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Financial Stocks

Insurance against Rising Interest Rates

By Elliott H. Gue, on Sep. 23, 2013

To get a sense of the headwind that the Fed’s extraordinarily accommodative policies created for the insurance industry, check out this graph comparing the median pretax yield reported by the major insurers for their investment portfolios to the yield on the 10-Year US Treasury note and BBB-rated US corporate bonds.

Source: Bloomberg

With the yields on both corporate debt and the 10-year Treasury well below the median yield on insurers’ portfolios over the past few years, the industry’s investment income has declined as those higher-rate bonds roll over.

Against this backdrop, it’s no surprise that shares of life insurers lagged the broader market from the beginning of 2010 to the end of 2012; over this period, the Bloomberg North American Life Insurance Index delivered a total return of 28.2 percent, compared to the 36.2 percent gain posted by the S&P 500.

But the tide is turning. As the Fed normalizes its monetary policy and interest rates tick up, the coupons available on government and corporate bond should recover to levels that are on par with life insurers’ median portfolio yields. These incremental improvements mean that life insurers will face a progressively lower yield haircut.

The recent uptick in interest rates in the wake of the Fed’s initial announcement of plans to phase out quantitative easing has helped to catalyze a 45 percent rally in the Bloomberg North American Life Insurance Index thus far in 2013. That’s more than double the return posted by the S&P 500.

Despite this dramatic outperformance, life insurers are still in the early innings of their recovery story; rising interest rates will remain a tailwind for the group for at least the next two to three years.

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