(Bloomberg)—Insurance investors are betting the corporate bond rally that bolstered industry stocks can withstand concern that the Greek rescue plan will be insufficient to stabilize debt markets.

Prudential Financial Inc., American International Group Inc., MetLife Inc. and Allstate Corp. had a net unrealized gain of $13.2 billion on the securities on March 31, compared with a $38.6 billion loss a year earlier. The figures reflect market fluctuations that aren't counted toward earnings and are tracked by investors and rating firms as a gauge of financial strength.

U.S. insurers, which hold more than $2.2 trillion in corporate debt, added to their portfolios in early 2009 when the bonds sunk in value, and then benefited from their rebound over the next year. Corporate bonds have returned 22% since March 31 of last year, including reinvested interest, after losing about 5% in 2008, according to Bank of America Merrill Lynch's Global Broad Market Corporate Index.

“One of the reasons I'm overweight in the group is it really lives and dies by U.S. corporate bonds, which I still think is a relatively good asset class,” Randy Binner, an analyst with FBR Capital Markets, said of life insurers. “When you mention the rally in corporate bonds, that really drives their book values.”

The 24-stock KBW Insurance Index gained 11% this year through Thursday, compared with the 1.1% drop in the Standard & Poor's 500 Index. Prudential is up 19% since Dec. 31.

Bonds and punishment

An end to the corporate debt rally could pressure life insurers, said Wayne Dalton, a senior industry analyst with SNL Financial in Charlottesville, Va. Corporate bonds lost 0.6% since April 30 and are headed for their first monthly decline this year, Bank of America Merrill Lynch data show.

“Given what's happened this quarter, it'll be interesting to see where we're at June 30” with the value of life insurers' fixed-income portfolios, Mr. Dalton said. “If bonds are having a bad time, you'd probably see the stock price punished.”

Corporate debt sales have dwindled and credit risk indicators have risen this month, even after European policymakers unveiled a loan package worth almost $1 trillion and a program of bond purchases on May 10 to help countries including Greece under attack from speculators.

Europe's sovereign debt crisis could threaten portfolio gains if it isn't contained, Thomas Watjen, chief executive officer of Unum Group, said in a May 25 interview at Bloomberg headquarters in New York.

‘Capital-market event'

“The more it starts to spread from Greece to Spain to others, it's going to continue to be a prominent capital-market event,” said Mr. Watjen, whose company oversees more than $30 billion in corporate debt. “Whether it becomes an economic event and begins to affect our growth rates, for example, in the U.S., I'm not quite there yet, personally.”

The chance of credit-rating downgrades for U.S. companies that aren't financial institutions is the lowest since July 1998 as the nation's improving economy overshadows European debt strains, ratings firm Standard & Poor's said in a report Thursday.

Unum bought bonds issued by Wal-Mart Stores Inc., the world's largest retailer, and obtained a yield in early 2009 that would typically be available only from a lower-rated company, Mr. Watjen said. Unum, the biggest U.S. long-term disability insurer, had an unrealized gain of $1.96 billion on its corporate bond holdings on March 31.

Prudential, the second-biggest U.S. life insurer, had $3.1 billion of unrealized gains from corporate debt as of March 31, compared with $7.9 billion of unrealized losses a year earlier, the company said in a May 7 filing. No. 1 MetLife had $2.5 billion in unrealized gains from the bonds at the end of the first quarter, compared with a $15.4 billion unrealized loss.

AIG, Allstate

AIG had $6.6 billion in unrealized gains from corporate debt on March 31, compared with $11.8 billion of unrealized losses a year earlier. Allstate had a gain of $914 million on March 31, compared with a loss of about $3.5 billion.

U.S. insurers bought corporate debt at the fastest pace in five years in 2009, as net purchases climbed to $153 billion, Federal Reserve data in March showed. That compares with outflows of $59 billion in 2008.

A rise in interest rates could pressure the value of insurers' bonds. Futures show traders were betting late Thursday that there's a 39% chance Federal Reserve policy makers will raise their target rate for overnight loans between banks by at least 0.25 percentage point by their December meeting, up from a 34 percent chance on May 26.

‘Fundamental improvement’

Leslie Barbi, managing director of fixed-income securities at policyholder-owned Guardian Life Insurance Co. of America, said bond investors have been encouraged by “clear fundamental improvement” in the economy and borrowers’ ability to cut costs.

“Here’s a case with a sector in the fixed-income market where you can see why true credit improvement and fundamental improvement will come through,” said Ms. Barbi, who helps oversee $23 billion.

The extra yield investors demand to own corporate debt instead of similar-maturity government debt has widened 51 basis points from the year’s low on April 21 to 193 basis points as of Thursday, Bank of America Merrill Lynch data show. Still, that compares with a spread of 355 basis points a year ago.

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