April 16 (Bloomberg) -- U.S. commercial insurers may be downgraded by Moody’s Investors Service on the declining value of holdings and the prospect of higher costs to reimburse corporate clients facing shareholder lawsuits.

“Deterioration in investment portfolios, outsized catastrophe losses, and the potential for significant litigation costs relating to corporate bankruptcies and the subprime mortgage crisis all could place additional strain on the sector,” the ratings firm said in a statement today. Moody’s lowered its outlook on the sector to “negative” from “stable.”

Commercial insurers have reported declining profits and losses as the financial crisis lowered the value of investments backing policies. Companies that sell management liability coverage, including American International Group Inc. and Chubb Corp., may face rising claims as investors turn to the courts to recover losses tied to the collapse of the mortgage industry.

The 25-stock Standard & Poor’s Supercomposite Property & Casualty Insurance Index has fallen about 25 percent in the last year. That beats the 38 percent drop in the S&P 500 Index over the same period.

Insurance companies, which invest premium before paying claims, were left with slimmer cushions after accumulating $72.7 billion of total capital losses last year, compared with gains of $8.3 billion in 2007, according to the Property Casualty Insurers Association of America. New York-based AIG reported a 2008 net loss of $99.3 billion on bad housing bets.

Net income across the industry dropped 96 percent to $2.4 billion last year as hurricanes, tornadoes and price competition caused carriers to pay more in claims than they collected in premium revenue, according to the insurer group.

U.S. securities class-action lawsuits increased by 19 percent in 2008 to the highest level in four years on a surge of litigation against financial firms, according to a review by Stanford Law School and Cornerstone Research.

To contact the reporter on this story: Andrew Frye in New York at afrye@bloomberg.net

Last Updated: April 16, 2009 11:17 EDT