There are scores of asset classes and sectors that are sensitive to fluctuations in U.S interest rates. As displayed by master limited partnerships (MLPs), real estate investment trusts (REITs) and the utilities sector this year, some favored groups obviously benefit from lower rates.
There are also groups that have languished due to this year’s 19.6% slide by 10-year Treasury yields. Among those sub-sectors are insurance providers, but that does not mean investors should throw in the towel on property and casualty names.
“Against this backdrop of a softening of rate adequacy (at least for some insurers) and an increase in weather losses (that might not be covered by reinsurance and thus would impact insurers’ profitability) , many investors may be wondering if there is any more room for further premium pricing improvement in the broader property-casualty underwriting arena. The answer is: it depends,” said S&P Capital IQ in a new research note.
The iShares U.S. Insurance ETF (NYSEArca: IAK) is up just 1.3% this year while the PowerShares KBW Property & Casualty Insurance Portfolio (NYSEArca: KBWP) is higher by a third of a percent. Still, S&P Capital IQ has overweight ratings on both ETFs and a positive view of the broader property and casualty group.
That positive outlook is “largely because we believe the industry’s fundamentals remain fairly healthy. Moreover, most segments of this industry have emerged from the credit crisis relatively unscathed, from both a financial and a regulatory standpoint. Although they now have a degree of federal regulatory oversight, most insurers have seen little to no change in their business models. Finally, while this period of prolonged low interest rates has crimped investment income growth for all insurers, we note that the property-casualty industry has a better “match” between their assets and liabilities since they are able to reprice their policies every six to 12 months,” said the research firm.
The $129 million IAK is home to some of the most familiar insurance names with the ETF allocating nearly 38% of its combined weight to American International Group (NYSE: AIG), MetLife (NYSE: MET), Prudential and Dow component Travelers (NYSE: TRV).
As AIG has emerged from being a ward of the U.S. Treasury Department, the shares have surged 56% in the past two years and have become a beloved hedge fund long position in the process. [Why Some Analysts Like Insurance ETFs]
Travelers, the twelfth-largest member of the Dow, recently reported “second quarter after-tax operating income of $673 million, down 18% from the $816 million it reported in the second quarter of 2013. The company has been using its excess capital to buy back shares, a trend that continued in the second quarter of 2014. Thanks to a buyback-driven 9% decline in share count, Travelers posted operating earnings of $1.93 a share for the quarter, down 9% from $2.13 a share in the second quarter of 2013,” notes S&P Capital IQ.
IAK has a 46% weight to property and casualty stocks. As its name implies, KBWP is entirely focused on property and casualty stocks, which could prove to be a positive trait as more Americans pass on getting life insurance. Traditional life insurance companies are losing ground to mutual funds and 401(k)s as Americans turned to the markets to accumulate enough money for retirement. [Americans Passing on Life Insurance]
KBWP’s top-10 holdings, a group that combines for about 60% of the ETF’s weight, include Allstate (NYSE: ALL), Travelers, Progressive (NYSE: PGR) and Chubb (NYSE: CB). The exclusive focus on property and casualty insurers keeps KBWP from being large-cap heavy as mid- and small-cap value stocks combine for nearly three-quarters of the fund’s weight.
“Insurers grow premium revenues in two ways: through rate increases and through exposure growth. While rates for many lines of coverage have started to trend upward, the other variable in the market cycle equation is exposure growth (i.e., the ability to expand or write new business). This will depend to a large degree on the rebound in economic activity. Many insurers in our coverage universe have held the line on pricing and have achieved rate increases. For some, however, the offset has been a decline in retention levels. During 2013, retention levels varied rather widely among carriers. Some of this is intentional: as firms seek to manage their risk profile and businesses, they may let certain business go,” said S&P Capital IQ.
PowerShares KBW Property & Casualty Insurance Portfolio
