AM Best


Best's Briefing: U.S. Fed's Ruling on Banks' Use of Municipal Securities Not Material for Insurers


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Jim Peavy
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FOR IMMEDIATE RELEASE

OLDWICK - SEPTEMBER 17, 2014 11:21 AM (EDT)
Recently, the U.S. Federal Reserve Board (Fed) indicated that holdings in municipal securities would not qualify as high-quality liquid assets (HQLA) under a new liquidity coverage ratio (LCR). The LCR, adopted by the Fed on September 3, 2014, will be effective January 1, 2015. The LCR is designed to capture potential liquidity stress within a 30-day period for banks as part of Basel III. Generally speaking, banks would be required to maintain a certain ratio of HQLA as a percentage of their total cash outflows, according to the latest Best's Briefing.

A.M. Best views any change to Basel III as having the potential to spill-over into Solvency II requirements. As a reminder, Basel III is structured as an agreement to raise the amount of capital held by banks, whereas Solvency II is attempting to strengthen the quality of capital by tailoring it to the specific risks of each insurer. Since banks and insurers often invest in similar securities, the interconnectedness of the two regimes can lead to migrations across the sectors.

To that end, A.M. Best assessed the LCR development with respect to potential impact on the insurance industry. As LCR is U.S.-based, the immediate focus was on the impact on U.S. (re) insurers. A.M. Best expects, at a minimum, some negative pricing impact, particularly on new issuances, and reduced liquidity, due to a potential decrease in overall demand for municipal securities. Although there was some indication that certain municipal securities may qualify for inclusion as HQLA in the future, it is too early to tell which, if any, types of municipal securities would fall under this classification.

The insurance industry has long been a holder of municipal bonds. This is especially true of property/casualty (P/C) insurers. As of year-end 2013, the P/C industry had 21.2% of its total investment portfolio in municipal securities, life/annuity (L/A) had 4.0%, and health 8.1%.

Analyzing the risk from a capital standpoint, municipal securities accounted for 47.6% of the P/C industry's policyholder surplus, 41.6% for L/A and 12.2% for health. The insurance industry derives significant benefits from holding municipal securities, not the least of which is a tax-advantaged return, increased diversification within the investment grade landscape and improved asset and liability management. A.M. Best recognizes that the credit quality of municipals bonds does vary significantly based on type (revenue or general obligation), region and other cash flow dynamics.

For the full, complimentary copy of this briefing, please visit http://www3.ambest.com/bestweek/purchase.asp?record_code=228669 .

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