The rising rate environment is no doubt backing life insurers more than others in the insurance space given higher sensitivity of their business model to interest rates. But neither the magnitude nor the pace of rate hike has the potential to measurably increase carriers’ investment income that they utilize to meet policyholders’ future claims.
Actually, for any gain, the rate-hike-driven improvement in income will have to more than offset the decline in yield on assets invested in. And the rate hikes so far are too small to fetch any significant benefit.
The rising rate environment should meaningfully enhance life insurers’ investment income in the long run and position them better in terms of minimum continuing capital and surplus requirement ratio. However, the change so far doesn’t look effective enough to make their prospects better in the near term.
Falling short of investors’ expectations recently turned life insurance into an out-of-favor industry. This is clearly evident from the Zacks classified Life Insurance Industry’s 5.9% loss since the Fed’s latest rate hike on Mar 15 versus 1.8% decline of the SP 500.
However, in addition to a likely escalation in investment income (though not significant), there are other reasons to be optimistic about the industry’s growth potential.
Key Performance Drivers
High hedging costs, which have been marring profitability, are likely to decline with subsequent rate hikes. This will, in turn, alleviate the pressure on investment yields.
Moreover, better control over underwriting expenses and a modest increase in premiums should help life insurers enhance their income in the quarters ahead.
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 the profits as U.S. stocks enter their eighth year of an epic bull market and promise room to run albeit with a few pauses.
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 commander-in-chief on expectations of stronger economic growth and higher inflation based on an expansive fiscal policy. If this trend continues, life insurers will likely see better days.
Also, strengthening fundamentals of corporate bonds and improvement in the real estate market should keep credit-related investment losses below average.
Above all, an increase in disposable income on the back of a continued growth in the economy and declining unemployment should lead to a rise in demand for life insurance and annuity products.
Zacks Industry Rank Indicates Better Performance Ahead
This 17-company group currently carries a Zacks Industry Rank of #49, which places it at the top 19% of the 250 plus Zacks classified industries. Our back-testing shows that the top 50% of the Zacks ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.
Business Alteration to Keep Supporting Growth
Life insurers did not shy away under difficulties that the low-rate environment created for them. Taking the ills in their stride, they choose to capitalize on the rapidly changing sector dynamics. As part of this effort, life insurers reduced the sensitivity of their product lines to interest rates to some extent and invested in less liquid assets. While this rationalization leads to lower benefits from a rising rate environment, it should make the growth path steady.
Along with altering economic and demographic conditions, more predictive risk-calculating techniques with the help of analytics are positioning life insurers for steady profitability.
Most importantly, life insurers managed to improve net income in the last few quarters by trimming underwriting expenses and daring a modest increase in premiums. 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 the 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 challenge that might crop up.
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 beaten down stocks based on a favorable Zacks Rank.
Here are a couple of top-ranked stocks that you may want to consider:
Health Insurance Innovations, Inc. (HIIQ): This Zacks Rank #1 (Strong Buy) stock gained over 170% in the last six months compared with about 8.9% gain for the SP 500. Its Zacks Consensus Estimate for the current year revised 31.8% upward over the last 60 days.
Reinsurance Group of America, Inc. (RGA): A 0.4% upward revision in the Zacks Consensus Estimate for the current year over the last 30 days led to a Zacks Rank #2 (Buy) for this stock. The price of this stock increased 15.6% over the last six months.
However, for some stocks in this space, it may not be easy to override challenges and benefit from the latent opportunities.
Particularly, we recommend staying away from the following bottom-ranked stock:
GWG Holdings, Inc. (GWGH): This Zacks Rank #4 (Sell) stock gained nearly 25% over the last six months. However, its Zacks Consensus Estimate for the current year revised from a loss of 0.86 to 1.39 over the last 60 days.
Check out our latest U.S. Insurance Industry Outlook for more on the current state of affairs in the overall insurance market.
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