Zacks Industry Outlook Highlights: GWG Holdings, ING Groep and Torchmark
For Immediate Release
Industry: Insurance, part 2
The Federal Reserve's delay in raising rates after the first hike in Dec 2015 has dampened the optimism about life insurers. It actually puts life insurers under pressure in terms of rationalizing long-term rate assumptions that they use to establish reserves.
The uncertainty over the rate hike schedule might compel life insurers to take some charges tied to a revision in long-term rate assumptions, but that should be manageable given their not-so-bad earnings prospects.
However, the expectation of a rising rate environment, sooner or later, has not totally extinguished the initial optimism.
The long-awaited rate hike decision by the Fed and anticipation of a gradual increase means a lot to life insurance business, as the industry is one of the major beneficiaries of a rising interest rate environment.
Life insurers derive income primarily by investing the accumulated premiums in long-term interest-earning assets like corporate and government bonds. Yields and coupons on these bonds are directly proportionate to the federal funds rate. In the prolonged low-rate environment, these instruments were unable to fetch sufficient returns to match insurers' future commitments to policyholders.
In particular, life insurers have long been suffering from spread compression on products like fixed annuities and universal life. However, the December hike and the expected gradual increase in rates in the future will enable them to earn a higher investment income and enjoy increased profit margins.
Further, high hedging costs, which have been marring profitability, are likely to decrease with the rate hike. This will, in turn, alleviate the pressure on investment yields.
Overall, a rising rate environment and consequently an upward yield curve will translate into better profitability for life insurers.
However, life insurers were not idle in a low-rate environment. Taking the ills in stride, they chose to grow on the back of the rapidly changing sector dynamics. As part of this effort, life insurers have reduced the sensitivity of their product lines to interest rates to some extent and have invested in less liquid assets. While this rationalization leads to lower benefit from a rising rate environment, it should make the growth path steady.
Along with altering economic and demographic conditions, increased life expectancy and more predictive risk-calculating techniques with the help of analytics are positioning life insurers for steady profitability.
Most importantly, life insurers managed to increase 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 the losses from a prolonged rate environment. This action is actually reducing the value they promised to policyholders.
The resilience of the equity market should also make variable annuity portfolios and other fee-driven businesses contribute significantly to growth.
Recently, life insurers have 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.
A strong balance sheet position should also help life insurers perform better. The industry's statutory capital level improved significantly in the last few quarters, with the help of steady retained earnings and effective capital management. A beefed-up capital market should keep the industry's liquidity profile strong over the upcoming quarters and help the industry participants confront any challenge that might crop up.
Strengthening fundamentals of corporate bonds and improvement in the real estate market should keep credit-related investment losses below average. Further, with continued economic recovery and declining unemployment, disposable income is on the rise. This should lead to a rise in demand for life insurance and annuity products.
However, in the absence of decent growth in a rate-driven income for a prolonged period, insurers had to bank on alternative asset classes to optimize returns. In case they added any risky asset class in their investment portfolio in the hope of better yields, they may have invited further losses.
Stocks to Consider
As you can see, there are plenty of reasons to be optimistic on U.S. life insurers now. So one may consider buying some life insurance stocks that promise better performance based on a favorable Zacks Rank.
We highly recommend GWG Holdings, Inc. ( GWGH ), which carries a Zacks Rank #1 (Strong Buy).
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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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.