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The Federal Reserve’s recently released minutes of last month’s meeting point to its dovish stance. There is no cue of an interest rate hike in 2019 in stark contrast to the earlier plan of three hikes.
In its first official meeting of 2019, concluded last month, the Federal Open Market Committee voted to maintain its target rate range at 2.25-2.5% via a unanimous voting. In 2018, the fed funds rate was increased four times.
The Fed’s dovish stance on interest rates harps on a number of factors such as Brexit uncertainty, China’s economic slowdown, a rapid waning of fiscal policy stimulus, which included the Tax Cut and Jobs Act of 2017, and a further tightening of financial market conditions.
While a rising interest rate environment is a positive for sectors such as banks and insurers, there are still some stocks that would be able to outperform by virtue of their strong business fundaments and solid balance sheets.
Against this backdrop, let’s see the impact that a no interest hike scenario would have on the insurance sector, whose profitability is directly linked to interest rates.
No Interest Rate Hike to Hurt Insurers
Insurers by virtue of the nature of their business, which requires them to pay claims and guaranteed returns on some kind of policies, are required to invest the premium received, less the expenses to run the business, in financial assets. The income generated from such investments called net investment income also forms one of the drivers of earnings.
Since insurers have an obligation to make good the claims and pay out the guaranteed returns, they play safe by investing in government bonds and high-grade corporate bonds. Therefore, an insurer’s investment income and profit depends on the prevailing interest rates.
Apart from impacting net investment income, interest rates also impact insurers’ reserves. Insurers have future liability and are required to maintain capital in commensurate with these liabilities. These reserves are calculated by discounting the future outflows at a discount rate, which is mostly in line with interest rates. Therefore in a period of low interest rates, insurers are required to keep a greater amount of capital as reserves, which causes undue strain.
How Are the Players Dealing?
Having faced with very low interest rates for many years, insurers have made changes to business and product mix by emphasizing and promoting products that are less sensitive to interest rates and equity markets, and increasing focus on sale of products with variable returns. Also, players have sought alternative investments such as in private equity, hedge funds, managed futures, real estate, commodities and derivatives contracts, in order to increase their return on investments.
Moreover, the players are seeking an increase in insurance pricing by raising premiums. Recently, InsuranceNewsNet reported that premium for both Commercial and Personal Lines has increased by 2-2.5%. This should aid revenue growth at a time when net investment income is expected to remain muted.
This aside, the huge surplus capital available in the insurance industry is being used for acquisitions and mergers, share buyback and dividend hikes. These should lead to long-term growth.
Therefore, despite no upward interest rate movement, we believe insurers that have braced themselves for a dovish interest rate environment will be winners.
Our Picks
We have picked up some stocks with a Strong Zacks Rank #1 (Strong Buy) or 2 (Buy) that have witnessed an upward revision to their earnings estimates, expected earnings growth above industry and strong fundamentals. You can see the complete list of today’s Zacks #1 Rank stocks here.
The Allstate Corp. (ALL - Free Report) , carrying a Zacks Rank #2, has witnessed an upward movement in 2019 earnings estimates by 0.5% over the last 30 days. The company is poised to grow on the back of its well-performing property and liability segment. A number of initiatives undertaken by Allstate to improve profitability in the auto segment will also drive long-term growth. A strong balance sheet and intelligent capital management are the other positives. The acquisition of SquareTrade, PlumChoice and InfoArmor provides further business diversification.
Cincinnati Financial Corp. (CINF - Free Report) , with a Zacks Rank #1, has witnessed an increase in 2019 earnings estimates by 0.5% over the last 30 days. The company’s low leverage, ample capital, consistent cash flow generation, favorable reserve release, share repurchases and steady dividend hikes should drive growth. Management is appointing agencies and expanding product offerings to ramp up its business profile.
RLI Corp. (RLI - Free Report) , sporting a Zacks Rank #1, has witnessed an upward increase in 2019 earnings estimates by 12.5% over the past 30 days. The company is one of the industry’s most profitable P&C writers with an impressive record of underwriting profits in 38 of the past 41 years (particularly the last 23 years). Ability to steadily increase dividend, maintain combined ratios at favorable levels and boast a solid capital position are other positives. Continuous strategic investments in fortifying the Casualty segment also bode well.
Arch Capital Group Ltd. (ACGL - Free Report) with a Zacks Rank #1 has witnessed an upward increase in 2019 earnings estimates by 0.8% over the past 30 days. The company boasts a strong product portfolio and has been maintaining an exemplary track record of premium growth. This apart, the insurer has been making efforts to diversify its Mortgage Insurance business via strategic acquisitions. Moreover, banking on a solid capital position, the company effectively deploys money to pursue its growth-driving initiatives.
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This outperformance has not just been a recent phenomenon. From 2000 – 2018, while the S&P averaged +4.8% per year, our top strategies averaged up to +56.2% per year.
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4 Insurers to Gain Despite Fed's Dovish Stance
The Federal Reserve’s recently released minutes of last month’s meeting point to its dovish stance. There is no cue of an interest rate hike in 2019 in stark contrast to the earlier plan of three hikes.
In its first official meeting of 2019, concluded last month, the Federal Open Market Committee voted to maintain its target rate range at 2.25-2.5% via a unanimous voting. In 2018, the fed funds rate was increased four times.
The Fed’s dovish stance on interest rates harps on a number of factors such as Brexit uncertainty, China’s economic slowdown, a rapid waning of fiscal policy stimulus, which included the Tax Cut and Jobs Act of 2017, and a further tightening of financial market conditions.
While a rising interest rate environment is a positive for sectors such as banks and insurers, there are still some stocks that would be able to outperform by virtue of their strong business fundaments and solid balance sheets.
Against this backdrop, let’s see the impact that a no interest hike scenario would have on the insurance sector, whose profitability is directly linked to interest rates.
No Interest Rate Hike to Hurt Insurers
Insurers by virtue of the nature of their business, which requires them to pay claims and guaranteed returns on some kind of policies, are required to invest the premium received, less the expenses to run the business, in financial assets. The income generated from such investments called net investment income also forms one of the drivers of earnings.
Since insurers have an obligation to make good the claims and pay out the guaranteed returns, they play safe by investing in government bonds and high-grade corporate bonds. Therefore, an insurer’s investment income and profit depends on the prevailing interest rates.
Apart from impacting net investment income, interest rates also impact insurers’ reserves. Insurers have future liability and are required to maintain capital in commensurate with these liabilities. These reserves are calculated by discounting the future outflows at a discount rate, which is mostly in line with interest rates. Therefore in a period of low interest rates, insurers are required to keep a greater amount of capital as reserves, which causes undue strain.
How Are the Players Dealing?
Having faced with very low interest rates for many years, insurers have made changes to business and product mix by emphasizing and promoting products that are less sensitive to interest rates and equity markets, and increasing focus on sale of products with variable returns. Also, players have sought alternative investments such as in private equity, hedge funds, managed futures, real estate, commodities and derivatives contracts, in order to increase their return on investments.
Moreover, the players are seeking an increase in insurance pricing by raising premiums. Recently, InsuranceNewsNet reported that premium for both Commercial and Personal Lines has increased by 2-2.5%. This should aid revenue growth at a time when net investment income is expected to remain muted.
This aside, the huge surplus capital available in the insurance industry is being used for acquisitions and mergers, share buyback and dividend hikes. These should lead to long-term growth.
Therefore, despite no upward interest rate movement, we believe insurers that have braced themselves for a dovish interest rate environment will be winners.
Our Picks
We have picked up some stocks with a Strong Zacks Rank #1 (Strong Buy) or 2 (Buy) that have witnessed an upward revision to their earnings estimates, expected earnings growth above industry and strong fundamentals. You can see the complete list of today’s Zacks #1 Rank stocks here.
The Allstate Corp. (ALL - Free Report) , carrying a Zacks Rank #2, has witnessed an upward movement in 2019 earnings estimates by 0.5% over the last 30 days. The company is poised to grow on the back of its well-performing property and liability segment. A number of initiatives undertaken by Allstate to improve profitability in the auto segment will also drive long-term growth. A strong balance sheet and intelligent capital management are the other positives. The acquisition of SquareTrade, PlumChoice and InfoArmor provides further business diversification.
Cincinnati Financial Corp. (CINF - Free Report) , with a Zacks Rank #1, has witnessed an increase in 2019 earnings estimates by 0.5% over the last 30 days. The company’s low leverage, ample capital, consistent cash flow generation, favorable reserve release, share repurchases and steady dividend hikes should drive growth. Management is appointing agencies and expanding product offerings to ramp up its business profile.
RLI Corp. (RLI - Free Report) , sporting a Zacks Rank #1, has witnessed an upward increase in 2019 earnings estimates by 12.5% over the past 30 days. The company is one of the industry’s most profitable P&C writers with an impressive record of underwriting profits in 38 of the past 41 years (particularly the last 23 years). Ability to steadily increase dividend, maintain combined ratios at favorable levels and boast a solid capital position are other positives. Continuous strategic investments in fortifying the Casualty segment also bode well.
Arch Capital Group Ltd. (ACGL - Free Report) with a Zacks Rank #1 has witnessed an upward increase in 2019 earnings estimates by 0.8% over the past 30 days. The company boasts a strong product portfolio and has been maintaining an exemplary track record of premium growth. This apart, the insurer has been making efforts to diversify its Mortgage Insurance business via strategic acquisitions. Moreover, banking on a solid capital position, the company effectively deploys money to pursue its growth-driving initiatives.
Today's Best Stocks from Zacks
Would you like to see the updated picks from our best market-beating strategies? From 2017 through 2018, while the S&P 500 gained +15.8%, five of our screens returned +38.0%, +61.3%, +61.6%, +68.1%, and +98.3%.
This outperformance has not just been a recent phenomenon. From 2000 – 2018, while the S&P averaged +4.8% per year, our top strategies averaged up to +56.2% per year.
See their latest picks free >>