Fed is likely to introduce harsher monetary policies from its May FOMC to combat mounting inflation, which is currently at its 40-year high. At present, skyrocketing inflation is the primary crisis in the global economy. The pandemic-led devastation of the global supply-chain system in the last two years is yet to be recovered. The prolonged war between Russia and Ukraine has made the situation worse.
Market participants have started factoring a higher interest rate in their financial models. Consequently, yields on U.S. government bonds of different maturities climbed recently. A likely shift in Fed policies toward a more hawkish stance is expected to benefit the insurance industry.
We have selected five insurance stocks with a favorable Zacks Rank likely to gain from a higher market interest rate. These are — Cincinnati Financial Corp. CINF, The Travelers Companies Inc. TRV, Arch Capital Group Ltd. ACGL, Fidelity National Financial Inc. FNF and American Financial Group Inc. AFG.
Spike in U.S. Sovereign Bond Yield
In its latest FOMC meeting in March, the central bank hiked the benchmark interest rate by 25 basis points for the first time in more than three years. On Apr 6, the Fed released the minutes of its March FOMC. Fed officials almost unanimously agreed that the central bank must reduce the size of its nearly $9 trillion balance sheet by around $95 per month starting from May.
A maximum of $60 billion in Treasury Notes and $35 billion in mortgage-backed securities would be allowed to roll off for three months. Moreover, the minutes revealed that most officials have agreed that the Fed must raise the interest rate by 50 basis points in the next two FOMC’s in May and June.
On Apr 5, Fed Governor Lael Brainard said that a steady increase in the benchmark interest rate and an aggressive balance sheet reduction is needed to bring back the price level. Fed Chairman Jerome Powell has already indicated that the central bank will not hesitate to take harsher measures if it fails to contain inflation.
As a result, the term structure of the U.S. government bond yield has stiffened recently. On Apr 8, the yields on the benchmark 10-Year U.S. Treasury Note jumped to 2.7%, its three-year high. The yield on the short-term 2-Year U.S. Treasury Note and long-term 30-Year U.S. Treasury Note closed at more than 2.5% and 2.72%, respectively.
In the last week of March, the yield between 5-Year and 30-Year Treasury Notes inverted for two days and the yield between 2-Year and 10-Year Treasury Notes inverted for a day. Yield curve inversion is often recognized as an indication of an upcoming recession.
Insurance Industry to Gain
A reduction in bond buying will push bond prices down. This will increase the yield to maturity of bonds. Higher bond yields will raise the market’s risk-free returns. A hike in risk-free market interest rate will raise the cost of funds, enabling the financial companies to widen the spread between longer-term assets, such as loans, with shorter-term liabilities, thus boosting the financial sector’s profit margins.
Insurance providers are generally compelled to hold lots of long-term safe bonds to back the policies that are written. A higher interest rate will benefit insurance companies. The spread between the longer-term assets and shorter-term liabilities will increase the spread of insurers. Moreover, the insurance industry’s profitability has risen historically during the period of rising interest rates.
Our Top Picks
We have narrowed our search to five large-cap (market capital > $10 billion) insurers that saw positive earnings estimate revisions within the last 60 days. Each of our picks carries either a Zacks Rank #1 (Strong Buy) or 2 (Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.
The chart below shows the price performan e of our five picks in the past three months.
Image Source: Zacks Investment Research
Cincinnati Financial continues to increase premiums through a disciplined expansion of Cincinnati Re while the division makes a nice contribution to its overall earnings. Price increases and a higher level of insured exposures are the other positives.
Cincinnati Financial is focused on earning new businesses by appointing new agencies and believes that an agent-focused business model will drive long-term premium growth. CINF boasts a solid capital position based on which it has returned value to its shareholders. Favorable reserve release should drive growth for Cincinnati Financial. Consistent cash flow and sufficient cash balances will continue to boost liquidity.
The Zacks Consensus Estimate for current-year earnings of the Zacks Rank #1 CINF has improved 5.7% over the last 60 days.
The Travelers Companies boasts a strong market presence in auto, homeowners’ insurance, and commercial U.S. property-casualty insurance with solid inorganic growth. A high retention rate, increase in new business and positive renewal premium change bode well. TRV’s commercial businesses should perform well, owing to market stability.
The Travelers Companies remains optimistic about the personal line of business, given growth at the profitable agency auto and homeowners business. TRV expects net investment income from non-fixed income portfolio to be $430 million to $440 million quarterly in 2022. Sufficient capital boosts shareholder value.
The Zacks Consensus Estimate for current-year earnings of the Zacks Rank #2 TRV has improved 0.3% over the last 30 days.
Arch Capital boasts a strong product portfolio and has been maintaining an exemplary track record of premium growth. Premiums should benefit ACGL from new business opportunities; rate increases, growth in existing accounts and growth in Australian single premium mortgage insurance.
This apart, Arch Capital has been diversifying its Mortgage Insurance business via strategic acquisitions that complement the strength in the specialty insurance and reinsurance businesses. A solid capital position shields ACGL from market volatility. It effectively deploys capital to pursue growth initiatives. Strategic buyouts strengthen the portfolio of Arch Capital and offer geographic diversification.
The Zacks Consensus Estimate for current-year earnings of the Zacks Rank #2 ACGL has improved 0.2% over the last 30 days.
Fidelity National Financial is one of the nation’s largest title insurance companies through its title insurance underwriters. Fidelity National Financial also provides flood insurance, personal lines insurance and home warranty insurance through its specialty insurance business.
Fidelity National Financial is a leading provider of outsourced claims management services to large corporate and public sector entities through its minority-owned subsidiary, Sedgwick CMS.
The Zacks Consensus Estimate for current-year earnings of the Zacks Rank #2 FNF has improved 3.2% over the last 30 days.
American Financial Group is an insurance holding company, which provides specialty property and casualty insurance products in the United States. AFG is actively involved in startups, small-to-medium sized-acquisitions, and product launches.
Better industry fundamentals, a high renewal ratio, and a favorable combined ratio should drive growth. A solid capital position enables American Financial Group to deploy capital effectively. Consistent price increase in property and casualty business should favor results. AFG boasts impressive inorganic growth and is prudently investing in businesses.
The Zacks Consensus Estimate for current-year earnings of the Zacks Rank #2 AFG has improved 3.3% over the last 60 days.
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The Travelers Companies, Inc. (TRV) : Free Stock Analysis Report
Cincinnati Financial Corporation (CINF) : Free Stock Analysis Report
American Financial Group, Inc. (AFG) : Free Stock Analysis Report
Fidelity National Financial, Inc. (FNF) : Free Stock Analysis Report
Arch Capital Group Ltd. (ACGL) : Free Stock Analysis Report
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