Top-Down Macro, Bottom-Up Impact: Insurance EPS Upside as Rising Rates Lift Investment Income

Looking back to the beginning of 2022, just prior to the onset of rising rates, the maturity profiles of insurance companies’ fixed income portfolios varied meaningfully. The variation in the level of securities scheduled to mature mattered. Companies with high levels of maturities over the next year—as interest rates rose from near zero to today’s range of 5.0% to 5.25 %—were able to boost their fixed income portfolio yields and investment income by reinvesting maturing securities into higher rates.

A new FactSet template enables users to select multiple companies and compare fixed income maturity profiles at the group level. Identifying differences in maturity profiles helps identify which companies were positioned to benefit—or not—from higher investment income attributed to the most aggressive pace of rate hikes since Paul Volcker was Fed Chairman 40 years ago.

Top-Down Macro: Rising Rates

In March 2021 inflation began a two-year upward thrust that pushed one gauge of inflation, the consumer price index (CPI), to levels not seen since Michael Jackson’s Thriller topped the music charts over 40 years ago. This historic rise in inflation began with small, irregular pick-ups in the YOY CPI compared to the small, regular increases previously. By summer 2021, the YOY increases in prices had nearly doubled, and by fall, they had more than tripled.

Despite the upticks, The Fed did not raise rates. The reason was that price increases were attributed to transitory factors, such as labor shortages and disruptions in supply chains. The prevailing view was those factors would eventually correct as the global economy worked through pandemic-related challenges. There was also a very real concern that an increase in rates posed a greater threat to the recovering US economy than a bout of transitory inflation.

As transitory factors proved more persistent than expected and pushed the CPI higher, the hesitation about raising rates ended abruptly. Pivoting from the years-long, near-zero interest rate environment to which the investment world had grown accustomed, the central bank began a succession of rate increases: 25bps in March, 50bps in April, and 75bps in May. Despite the first three hikes, the CPI YOY increases reached a 41-year high of 9.1% in June 2022.

Top-Down Macro: Implications of Rising Interest Rates

Life insurance companies were well positioned to benefit from the Fed’s tightening monetary policy and rising interest rates over the last year. The reason is their investment total portfolios include a high percentage of fixed income securities, which are owned to generate steady, predictable levels of investment income to help pay policy claims. As lower-yielding securities in the fixed income portfolio mature, firms can reinvest the proceeds at higher interest rates and increase total investment income.

Figure 1 below shows the increase in yields over the last year across the curve. The most dramatic shift has been in the short end. The pick-up in US Treasury yields compared to a year ago for shorter-dated maturities (less than two years) is about 400bps, while the pick-up in yields for longer-dated Treasuries (greater than 10 years) is less than 100bps.

At the beginning of 2022, insurance companies that held fixed income securities maturing over the next year very likely reinvested at higher rates across the curve. The fact that rising rates is a positive for life insurance companies is a glimmer of good news amidst the challenges that higher rates have imposed on growth stocks, home sales, and lending, for example.

Figure 1: YOY Increase in Yields

Source: Markets Markets Overview - FactSet workstation

Note: As rates rise, the decline in value of fixed income securities is generally reported as an unrealized loss given insurance companies often classify fixed income securities as held to maturity. As bonds mature, the unrealized loss is reduced to zero (FASB 115). This is one reason insurance companies are often valued based on book value that excludes unrealized gains and losses (BV x FASB 115).

Bottom-Up Fundamentals: Investment Income

Investment income is a crucial factor that helps determine a life insurance company’s net income. Derived from AM Best’s Aggregate & Average dataset (now standard on the FactSet workstation), Table 1 below shows the split between net underwriting income and net investment income for the life insurance industry over the last five years. The highlighted data show the relative importance that investment income plays in the profitability of that industry.

Table 1: Investment Income Has Been an Important Contributor to the Life Insurance Industry’s Net Income Over the Past Four Years

Source: FactSet

Which Insurance Companies Have Benefited from Maturing Bond Portfolios?

The data in Table 2 below shows the maturity profile of life, annuity, and accident groups for several insurance companies as of year-end 2021. We created the table with a new template in the FactSet template library. The red cells highlight the percentages of securities in the fixed income portfolio that were scheduled to mature in 2022 as the Fed hiked rates.

The FactSet template shows MetLife had the highest percentage of bonds scheduled to mature over the next year compared to the other companies. This is important, as MetLife’s higher level of fixed income maturities allows the company to reinvest maturing securities into the rising interest rate environment—and boost overall investment yields and investment income.

Table 2: Maturity Profiles for Select Insurance Companies as of Year-End 2021

Source: FactSet

Behind the Data

Our template is derived from data in the statutory summary investment schedule for the life, annuity, and accident groups for each company. Figure 2 below shows where to locate the data in the workstation:

1. Enter the group’s entity ID
2. Select the summary investment schedule within the statutory statement menu
3. Locate the specific data in the quality/maturity tab.

Percentages for each maturity band shown in the template are calculated with a code that pulls totals for each bond type within a maturity band, and then divides individual maturity totals by the portfolio total.

Figure 2: Steps to Access Statutory Summary Investment Schedule Data in the FactSet Workstation

Source: FactSet

Table 3 below shows overall portfolio yields—not just fixed income portfolios—the companies in Table 2 earned. Note the overall portfolio yields in the table increased at a double-digit pace in 2022, despite a downward trend in other markets, including equities. Companies with a high level of maturing, fixed income securities—such as MET—had the ability to offset lower yields in other asset class portfolios with rising fixed income portfolio yields, which contributed to increasing overall yields.

Table 3: Portfolio Yields for Select Insurance Companies

Source: FactSet

Pulling it Together

The combination of rising rates and maturing fixed income securities in 2022 provided certain insurance companies—those with higher levels of maturities—with an outsized opportunity to reinvest maturing securities into a rising interest rate environment. The resulting rise in the yield on fixed income portfolios contributed positively to overall investment yields, which likely helped offset lower yields earned on other asset classes during a period of general market decline (Figure 3).

Figure 3: S&P 500 Averages March 1, 2022, to February 28, 2023

Source: FactSet

This blog post is for informational purposes only. The information contained in this blog post is not legal, tax, or investment advice. FactSet does not endorse or recommend any investments and assumes no liability for any consequence relating directly or indirectly to any action or inaction taken based on the information contained in this article.