Months of speculation on the timing of the Fed’s first rate hike since June 2006 may finally be put to rest at the next policy meeting slated for Dec 15–16. If this happens, the credit will go primarily to the employment report released last Friday that came in stronger than expected.
The employment report revealed that nonfarm payrolls rose 211,000 in November. The employment figure for September and October was also revised upward by 35,000.
The reported unemployment rate of 5.0% is the lowest in 7.5 years, and is close to full employment according to some of the Fed officials.
Many analysts and market participants had expected the Fed to start monetary tightening earlier during the year itself. However, a weak economic data in the second and the third quarters of 2015, held the Fed officials back from hiking the interest rates.
Now, a host of factors including a strong jobs report, a moderate pace of economic growth and the return of the Fed’s inflation target to 2% point to the first rate hike in a decade.
Even if the Fed lifts up the interest rates from their near zero levels, the pace of tightening will likely be gradual. The Fed will remain watchful of the performance by the U.S. economy to design its rate-hiking cycle.
Losers and Gainers
While low interest rates over the past many years have benefitted some sectors, others have literally been suffering. The gainers include Utilities and Real Estate Investment Trusts (REITs). Since REITs are highly dependent on borrowings for acquisitions, development and redevelopment activities, a low borrowing cost nothing short of a blessing.
Utilities too are capital intensive in nature and the funds generated from internal sources are not always sufficient to meet their requirements. Hence these companies end up with high debt loads. Low interest rates naturally help these sectors to pay off debts and book profits.
On the flip side, financial companies such as banks, insurers, brokerages and asset managers suffered. Low interest rates compressed net interest margins of banks and ate into the investment income of insurance companies.
Insurance Stocks Look Promising
The insurance sector which derives part of their revenues from investment income has been badly hit by low yields.
The business model of an insurance company consists of collecting premium and paying out claims when they occur. The funds held in the form of premium collected are invested to generate returns. Since insurance companies are liable to pay out eligible claims, they prefer safe investments such as corporate and government bonds.
Years of low interest rates have resulted in low bond yields that have eaten into their investment income and dented their revenue growth. Major insurers, both life as well as property and casualty (P&C), such as The Chubb Corp. CB, The Allstate Corp. ALL, AmTrust Financial Services, Inc. AFSI, The Travelers Companies, Inc. TRV, Assurant Inc. AIZ, Cincinnati Financial Corp. CINF and Hartford Financial Services Group, Inc. HIG have been troubled by near zero interest rates.
A number of companies have worked out an alternative over the years. They have invested the cash, which would have otherwise earned low returns, in forming new units and buying businesses. W.R. Berkley for instance has incepted 27 units from 2006 to date and has added 7 units via acquisitions.
Travelers reported the acquisition of the majority interest in the property casualty business of its J. Malucelli joint venture in Brazil in Oct 2015. Another insurer ACE Limited acquired The Siam Commercial Samaggi Insurance PCL in 2014 and is expanding in Brazil with the buyout of ItauSeguros SA, the P&C insurance unit of ItaúUnibanco S.A. The company has also closed the buyout of Fireman’s Fund this year.
Though Yellen had commented that the pace of rate hike will be gradual, a rising yield curve will surely benefit the low-yield ridden insurance companies.
7 Insurance Stocks to Bet On
Using our style score system, we have selected 7 insurance stocks that are currently well positioned to gain from a rate hike
Our research shows that stocks with a Value Style Score of ‘A’ or ‘B’ when combined a Zacks Rank #1 (Strong Buy) or 2 (Buy) offer the best investment opportunities in the value investing space. On the basis of our findings, the picks with immense potential are:
American Equity Investment Life Holding Company AEL which sells fixed index and fixed rate annuity products in 50 states and the District of Columbia. It also offers life insurance products comprising traditional ordinary and term, universal life, and other interest-sensitive life insurance products.
Value Score: A
Zacks Rank #2
Primerica, Inc. PRI sells Term Life Insurance; Investment and Savings Products; and Corporate and Other Distributed Products. It underwrites individual term life insurance products. The company also distributes and sells mutual funds and certain retirement plans, managed accounts, variable and fixed annuities, fixed indexed annuities, and segregated funds. In addition, it offers auto and homeowners' insurance referrals, long-term care insurance, debt resolution referrals, mortgage loan referrals, and insurance products, including supplemental medical and dental, accidental death, and disability, as well as student life products for small businesses.
Value Score: B
Zacks Rank #2
Symetra Financial Corporation SYA, through its subsidiaries, provides products and services that serve the retirement, employee-based benefits, and life insurance markets in the United States and the District of Columbia. The company distributes its products through a network of benefits consultants, financial institutions, broker-dealers, and independent agents and advisers.
Value Score: A
Zacks Rank #2
ACE Limited ACE provides a range of property and casualty insurance and reinsurance products worldwide. The company is due to acquire another insurer The Chubb Corp. (CB). ACE Limited has always considered acquisition as an efficient strategy for inorganic growth and global expansion.
Value Score: B
Zacks Rank #2
Alleghany Corporation Y , together with its subsidiaries, provides various insurance services in the United States. In Oct 2015, the company’s subsidiary, R.C. Tway Company, acquired Smit Mobile Equipment B.V. and Smit Mobile Equipment (UK) Ltd. Back in 2012, the company acquired reinsurer Transatlantic Holdings.
Value Score: B
Zacks Rank #2
The Travelers Companies, Inc. TRV has considered mergers and acquisitions as a means to grow inorganically amid the low interest rates. In 2010, the company entered into a joint venture with J. Malucelli Participacoes em Seguros e Resseguros and then increased its stake in the same company to 49.5% in 2012 and 95% in 2014. It also acquired the majority stake in Cardinal Compañía de Seguros. Last year, Travelers completed the acquisition of The Dominion of Canada General Insurance Company.
Value Score: A
Zacks Rank #2
Selective Insurance Group Inc. SIGI is a regional insurance holding company which, through its insurance subsidiaries, offers a broad range of property and casualty insurance products. Selective's commercial insurance products are directed to small- to medium-sized service-oriented businesses, governmental entities and some selected classes of light industry. The company also offers personal insurance products to individuals and families.
Value Score: A
Zacks Rank #2
Bottom Line
Since the Fed is gearing up to raise interest rates, now is a good time to re-evaluate where risks may lurk in your portfolio and to seek newer opportunities.
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