Arguably, it is a vexing revelation to some, but insurance stocks and exchange traded funds that have eagerly waited for the Federal Reserve to raise interest rates could be stung by further strength for the dollar, potentially the result of higher rates.
A report out earlier this week from Sterne Agee argues that the combination of declining 10-year Treasury yields and the stronger greenback could be trouble for life insurance stocks, reports Clayton Browne for ValueWalk.
The Sterne Agee noted included ratings on shares of 14 life insurance providers, but just five buy ratings along with an underperform rating on Symetra Financial (NYSE: SYA). Symetra is minor holding in the iShares US Insurance ETF (NYSEArca: IAK), accounting for less than 0.4% of that ETF’s weight.
Still, the $132.9 million IAK has a large combined allocation to many of the life insurance providers Sterne Agee assigns a tepid neutral rating to. For example, American International Group (NYSE: AIG), Hartford Financial (NYSE: HIG), Lincoln National (NYSE: LNC), Assurant (NYSE: AIZ) and Principal Financial (NYSE: PFG) combine for 22% of IAK’s weight.
“The good news for life insurers is that credit spreads have widened out to close to historical average levels, with the Merrill Lynch Corporate Master yield at 3.16% implying spread versus the 10-Year at 115 bps, not too far away from the 30-year average of 122 bps. Because of this spread widening, new money yields (using the Corporate Master as a benchmark) are around 35 bps higher than they were in May 2013 when the 10-year last yielded 2.00%. Never mind the fact that the S&P 500 is also over 22% higher in the same period. Given this improving macro background, our Life Index has risen an impressive 47% since May 2013,” according to the Sterne Agee note posted by ValueWalk.
Although interest rates remaining low has weighed on insurance stocks and ETFs, the industry’s fundamentals are healthy and increased regulatory scrutiny has not triggered material changes to the industry’s business model.
In an August research note, S&P Capital IQ highlighted better matches between insurance companies’ assets and liabilities while noting “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 the research firm. [Low Interest Rates Crimp Insurance ETFs]
The $328.4 million SPDR KBW Insurance ETF (NYSEArca: KIE), an equal-weight ETF allocates 8% of its combined weight to Symetra, Hartford, Assurant and Lincoln National. While life insurers are the second-largest insurance sub-sector within KIE, the ETF’s 26.1% weight to that group is well below its nearly 36% allocation to property and casualty firms. [Differences Among Insurance ETFs]
While insurance ETFs may be able to fight off the ill effects of a strong dollar to some degree, there is no denying the combination of the a strong dollar and low interest rates is harmful. Interest rates plunged over the past 12 months while the PowerShares DB U.S. Dollar Index Bullish Fund (NYSEArca: UUP) surged 12.6%, but KIE and IAK posted an average gain of just 5.7% over that period.
SPDR S&P Insurance ETF