Zacks Investment Research | Sep 12, 2016 11:01PM ET
With another Federal Open Market Committee (FOMC) meeting scheduled between Sep 20 and Sep 21, the market is yet again optimistic about a rate hike, especially due to the favorable developments on the employment front in July and August.
As per the U.S. Bureau of Labor Statistics, unemployment rate remained unchanged at 4.9% over the last three months. Employment, on the other hand, increased in both July and August. In addition, inflation was below 2%. All such favorable economic conditions indicate the possibility of a rate hike.
Notably, the Fed reduced the median forecast for the number of rate hikes this year to two at its Mar 2016 meeting from four decided upon at its meeting last December. In fact, the Fed at the July meeting this year indicated at a possibility of only one hike. The Fed had last increased the interest rate in Dec 2015 to only 0.25–0.50%, which has remained unchanged ever since.
While the rate hike may be unfavorable for some sectors, the Insurance industry is among those that stand to benefit from the same. This is because investment income, which is directly proportional to interest rate, is an important component for insurers’ top line. Life insurers are poised to benefit the most in case of a rise in interest rate.
Higher rates should come as a respite for life insurers that suffered spread compression on products like fixed annuities and universal life due to sustained low rates. These insurers generate most of their earnings from the spread between investment returns and what they credit as interest on insurance policies and products. Hence, a higher interest rate yields more investment return for life insurers.
Insurers invest the premium they receive form policy holders in bonds and securities, which are reinvested in fixed-income securities upon maturity. Due to a sustained low interest rate, the reinvestment rates have also declined, in turn, hurting income. The potential rise in rates is therefore being viewed as a silver lining for the life insurance stocks. Annuity sales too should benefit from a higher rate environment.
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