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How Vulnerable is Insurance Industry Under Coronavirus Scare?

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With the coronavirus threat spreading worldwide at an alarming rate, it is now expected to weigh heavily on global economic growth.

With travel, production, demand and consequently sales being already hampered, business in every sector is suffering massive losses. Major indices across the globe have  been downhill, wiping off investors’ wealth in trillions. Businesses are facing supply-chains glitch and several facilities across China remain non-operative, triggering a widespread fear of global recession.

Many companies issued profit warnings like the leading names, Apple Inc. AAPL and Microsoft Corporation MSFT.

On Friday Feb 28, stock markets were down again, heading for their worst week since the peak of the global financial crisis in 2008. The S&P 500 Index dropped more than 10% from the record highs set just over a week ago. Also, yield on the 10-year U.S. Treasury note hit an all-time low on Thursday as investors are moving toward safe-haven assets.

The imminent damage is now quite visible and it prompted the Fed to recently issue a statement that it will do what is appropriate to boost the economy. This in all probability, points to a rate cut to support the slackening economy.  

Per the CME FedWatch tool, there is 77.1% chance of the central bank slashing interest rates by 25 basis points (bps) and 22.9% chance of a 50-bps cut in March. This is a drastic change from 35.4% chance of a 25-bps rate reduction predicted a day before.

Further, the impact of the coronavirus outbreak on the U.S. economy is now likely to be more startling than previously expected. Per IHS Markit data, manufacturing and business activities in the country seem to have ramped down in February for the first time since the federal government’s shutdown in 2013.

With the economy likely to be adversely impacted by coronavirus concerns, insurance companies are expected to suffer a double whammy. With the Fed likely to trim interest rates again in March, it will strain investment income, which forms one of the key revenue drivers of a company in the insurance space.

Yield on investment income is affected by Federal Reserve’s interest rates. Though the decline in interest will cause an appreciation in the value of bond holdings, net investment yield will take a hit. All in all, a low interest rate scenario is not a very positive sign for insurance players.

Also, persistently low interest rates are identified as a major threat to life insurance companies, given their rate-sensitive products and investments. Interest rate risk can surface in various ways, impacting life insurers' earnings, capital and reserves, liquidity and competitiveness. Moreover, the impact of a low interest rate environment depends on the level and type of guarantees offered. Life insurers' earnings are typically derived from the spread between their investment returns and what they credit as interest on insurance policies and products. During times of continuous low interest rates, life insurers' income from investments might be insufficient to meet contractually guaranteed obligations to policyholders which cannot be lowered.

Nevertheless, insurers resorted to various tools to address their risky exposure to persistently low interest rates. Insurers are resorting to product modifications (by lowering guaranteed rates) and are better matching their assets and liabilities to tackle the low interest rate environment.

Thus investors should take extra caution while investing in insurance stocks. A safer choice would be to pick up property and casualty insurers. These companies have been enjoying top-line growth with vast and diversified businesses. Premium rate increase in Personal and Commercial lines of insurance has been seen from the past many quarters and this trend is expected to continue. Also a benign catastrophe loss in 2019 led to strong capital levels, which will allow insurers to buy back shares, increase dividend, go for mergers and acquisitions, thus driving overall growth.

Some of the property and casualty stocks with a top Zacks Rank are W. R.Berkley Corp. WRB, CNA Financial Corp. CNA, American Financial Group, Inc. AFG and Cincinnati Financial Corp. CINF.

While CNA Financial sports a Zacks Rank #1 (Strong Buy), the other three stocks carry a Zacks Rank #2 (Buy).You can see the complete list of today’s Zacks #1 Rank stocks here.

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