The Federal Reserve is widely expected to hike rates on Mar 15 after its meeting with policymakers. The Fed will also want to ride the wave of robust labor market data to get a couple more rate hikes under its belt this year. A remarkable harmony, in the meantime, has also emerged among the Fed, Wall Street investors and distinguished economists over the need to raise rates multiple times.
Insurance stocks, especially, tend to flourish with a rise in rates. In fact, the relationship between interest rates and insurance companies is linear and straightforward, meaning the higher the rate, the greater the growth. This calls for investing in solid insurance stocks for hefty returns.
Fed Rate Hike Looms
With the U.S. economy generating jobs at a steady clip in February, unemployment rate dipping and annual wage growth increasing, it’s all but certain that the central bank will push the cost of borrowing by a quarter of a point in its two-day Federal Open Market Committee meeting that got underway. U.S. employers added 235,000 jobs in February in the first full month after President Donald Trump took office, smashing expectations of 191,000. The unemployment rate, in the meantime, dipped to 4.7% from 4.8%, while wages for American workers went up 0.2% last month to $26.09 an hour (read more: 4 Strong Buy Staffing Stocks on Blowout Job Creation).
Thanks to such robust jobs data, policymakers have concluded that inflationary pressure is in line with expectations as the economy approaches full employment. Trump’s policies to increase infrastructure spending and cut taxes are also expected to have an inflationary impact, which should push interest rates even higher.
These are encouraging developments as Fed Chair Janet Yellen and several other officials wanted to get rates off the ground throughout her three-year tenure. She had already said, citing a solid labor market, that waiting too long to hike rates would be imprudent as it might hamper the broader financial markets and dampen economic growth.
The CME Fed Watch tool based on Fed fund rate futures shows that the broader market has paid heed to Fed member comments and the probability of a rate hike in March is 93%. According to a survey by The Wall Street Journal, many economists unanimously expect the central bank to raise rates at its June meeting, while banking behemoth The Goldman Sachs Group, Inc. (GS - Free Report) expects an increase in rates in March, June and September (read more: 5 Bank Stocks to Buy as Fed Hints at a Rate Hike in March).
Insurance Stocks to Gain from Rate Hike
Insurance companies are eagerly waiting for the Fed to start raising interest rates. Rising rates act as a boon for insurance companies as they derive their investment income from investing premiums, which are received from policyholders in corporate and government bonds. Yields and coupons on these bonds rise in response to a rise in Fed fund rates and bank interest rates. This enables life insurers to invest their premiums at higher yields and earn more investment income, expanding their profit margins. Not only investment income, which is an important component of insurers’ top line, annuity sales should also benefit from a higher rate environment.
In the year-to-date period ended Mar 14, the SPDR S&P Insurance ETF (KIE - Free Report) generated returns of 5.2% on increasing expectations of a rate hike this month. As of the last filing, its top three holdings, Progressive Corp (PGR - Free Report) , Allstate Corp (ALL - Free Report) and Unum Group (UNM - Free Report) rose 12%, 10.9% and 10.2%, respectively. KIE has not only delivered an impressive performance over the past one year, it has also hit a 52-week high of around $86.89.
5 Solid Choices
Interest rates are a key performance driver for insurance companies, impacting their margins, hedging costs and product sales. Higher interest rates boost margins of insurers and with rate hike impending, surely they are poised to benefit.
We have, thus, selected five insurance stocks that have a price to book (P/B) ratio less than the industry’s median P/B values. It essentially means that the stocks are trading at a discount to the industry.
We have also considered P/B values that are not 2 or higher, else, it will indicate that the company is pricey. For an insurance firm, book value is a solid measure of most of its balance sheet, which consists of bonds, stocks and other securities. Additionally, we have selected stocks that flaunt a Zacks Rank #1 (Strong Buy) or 2 (Buy).
American Equity Investment Life Holding Company (AEL - Free Report) develops and sells fixed index and fixed rate annuity products in the U.S. The company has a P/B ratio of 0.99, less than the industry’s median value of 1.09. American Equity Investment Life has a Zacks Rank #2.
The company has outperformed the Insurance - Life Insurance industry on a year-to-date basis (+14.1% vs. +10.1%).
Fidelity & Guaranty Life provides annuities and life insurance products in the U.S. It offers fixed indexed annuities, fixed rate annuities, single premium immediate annuities and indexed universal life insurance policies. The company has a P/B ratio of 0.89, less than the industry’s median value of 1.09. Fidelity & Guaranty Life has a Zacks Rank #2.
The company has performed better than the Insurance - Life Insurance industry on a year-to-date basis (+12.2% vs. +10.1%).
ING Groep N.V. (ING - Free Report) is a Dutch insurance conglomerate which also operates in the U.S. The company has a P/B ratio of 1.07, less than the industry’s median value of 1.09. ING Groep has a Zacks Rank #1. You can see the complete list of today’s Zacks #1 Rank stocks here.
The company has given a year-to-date return of 8.1%.
Unum Group provides group and individual disability insurance products and services primarily in the U.S. The company has a P/B ratio of 1.26, below the industry’s median value of 1.44. Unum Group has a Zacks Rank #2.
The company has outshined the Insurance - Accident and Health industry on a year-to-date basis (+10.2% vs. +4.8%).
Allianz SE (AZSEY - Free Report) provides property-casualty and life/health insurance, and asset management products and services worldwide, including the U.S. The company has a P/B ratio of 1.03, lower than the industry’s median value of 1.04. Allianz has a Zacks Rank #2.
The company has outperformed the Insurance - Multi line industry on a year-to-date basis (+9% vs. +2.4%).
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