Municipal Debt for U.S. Insurers: More Than Meets the Eye

Post-crisis dynamics in the muni market have created new challenges for insurers and make the case for specialized and dedicated attention.

Municipal finance has been making headlines in recent weeks beginning with the highly anticipated Puerto Rico default. Within the U.S., several states including Illinois, Connecticut and New Jersey have also been making headlines as they wind up their fiscal review and budgeting process. In the wake of these events, we think it’s timely to address the municipal debt market and in particular how insurance portfolios should consider these risks and opportunities. U.S. insurers have long looked to municipal bonds as a relatively stable source of high-quality yield. Historically, exposure to the asset class has often been treated as little more than an extension of a core fixed income portfolio. However, post-crisis dynamics in the municipal debt market and potential changes in the investment landscape related to infrastructure policy have given rise to new challenges and amplified old ones, suggesting that the asset class demands specialized, dedicated attention.

Weaker-than-expected post-recession GDP growth in the U.S. coupled with government policy shifts related to healthcare have impacted some corners of the U.S. more than others. These market dynamics underscore the need for dedicated municipal debt experts to navigate market opportunities and avoid potential missteps.

Introduction

At more than $3.8 trillion, the U.S. municipal bond market is one of the largest sectors within the global fixed income investment universe. Municipals long have been a staple of insurance company portfolios, contributing tax efficiency in the case of P&C companies and providing a source of highly rated duration for life companies to support asset/liability management. As of December 31, 2016, domestic insurance companies held nearly 15% of outstanding municipal debt.1

Insurers including both P&C and Life companies historically have managed their municipal bond exposure in a variety of ways. Some establish in-house management capabilities to oversee their portfolios, while others outsource dedicated municipal bond mandates to third-party investment managers. Interestingly, it remains common for insurers to manage municipal assets as part of an existing core fixed income portfolio, effectively including AA and A-rated municipal debt as part of a broad allocation to investment grade credit. This approach likely is driven by the fact that the municipal market was once largely guaranteed by insurance wrap providers such as Ambac and MBIA. While the municipal market remains highly rated, the removal of the insurance guarantee means that today’s market is truly credit driven; thus, dedicated, independent analysis is critical in security selection and portfolio management. Accessing municipal issuance is another important factor. The municipal broker-dealer marketplace is extremely fragmented, requiring significant resources and relationships to access the whole of municipal new issuance and participate in the vibrant secondary market. A final wrinkle impacting the role municipals play for insurers is the prospect of tax reform, as some proposals currently being floated could negatively impact the municipal bond market.

Figure 1: The Municipal Bond Market Has Grown to Almost $4 Trillion

Source: Securities Industry and Financial Markets Association. SIFMA.org. U.S. Bond Market Issuance and Outstanding, as of 12/31/2016.

The complexity associated with these factors coupled with ongoing dynamics playing out in markets related to low yields and length of credit cycle helps to explain why insurers are taking a fresh look at the role municipal debt can play in their portfolios.

1Securities Industry and Financial Markets Association, as of December 31, 2016.

This material is provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. Information is obtained from sources deemed reliable, but there is no representation or warranty as to its accuracy, completeness or reliability. All information is current as of the date of this material and is subject to change without notice. Any views or opinions expressed may not reflect those of the firm as a whole. Neuberger Berman products and services may not be available in all jurisdictions or to all client types. Investing entails risks, including possible loss of principal. Investments in hedge funds and private equity are speculative and involve a higher degree of risk than more traditional investments. Investments in hedge funds and private equity are intended for sophisticated investors only. Diversification does not guarantee profit or protect against loss in declining markets. Indexes are unmanaged and are not available for direct investment. Past performance is no guarantee of future results.

The views expressed herein are those of the Neuberger Berman Fixed Income Investment Strategy Committee. Their views do not constitute a prediction or projection of future events or future market behavior. This material may include estimates, outlooks, projections and other “forward-looking statements.” Due to a variety of factors, actual events or market behavior may differ significantly from any views expressed.

This material is being issued on a limited basis through various global subsidiaries and affiliates of Neuberger Berman Group LLC. Please visit www.nb.com/disclosure-global-communications for the specific entities and jurisdictional limitations and restrictions.

The “Neuberger Berman” name and logo are registered service marks of Neuberger Berman Group LLC.

©2017 Neuberger Berman Group LLC. All rights reserved.