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Deteriorating corporate credit conditions represent a key risk to life insurance companies, which have accumulated lower-rated bonds in recent years as they search for higher yields, says Moody’s Investors Service in a new report.

The rating agency said that both U.S. life insurers and reinsurers are vulnerable to declining credit ratings among corporate issuers in the current economy.

Over the past decade, when interest rates were at record lows, insurers expanded their exposure to higher-yielding bonds, Moody’s said.

For instance, life insurers’ exposure to Baa-rated bonds grew to 37% of total bond holdings in 2021.

Now, as interest rates rise and economic prospects dim, companies face increased financial pressure and deteriorating credit quality, leaving insurers “susceptible to the negative effects” of falling credit ratings, Moody’s said.

“A sharp economic downturn that leads to a large number of rating downgrades and rise in defaults within insurers’ bond portfolios would likely reduce life insurers’ capital strength,” it reported.

While insurers are generally well capitalized, some may face pressure on their own credit ratings amid significant ratings migration — particularly insurers with a higher share of lower-rated bonds, as capital charges for these holdings are higher, Moody’s noted.

“The higher capital requirements would reduce [risk-based capital] ratios, potentially limiting insurers’ ability to take out excess capital as dividends,” it said.