A taper test for struggling insurers

Easy monetary policy is distorting the relationship between US Treasury yields and insurance stocks. The taper will see yields spike – which may push insurers lower still.

Recent trading history suggests domestic insurers want US Treasury yields to be lower. Since the non-taper of September, the US government shutdown and debt ceiling dramas have stirred the yield on the 10-year US Treasury note marginally higher, and the resulting higher interest rates available for insurers have pushed their share prices down. And all of this is taking place despite higher rates equating to higher investment earnings for insurers.

Historically speaking, financials prefer higher interest rates so they can make a healthier margin and, in turn, profit. Higher rates on debt securities give insurers a better return on their idle funds, which can be passed on to investors. But easy monetary policy, which is being used to manipulate benchmark yields, is distorting the investment norms of old.

The medium-term view on insurers really comes down to the actual execution of the much talked about taper of the $US85 trillion ($90.04 trillion) a month bond-buying program. Once tapering is announced, yields (pink line, graph below) will move higher, possibly resulting in share prices of insurers (green line) heading towards even lower ground if this recent trend is anything to go by.

Graph for A taper test for struggling insurers

Source: Bloomberg

The main insurance-only players in Australia are Insurance Australia Group and QBE Insurance Group – both very different companies. Suncorp Group and AMP are also significantly tilted towards insurance but can offset insurer-specific exposures through their other businesses.

QBE seems to have investors clearly divided – it is either a love or hate relationship due to its torrid past few years, marked by both disappointment and joy alike.

IAG on the other hand has managed to double its share price in less than two years, and continues to deliver the goods when it comes to improving margins. Reporting season showed that IAG is perhaps a touch more conservative than its cohorts, especially with regard to natural liability allowances – something QBE has been caught out on before.

QBE has bounced 41 per cent from its December lows, but still has plenty of work ahead. This year’s gains have been spurred on by higher interest rates and a weaker Australian dollar. But the US hurricane season is yet to come, which could impact earnings if it is a particularly treacherous one.

On the investor front, focus should be on the underlying earnings momentum which has evaded QBE in recent times and led to its disappointing earnings results. 

For now, the ongoing performance of IAG, QBE and the broader insurance sector will be largely determined by the yield on the US 10-year Treasury note.