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The rate environment has been favoring life insurers since the Fed started tightening its monetary policy a couple of years back, given the high sensitivity of their business models to interest rates. But neither the pace nor the magnitude of rate hikes has been enough for a measurable benefit so far.

However, the Fed’s rate hike last week and three more likely increases in 2018 might change the fate of life insurers by steadily boosting their investment income.

Actually, for any gain, the rate-hike-driven improvement in investment income will have to more than offset the decline in yield on assets invested in. And the rate hikes so far have not been enough to fetch any significant benefit.

However, the likely change in the frequency of rate hikes should position carriers better in terms of generating investment income and maintaining minimum surplus requirement.

While the rate environment has not been too effective so far, investors have reacted positively to the industry’s progress. This is clearly evident from the Zacks Life Insurance Industry’s 22.7% gain since the beginning of the year versus the S&P 500’s 20.2% rally.

In addition to a likely escalation in investment income based on an improved rate scenario, there are reasons to be optimistic about the industry’s growth.

Key Drivers Beyond Rate Hikes

High hedging costs, which have been marring profitability, are likely to decline with rising interest rates. This will, in turn, alleviate the pressure on investment yields.

Moreover, better control over underwriting expenses and continued increase in premiums should help life insurers enhance their income in the quarters ahead. The individual life insurance premiums, which showed decent growth since the last recession, will likely continue the trend with rising demand driven by a strong job market and the aging population (for retirement savings).

In the low-rate era, life insurers managed to stay afloat by going beyond their conservative approach and through capital flexibility. In order to keep their commitments to policyholders, they increasingly resorted to riskier asset classes — such as equities. While increased dependence on this strategy has made them vulnerable to faltering on claim payments as there is no guarantee of steady returns from riskier assets, no major setback is likely in the near term. In fact, this arrangement should make variable annuity portfolios and other fee-driven businesses contribute a little more to profits, as the equity market is expected to remain favorable.

What made life insurers resort to racier asset classes is ultra-low bond yields due to global growth concerns. However, bond yields have improved since Donald Trump became President on expectations of better economic growth and higher inflation based on an expansive fiscal policy. If this trend continues, life insurers will likely see better days.

Also, as the U.S. corporate bond market remains healthy and the real estate market is unlikely to disappoint with strength is job market, life insurers’ credit-related investment losses should be below average.

Above all, increasing disposable income on the back of continued growth in the economy and declining unemployment should perk up demand for life insurance and annuity products.

Zacks Industry Rank Indicates Solid Upside Potential

This 14-company group currently carries a Zacks Industry Rank of #56, which places it in the top 22% of the 250-plus Zacks industries. Our back-testing shows that the top 50% of Zacks-ranked industries outperform the bottom 50% by a factor of more than 2 to 1.

Business Restructuring to Work in Favor

Life insurers did not shy away under difficulties that the low-rate environment had created for them. Taking them in stride, they had chosen to capitalize on the rapidly changing sector dynamics. As part of this effort, life insurers had reduced the sensitivity of their product lines to interest rates to some extent and invested in less-liquid assets. While this rationalization is curbing the benefits from the rising rate environment, it should make the growth path steady.

The changing economic and demographic conditions are making risk calculation difficult, but life insurers are adopting more predictive techniques with the help of analytics.

Most importantly, life insurers have managed to improve net income in the last few quarters by trimming underwriting expenses and modestly increasing premium rates. In fact, some life insurers are quietly hiking rates on some universal life policies in order to offset losses emanating from a tough industry backdrop. This action is actually narrowing the gap between what they receive as premium and what they promised to pay policyholders.

Life insurers have also 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.
Moreover, a beefed-up capital market should strengthen the industry’s liquidity profile in the upcoming quarters and help its participants confront any unforeseen challenge.

How to Play Life Insurance Stocks

Life insurers’ near-term prospects are looking up on a number of positive factors. So, it would be prudent to pick a few stocks based on a favorable Zacks Rank.

Here are a few top-ranked stocks that you may want to consider:

American Equity Investment Life Holding Company (AEL - Free Report) : This Zacks Rank #1 (Strong Buy) stock has gained 41% year to date versus the S&P 500’s 20.2% rally. Its Zacks Consensus Estimate for the current year earnings has been revised 13.2% upward over the last 60 days. You can see the complete list of today’s Zacks #1 Rank stocks here.

Reinsurance Group of America (RGA - Free Report) : An 8.3% upward revision in the Zacks Consensus Estimate for the current year over the last 60 days led to a Zacks Rank #2 (Buy) for this stock. The stock has gained over 23% year to date.

Lincoln National Corp. (LNC - Free Report) : This Zacks Rank #2 stock has gained over 17.2% year to date. Its Zacks Consensus Estimate for the current year has been revised 2.9% upward over the last 60 days.

Check out our latest U.S. Insurance Stock Outlook for more on the current state of affairs in the overall insurance market.

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