Life insurers are among those that stand to gain from a higher interest rate environment. And with convincing economic indicators so far, an interest rate hike is inevitable sooner or later.
Why interest rates are crucial to life insurers…
Life insurers derive income by investing the accumulated premiums in long-term interest-earning assets like corporate and government bonds. Yields and coupons on these bonds are directly proportionate to the federal funds rate. In the prolonged low rate environment, these instruments have been unable to fetch sufficient returns to match insurers’ future commitments to policyholders.
In particular, life insurers have long been suffering from spread compression on products like fixed annuities and universal life. However, the imminent rate hike will enable them to earn higher investment income and increase profit margins.
Further, high hedging costs, which have been marring profitability, are like to decrease with a rate hike. This will, in turn, alleviate the pressure on investment yields.
Overall, a higher rate environment and consequently an upward yield curve will translate into better profitability for life insurers.
On the other hand, life insurers were not idle in a low-rate environment. Taking the ills in stride, they chose to grow on the back of the rapidly changing sector dynamics. This approach should propel rate-driven growth.
Along with altering economic and demographic conditions, increased life expectancy and more predictive risk-calculating techniques with the help of analytics are positioning life insurers for steady profitability.
Most importantly, life insurers have managed to increase net income in the last few quarters by trimming underwriting expenses and daring a modest increase in premiums. The improvement in equity markets should also make variable annuity portfolios and other fee-driven businesses contribute significantly to growth.
Recently, life insurers have been resorting to product modification and re-pricing, which should enhance their liability profiles and profitability. While re-pricing of traditional products with attractive additional features will help them earn more, product modification will lessen liabilities on insurers’ part by shifting risks related to equity and hedging to policyholders.
A strong balance sheet position should also help life insurers to perform better. The industry’s statutory capital level improved significantly in the last few quarters, with the help of steady retained earnings and effective capital management. A beefed-up capital market should keep the industry’s liquidity profile strong over the upcoming quarters and help industry participants confront challenges.
Strengthening fundamentals of corporate bonds and improvement in the real estate market should keep credit-related investment losses below average. Further, with continued economic recovery and declining unemployment, disposable income is on the rise. This should lead to a rise in demand for life insurance and annuity products.
However, in the absence of reliable returns from the corporate and government bonds, insurers have been banking on alternative asset classes to optimize returns. If they have added any risky asset class in their investment portfolio in the hope of better yields, they might have invited further losses.
Stocks Worth Betting On
As you can see, there are plenty of reasons to be optimistic about U.S. life Insurers now. So one may consider buying some life insurance stocks that promise better performance based on their strong fundamentals and a favorable Zacks Rank.
Specific life insurers that we like with a Zacks Rank #2 (Buy) are Primerica, Inc. (PRI - Snapshot Report) and StanCorp Financial Group Inc. (SFG - Analyst Report).
Check out our latest U.S. Insurance Industry Outlook for more on the current state of affairs in the overall insurance market.
Want the latest recommendations from Zacks Investment Research? Today, you can download 7 Best Stocks for the Next 30 Days. Click to get this free report>>