Bonds, stocks and commodities are cratering over fears that the Fed is going to taper its monetary stimulus, but there is one area that has actually been rewarding investors – life insurance shares.
Investors lucky enough to own life insurers have been in money-making mode, even as markets everywhere else have tanked.
Stock markets in both Canada and the U.S. plunged Thursday. The S&P TSX lost 300 points while the Dow Jones industrial average tumbled 354 points, its largest point drop in more than 18 months.
But Manulife Financial Corp., the country’s No. 1 insurer by size, touched a new high for the year and closed up 24 cents to $16.80. Industrial Alliance Insurance and Financial Services Inc. powered ahead $1.86 to $41.16, for the sector’s biggest gain, while Sun Life Financial Inc. closed modestly higher. It was much the same story in the United States, where life insurers, led by industry behemoth Metlife Inc., managed to close little changed, despite the general rout in the market.
Analysts say the life insurers are one of the few sectors that offer investors a safe port in a rising interest rate environment because the sector actually benefits from higher yields.
“The way I describe it is telling people that bond yields are to life insurers what metal prices are to mining companies,” says Desjardins Securities analyst Michael Goldberg, who has published research showing that life insurers’ share prices closely track interest rates over time.
“The market knows at the end of the day it’s one industry that’s not going to be hurt by rising rates,” observed Peter Routledge, analyst at National Bank Financial. “They’re a reasonably safe bet in a rising interest rate environment.”
The response of investors has been to say, “I’m going to get out of REITs, I’m going to get out of banks, but lifecos are a safe place to hide,” according to Mr. Routledge.
BMO Nesbitt Burns upgraded both Manulife and Industrial Alliance Thursday, based on the view that the insurers will benefit from a higher interest rate environment.
Fears that rates are on the way up have been prompted by Federal Reserve Board chairman Ben Bernanke, who said this week that the U.S. central bank would start to scale back its asset purchasing program, known as quantitative easing, if economic conditions continue to improve.
The Fed is buying $85-billion (U.S.) in Treasury bonds and mortgage-backed securities each month, creating demand that is driving their prices higher. The worry in the market is that if the Fed tapers its purchases, prices of bonds will start to fall.
Bonds and yields move in opposite directions, so the impact of the Fed’s massive buying has been keeping interest rates extremely low. The low rates, in turn, have had an elixir-like effect throughout markets, buoying the prices of everything from dividend-paying stocks to commodities and emerging market securities. Markets are skittish about the Fed cutting its purchases because the prices of almost all investments decline in a rising rate environment.
Life insurers, however, are an anomaly because they’ve been punished by low rates and need higher rates to thrive.
Insurers make their profits on the returns they earn on premiums received from policy holders. When rates are low, insurance company earnings suffer because the bonds they hold as investments offer only microscopic yields.
Earlier this year, for instance, the bellwether U.S. 10-year Treasury bond yielded about 1.6 per cent. With the growing prospect that the Fed will taper its bond buying, the yield reached more than 2.4 per cent Thursday. Life insurance companies typically hedge some of their exposure to low interest rates, but still tend to gain when yields rise.
Mr. Routledge said Treasury rates still aren’t at optimum levels for insurers, and need to rise to about 3.5 per cent to 4 per cent.
Banks, by contrast, don’t reap equally clear benefits from higher rates. If rates get too high, heavily indebted borrowers default, causing loan losses. But the banks stand to make money if the yield curve steepens, which happens when long term rates rise faster than short term rates. That will allow banks to borrow cheaply from depositors and gain more revenue from loans they make.
For the banks, it isn’t yet clear whether higher rates will be a boon or a bane, but for the moment, there is no doubt they’re good for life insurance companies.