Industry eyes opportunity to reinvest at higher yields and leave low rate era behind
Donald Trump may be just what the global insurance industry needs. Shares in several of the sector’s largest companies have outperformed the market strongly since the US election, on hopes that a prolonged squeeze on their returns is finally drawing to a close.
Years of ultra-low rates have eaten away at fixed income returns, hurting insurers as their business models require them to deploy policyholders’ premiums conservatively, usually through holding corporate and government bonds.
Now, they potentially have a lot to gain as financial markets reflect expectations of a US shift towards fiscal stimulus that is seen bolstering growth and sustaining a trend of higher interest rates.
“It takes away the feeling of your back being against the wall,” says Tod Nasser, chief investment officer at Pacific Life.
A jump in bond yields since the election earlier this month — along with the prospect of lighter financial regulation — have driven shares in the two biggest US-listed insurers by assets, MetLife and Prudential Financial, up about 18 per cent.
That has outpaced gains for several big US banks, and compares with a rise of less than 4 per cent in the benchmark S&P 500 index since Donald Trump became president-elect.
European insurers have also rallied — the UK’s Prudential by 19 per cent and France’s Axa by 14 per cent.
“The equity markets have gotten it exactly right,” says Michael Siegel, global head of insurance at Goldman Sachs Asset Management. “This industry is going to benefit from a gradual rise in interest rates.”
Insurers play a major role in world markets, with $24tn worth of investments — representing about 12 per cent of global financial assets, according to the International Monetary Fund.
A sustained trend of higher yields would finally enable the industry to reinvest funds from maturing bonds at more appetising levels. The multiyear bond bull market has been increasingly tough as insurers have had little choice but to buy at lower rates, effectively locking in weaker returns for years. About 15 per cent of US life insurers’ assets mature each year, estimates David Lomas, head of BlackRock’s global financial institutions group.
The benefits of higher yields would be felt by life insurers in particular. Their liabilities stretch out for decades, requiring them to invest for the long-term. The average duration of bonds they hold is about seven or eight years compared with three or four for their property and casualty counterparts.
Improved bond returns would make it easier for the life insurers to meet promises they have made in the past, and also make the pensions, savings and annuity products they offer more attractive to new consumers. “Life insurers naturally do better with higher rates,” says Nikhil Srinivasan, chief investment officer of Generali, the Italy-based insurer.
They would also make the industry more likely to resist the temptation of turning to higher-risk asset classes. Mark Snyder, managing director, global insurance solutions at JPMorgan Asset Management, says that while some types of higher-yielding investments “get a lot of press”, life insurers have so far avoided making substantial changes to their asset allocations. “If yields rise, they won’t have to,” he adds.
Despite the promise of reflationary economic policies, many in the industry are cautious. For a start, there are doubts about the incoming Trump administration and the president-elect’s pledge to unleash a $1tn economic stimulus package.
“You don’t really know which way Trump’s going to go,” says James Shuck, insurance analyst at UBS. “You need more certainty for the next leg up.”
Moreover, the companies’ investment portfolios will continue to feel the pinch from depressed yields for years to come. Strategists estimate that if bond prices remained unchanged, life insurers’ investment income would continue to fall for about another five years. “Better reinvestment rates will come through in a very phased fashion,” says Mr Shuck.
Equity valuations continue to reflect the lower-for-longer headache. MetLife and Prudential Financial trade at only about 80 per cent of the companies’ respective book values — a sign of investor pessimism.
The benchmark 10-year US government bond yield is now just shy of 2.4 per cent, up sharply from lows of 1.4 per cent touched in the summer. Yet it remains only just above the 2.3 per cent level at which it started the year.
Yields “are still dramatically below where they’ve been historically”, says Mr Siegel of Goldman. “If this is all the movement we get, it’s not a solution.”
Currently, falling bond prices reduces the value of existing assets held by insurers. For every 1 percentage point rise in interest rates, estimates Kurt Karl, Swiss Re’s chief economist, the value of the US property casualty industry’s fixed income assets falls by about $50bn.
However this is not as big problem as it might sound as unlike other investors, insurers tend to hold bonds until they mature, allowing them to withstand interim fluctuations in their value. “If you’re a hold-to-maturity investor, you don’t really suffer that mark-to-market swing,” Mr Lomas says.
Additional reporting by Robin Wigglesworth
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