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How Does a Fed Rate Hike Impact the Insurance Sector?

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Nov. 27 2015, Updated 2:05 a.m. ET

Performance of insurance stocks ahead of the Fed meeting

Life insurance companies are eagerly waiting for the Federal Reserve to start raising interest rates. The insurance sector is a direct beneficiary of a rise in interest rates. In 2013, life insurance stocks within the Financial Sector Select SPDR ETF (XLF) surged 59% when ten-year Treasury Yields rose from 1.76% to 3.03%.

In the trailing five-day period ended November 20, these stocks generated average returns of 3.0%. Genworth Financial (GNW) and Assurant (AIZ) were the clear outperformers, rallying 8.1% and 5.0%, respectively. Allstate Corp (ALL) gained the least, at 1.5%, followed by Hartford Financial Services (HIG), which gained  1.9%.

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Margin pressures

Interest rate movement is a key performance driver for life insurance companies, affecting their margins, hedging costs, and product sales. Low interest rates directly affect margins of insurers as they price their products using the expected long-term average rates.

Rising interest rates are beneficial for life insurance companies because they derive investment income from investing premiums in corporate and government bonds. Yields and coupons on these bonds rise in response to an increase in the federal funds rates and bank interest rates. This enables life insurers to invest their premiums at higher yields, earning higher investment income and increasing their profit margins. Margin pressures on life insurers have eased somewhat.

The Federal Reserve is a data-driven team, and a positive trajectory in indicators could result in a rate increase. Whether this occurs in December or later remains to be seen. The way forward is a rising yield curve, which can translate to greater profitability for life insurers.

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