NU Online News Service, June 27, 2:37 p.m. EDT

The largest city to file for bankruptcy protection in the United States will not spell doom for municipal-bond insurers, and only a dramatic rash of municipal failures would do serious damage to that industry segment, an economist says.

Yesterday, the Stockton, Calif. city council voted 6-1 to file for bankruptcy protection after months of negotiations with creditors failed to close a $26 million deficit in the city's budget.

The council will file for Chapter 9 bankruptcy protection, under which it will seek to suspend payment of bonds, claims and long-term debt by the general fund. The city will also seek to modify the terms of labor and employee agreements to reduce costs, including the “reduction and ultimately elimination of city contributions to retiree medical insurance,” the city says in a statement.

The move, says Steve Weisbart, senior vice president and chief economist for the Insurance Information Institute, will “not have much effect” on bond insurers.

Weisbart says, “Unless there was an unusually large number of municipal bankruptcies across the country, I would not expect any reaction from bond insurers,” except for rates being raised.

“This, by itself, is not a problem,” he asserts.

He says insurers usually reserve for such events, and they have had plenty of time to prepare for Stockton in particular, since the industry was well aware of the city's financial condition.

While the muni-bond insurers may avoid any serious disruption, insurers' investment portfolios may take a hit.

Moody's released a report in July of last year saying insurers hold $355 billion in municipal bonds, representing 60 percent of the industry's equity-capital base. Because they invest in long-duration bonds, the industry is exposed to interest-rate risk and greater market volatility.

However, the industry typically invests in high-grade bonds and is usually well diversified in geography and bond type.

During a Property and Casualty Joint Industry Forum in January of last year, V.J. Dowling, a managing partner with Dowling & Partners, addressed the municipal bond investment issue, saying small regional companies may have more to be concerned about than larger companies.

Larger companies can afford a significant number of investment advisors to obtain a balance in the carrier's investment portfolio.

Dowling said his research indicates that insurers remain diversified in their portfolios, differentiating between states and between the types of bonds they invest in.