 6 percent of the industry’s total invested assets.
One theoretical effect of a downgrade is that interest rates on newly issued U.S. government bonds and most other forms of fixed income securities would rise. This would mean that the market value of existing U.S. government bonds and other fixed income assets would fall. The extent of the drop in value would depend on many things, but the net impact on the value of assets held by P/C insurers should be modest and manageable.
As a general rule, longer term bonds would fall to a greater degree than shorter term bonds. In recent years, however, P/C insurers have been shortening the maturities on their bond investments, lessening the effect of an interest rate rise. In 2005, for example, bonds maturing in five years or longer constituted 55.8 percent of all bond holdings (including cash and short-term investments); by 2010, bonds maturing in five years or longer had dropped to 44.6 percent of all P/C insurer bond holdings (and of the longer term bonds, most were in the five- to 10-year maturity category).
Investment income is a comparatively small part of P/C insurer revenues when compared to the monies these insurers generate via premiums. Policyholder premiums paid to P/C insurers have totaled anywhere from $425 billion to $450 billion each year since 2003, with net investment gains ranging from $31 billion to $64 billion annually within this same time frame. A very small fraction of the net investment gains for P/C insurers come in the form of U.S. government bond income. And despite the downgrade all interest due will be paid by the U.S. government.
Premiums received in any given year generally cover P/C insurer claims and expenses for that 12-month period. As such, even if there were a drop-off in U.S. government bond income it would have an insignificant effect on insurers’ ability to pay claims and expenses.
Moreover, the industry’s policyholders’ surplus—the excess of assets over liabilities (what companies in other industries call “net worth”)—was a record $556.9 billion at year-end 2010, an 8.9 percent increase over where P/C insurers’ policyholders’ surplus stood as of December 31, 2009 ($511.4 billion).
So, even when envisioning an extremely unrealistic scenario whereby all U.S. government bond holdings were valued at half their nominal value, P/C insurers would still have the assets they needed to cover all of their liabilities plus a “cushion” for unexpected claims equal to $500 billion, the rough equivalent of 12 Hurricane Katrinas, the costliest natural disaster in U.S. history.