Munis increasingly appeal to US P&C insurers; special revenue bonds most at risk

Written by Adam Cadle

27/04/2020

Municipal bonds (Munis) now make up 13% or $272bn of P&C insurers’ cash and invested assets, or 7% ($492.6bn) for all US insurers, but special revenue bonds which make up 6% of P&C insurers’ cash and invested assets are most at risk, new research has shown.

Analysis published by the National Association of Insurance Commissioners (NAIC) said those special revenue bonds backed by airport and toll road revenues, and revenues from travel and tourism-related activities, are most at risk.

Moody’s Investors Service (Moody’s) revised its public finance sector outlook to negative from stable for airports, toll roads, not-for-profit and public healthcare, and higher education on 20 March. Standard & Poor’s (S&P) revised its public finance sector outlook to negative for all sectors on 1 April. Munis tied to these and other revenue sectors anticipated to be affected at a total of $71bn for P&C insurers or $126.6bn across the US insurance industry.

Other COVID-19 economic factors putting a strain on municipal revenues include the significant state expenditures on emergency healthcare to fight the virus and decreased tax revenue.

“The COVID-19 stresses also exacerbate challenges that municipalities had prior to the outbreak,” the NAIC said.

“These include, among others, demographic shifts (populations both aging and relocating, which affect tax receipts), substantial increases in pension and retirement healthcare costs, and the alarming exposure to equity markets. The exposure to equity markets is through the public pensions plans which are predominantly invested in equities. For example, of the $215bn, as of 30 Sept 2019, the New York State Common Retirement Fund had about 67% or $143bn in equity exposure. Equity markets down 25% would mean a decrease of the fund’s assets by $35.7bn to $179.3bn. If equity markets remain down or continue to decline over time, in order to maintain adequate funding, the fund will seek higher contributions from local municipalities at the same time those municipalities are trying to recover from the economic effects of COVID-19.”

On the positive side, the analysis said, default rates for Munis are historically very low.

“The five-year Moody’s rated cumulative default rate (CDR) of Munis from 1970 to 2018 is 0.16%, which is quite low, especially compared to the five-year CDR of 6.2% for global corporates over the same time period. Additionally, the municipal sector overall is highly rated, with approximately 92% of all the municipal credits that Moody’s rates falling into the “A” category or higher as of year-end 2018. Further, at year-end 2018, the median rating for US municipal credits was Aa3. This is in sharp contrast to the median rating for global corporates, which was Baa3.”

Another mitigating factor protecting insurers against Muni defaults is the insurance provided by financial guarantee insurance or bond insurers. However, if significant defaults materialise, bond insurers’ ability to pay claims may become strained, the report said.

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