With many market participants expecting the Federal Reserve to reveal its first interest rate increase of 2017 today, it is not surprising that financial services stocks and exchange traded funds are getting plenty of attention.
Within the financial sector, the second-largest sector allocation in the S&P 500, some groups are more correlated to rising rates than others. Among the potential winners in a rising rates environment are insurance stocks and ETFs such as the SPDR S&P Insurance ETF (NYSEArca: KIE).
Since the insurance industry largely targets the domestic economy, a strengthening U.S. dollar will have a lower impact on the sector. Insurance ETFs, sensitive to Treasury yield gyrations in their own regard, are often responsive to rising bond yields. Among industry ETFs that respond positively to rising Treasury yields, perhaps only regional bank funds have been more desperate for rising rates than insurance ETFs.
A rising rate environment may reflect a strengthening U.S. economy, and a healthier economy would help borrowers have an easier time repaying loans, with banks stuck with fewer non-performing assets.
Moreover, rising rates means that banks will generate greater revenue from the spread between what they pay deposit savers and the prime rates they charge credit-worthy clients and other highly-rated debt.
“Insurance companies typically hold large amounts of cash to back the policies they write. As such, the investments insurance companies own are typically ultra-safe, meaning bonds. Therefore, when interest rates are low, bonds owned by insurance providers typically sport low yields, limiting the income stream,” reports Investopedia. “The bottom line is that an insurance company makes money off the spread between what is owed to policyholders and the profit yielded by its bond investments. Higher interest rates usually increase that spread in the insurance industry’s favor.”
Competitors to KIE include the iShares US Insurance ETF (NYSEArca: IAK), PowerShares KBW Property & Casualty Insurance Portfolio (NYSEArca: KBWP) and >PowerShares KBW Insurance Portfolio (NYSEArca: KBWI).
Although it took insurance stocks awhile to get going in the current bull market, KIE has been one of the best-performing ETFs since March 2009, returning an average annualized return of 27.2% since 2009.
Many many think of KIE as an outstanding play, but the insurance ETF has been enjoying a streak of record runs, especially in recent months, with a notable spike after President Donald Trump’s election day win.
For more information on the insurance industry, visit our insurance category.