U.S. Debt Downgrade: No Significant Impact on Insurers

Standard & Poor’s announcement on August 5, 2011, that it “downgraded its long-term counterparty credit and financial strength ratings and related issue ratings on all AAA-rated U.S. insurance groups to AA+ with negative implications” is likely to have little impact on insurers say most experts and industry officials.

“The nation’s property/casualty insurers have very limited direct exposure to the U.S. government bond market and have collectively set aside hundreds of billions of dollars to pay unanticipated claims,” said Dr. Robert Hartwig, president of the I.I.I. and an economist. “Both of these factors will enable the industry to operate effectively despite the recent downgrade of long-term U.S. bonds.” Consequently, Hartwig added, “Existing policyholders, people and businesses filing claims and those seeking to purchase insurance will not experience any difficulties arising from the downgrade.”

California Insurance Commissioner Dave Jones issued a statement saying “These rating actions have no impact on insurer investments in U.S. government and government-related securities and therefore no impact on insurers' financial reporting of risk-based capital and asset valuation reserves. Further, S&P's downgrade to AA+ has no impact on insurers' claims paying abilities. The California Department of Insurance and other states' insurance regulators will continue to exercise strong financial oversight and carefully monitor the financial condition of insurers.

“There is no impact on insurer investments in U.S. government and government-related securities from the actions recently taken by the rating agencies. Risk-based capital and asset valuation reserves are unaffected. State insurance regulators and the NAIC will consider changes to our regulatory treatment if it becomes necessary in the future,” said NAIC President and Iowa Insurance Commissioner Susan E. Voss

According to the Insurance Information Institute (I.I.I.) 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 says the III.

Moreover, continued the III, 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 concludes the III.