The insurance industry is still reaping the rewards of higher investment yields, although the effect is gradually diminishing, analysts at RBC Capital Markets have highlighted in a recent report.
Property and casualty (P&C) insurers typically invest in short-term, high-quality investment portfolios like corporate bonds, Treasuries and other highly-rated fixed income instruments.
As a result, the investment income component of return on equities (ROE) is predominantly linked to somewhat comparatively shorter-dated market investment yields (an average maturity in the 3-5 year range) compared to life insurers who may have durations in the 7-8 year range.
Prior to the US Federal Reserve’s recent rate hikes, P&C insurers deliberately maintained short portfolio durations to take advantage of potential rate increases.
This tactic has paid off, analysts highlighted, with many P&C insurers now enjoying higher yields on new money yields compared to exiting book yields.
Although interest rates have dipped lately, they’re still high enough for Property & Casualty insurers to make a good profit from their fixed income investments. This is because they’re reinvesting their assets to take advantage of the higher rates.
Besides net investment income (NII), premium growth has also stayed healthy and that has boosted invested asset Levels, the report noted.
According to industry analysts, new money yields are currently 50 to 100 basis points above expiring yields for most covered companies. RBC Capital Markets continues to expect ROEs to be lifted by NII going into 2025.
“We expect NII should remain a nice contributor to EPS and RBC P&C coverage investment allocations mid-year 2024 ROEs in 2025 albeit with a slower growth rate than the previous two years. Even still, most carriers’ investment leverage levels are running at least in the 2x-3x range, capitalizing on higher yields and amplifying investment returns,” analysts stated.
Higher interest rates in recent years has led to negative bond marks on P&C insurer balance sheets due to unrealized losses in 2023.
Analysts continued: “In 2024, as the Fed started its rate reduction cycle, the AOCI drag on
book value has been reduced as well. We expect AOCI losses to amortize back into results over time as most insurers hold bonds to maturity, providing a tailwind to BVPS. We would note that some of the NII impact thus far has been on companies holding higher cash/short- term investments balances.”
RBC Capital Markets concluded: “We observed some signs of improvement in the alternative investment areas, and we would expect better results in 2025 based on recent trends. However, we would note that returns for many alt investments are still tracking below targeted return targets. Another thing to point out is that most P&C insurers have a very well-diversified portfolio and exposure to CRE is limited in most cases.”
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