December 13, 2021
In the current investment climate, investors have a variety of competing factors to consider when making investment decisions. One market factor that’s become reality is the rise in interest rates.
At the start of the pandemic, central banks around the world lowered interest rates to mitigate the impacts of slower economic growth, triggering record lows in 10-year U.S. Treasury yields. Now, Treasury yields are at last starting their rebound in response to economic re-openings and whispers of interest rate hikes in 2022 and beyond. This has created a new tilt in the investment environment, prompting investors to search for solutions that can not only navigate, but capitalize on rising rate scenarios.
One compelling solution is life insurance companies. Let’s look at three key reasons to consider investing in the life insurance sector as interest rates rise through the lens of our CI U.S. & Canada Lifeco Income ETF (TSX:FLI).
Unlike most sectors, life insurance companies are positively correlated to interest rate movements. One reason is that insurers often reinvest policyholder premiums into bond instruments, allowing them to profit when Treasury yields increase. To demonstrate, the below chart highlights key historical timelines when yields have risen. In Canada, the average life insurance company generated returns of 19% when Bank of Canada 10-year bond yields increased (an average of 81 bps).
And U.S. life insurance companies generated returns of 27% on average when U.S. Treasury 10-year yields increased (an average of 108 bps).
Average LifeCo Return: Top 10 largest North American life insurance companies, as measured by market capitalization, as of October 31, 2021, have been used for calculation purposes.
Canada: Great West Life, Manulife and Sun Life.
U.S.: Lincoln National, Principal Financial, MetLife, Globe Life, Unum Group, Prudential Financial and Aflac.
Source: Morningstar Direct and Bank of Canada, as of October 31, 2021
When most Canadians think of sound and reliable stocks, they immediately look to the banks. But the popularity of bank stocks for their stable returns also makes them more expensive on a relative basis. Over the last five years, insurers have looked increasingly more attractive next to Canadian banks, which currently trade at a 38% premium over FLI.
Plus, higher interest rates can have a positive impact on both banks and life insurance companies. This presents a unique opportunity for investors to benefit from rising interest rates through exposure to a discounted insurance sector instead of the big banks.
FLI is made up of an equally weighted portfolio of the 10 largest Canadian and U.S. life insurers for exposure to companies with strong market shares and yield potential. So far in 2021, the life insurance sector has outperformed the broader equity market while trading at near historic lows. In the third quarter of 2021, the sector was trading at a 62% discount to the S&P 500 Index, a 47% discount to the financials sector and a 13% discount to its own 5-year average.
FLI also has the added benefit of using a covered call strategy which can provide smoother risk-adjusted returns. As part of our covered call strategy, a call option is written on up to 25% of the portfolio to generate income and help reduce volatility. Meanwhile, the remaining 75% is exposed to upside growth potential for enhanced yield versus the fund’s benchmark.
After decades of declining interest rates, their rise has become a reality. Through income generation, attractive valuations and improving growth potential, exposure to life insurance companies through FLI could be an effective way for investors to benefit from rising interest rates.
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Published August 4, 2022