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While munis have long been a staple of property and casualty (P&C) insurers’ portfolios, this has generally been less true for life insurers. The bonds’ tax-exempt nature is a big reason: P&C companies have historically paid an effective tax rate of 5.25% on muni income, meaning 94.75% of that muni income is federally tax-free, while life insurers did not receive this tax benefit. Given tax-exempt munis’ lower yields, life insurers were generally better off buying higher-yielding corporates and other taxable bonds. Recent tax reform is changing this dynamic, however, and we believe now is the time for life insurers to consider adding tax-exempt munis to their strategic asset allocation.

New tax exemption, higher yields may give munis an edge over some corporates

Under the Tax Cuts and Jobs Act of 2017, life insurers now enjoy a substantial federal tax exemption on municipal bond income: 93.7% of muni income is effectively tax-free. (The effective 6.3% tax rate is the product of the new 21% corporate tax rate and the introduction of a 30% proration amount for life insurers.) This makes tax-exempt munis much more attractive for life insurers.

Munis with 20- to 30-year maturities and 4% coupons, in particular, can provide higher after-tax yields than corporate bonds with similar ratings and maturities at the new tax rate. This segment of the muni market was traditionally supported by P&C insurance companies and U.S. banks, but the new lower corporate tax rate has curbed demand from these buyers. As a result, yields on these bonds have been rising: AA and A rated munis with 20- to 30-year maturities and 4% coupons now offer an average after-tax pickup of roughly 25 basis points (bps) over corporate bonds with similar characteristics (see Figure 1).

Tax Reform Makes Munis More Compelling for Life Insurers

In addition to the potential for higher after-tax yields, we see several other key reasons why life insurers should consider adding muni bonds to their portfolios:

  • Diversification. Munis may offer diversification benefits versus a variety of asset classes. Specifically, munis may provide a lower correlation to equities than taxable credit (whether investment grade or high yield). Munis also tend to have a lower correlation to Treasuries than do core bonds (as proxied by the Bloomberg Barclays Municipal Bond Index and the Bloomberg Barclays US Aggregate Bond Index).
  • Lower default risk. Municipal default rates remain low relative to U.S. investment grade bonds: Over the past decade, A rated municipal bonds have defaulted at a cumulative rate of 0.07%, compared with 2.22% for A rated U.S. corporates. Munis have also tended to outperform taxable corporate credit during Federal Reserve hiking cycles (see Figure 2). PIMCO expects the Fed to continue to gradually raise rates over the next few years.
  • Enhanced asset-liability management. The average duration profile of munis is longer than that of generic corporate bond indexes or structured credit, making them an attractive hedge to life insurance liabilities. The relative cheapness of munis further out the yield curve supports the case for long-duration investors like life insurance companies to own munis.

Tax Reform Makes Munis More Compelling for Life Insurers

Tapping opportunities in munis

We believe tax-exempt munis have become more attractive to life insurers relative to taxable bonds, and given their added potential portfolio benefits, the time to consider incorporating them is now. We expect munis to continue to offer attractive risk- and tax-adjusted returns. And with a dedicated team of municipal bond portfolio managers and credit analysts managing nearly $40 billion in investor assets, PIMCO has the experience and resources to help our clients take full advantage of this opportunity.

To learn more about investing in municipals at PIMCO, please visit



All investments contain risk and may lose value. Investing in the bond market is subject to risks, including market, interest rate, issuer, credit, inflation risk, and liquidity risk. The value of most bonds and bond strategies are impacted by changes in interest rates. Bonds and bond strategies with longer durations tend to be more sensitive and volatile than those with shorter durations; bond prices generally fall as interest rates rise, and the current low interest rate environment increases this risk. Current reductions in bond counterparty capacity may contribute to decreased market liquidity and increased price volatility. Bond investments may be worth more or less than the original cost when redeemed. Equities may decline in value due to both real and perceived general market, economic and industry conditions. Investing in foreign-denominated and/or -domiciled securities may involve heightened risk due to currency fluctuations, and economic and political risks, which may be enhanced in emerging markets. Mortgage- and asset-backed securities may be sensitive to changes in interest rates, subject to early repayment risk, and while generally supported by a government, government-agency or private guarantor, there is no assurance that the guarantor will meet its obligations. Income from municipal bonds may be subject to state and local taxes and at times the alternative minimum tax. Sovereign securities are generally backed by the issuing government. Obligations of U.S. government agencies and authorities are supported by varying degrees, but are generally not backed by the full faith of the U.S. government. Portfolios that invest in such securities are not guaranteed and will fluctuate in value. Diversification does not ensure against loss. Derivatives may involve certain costs and risks, such as liquidity, interest rate, market, credit, management and the risk that a position could not be closed when most advantageous. Investing in derivatives could lose more than the amount invested.

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