Good for ↑
With the 10-year Treasury yield at 5.11%, pension funds must buy more long-term bonds, and life insurers earn a wider spread on annuities. Investors are dumping financial stocks without separating banks hurt by rates from insurers helped by them. Life insurers such as MetLife, Prudential and Corebridge stand to gain.
Source: Bloomberg ↗
Higher yields hurt banks through costlier deposits and credit losses. Life insurers and annuity sellers work the other way. They price annuities off long-term Treasury yields. At 5.11% on the 10-year, a level last seen in 2007, new premiums they invest earn far more. That widens the gap between what they promise customers and what they earn. Annuity sales also tend to jump at these yields, as savers lock in guaranteed income. Those premiums get invested at the high yields. Pension funds that match their bonds to future payouts must also buy more long-term bonds as yields rise. Rising yields usually lower stock valuations. But an insurer's embedded value, the present worth of its existing policies, tends to rise, because its assets earn more while its promises stay fixed. Investors selling financial stocks as one block miss this.
Investors believe rising yields are bad for financial stocks in general. They point to credit stress, pressure on banks to pay more for deposits, and paper losses on bond holdings. In their view, the financial sector fund should lag while rates stay high.
Why that may be wrong
The financial sector fund holds both banks, which higher rates hurt, and life insurers, which higher rates help. When investors sell the whole fund as rates rise, insurers get dragged down too. Treating all financials as hurt by rates misses that higher yields push these businesses in opposite directions, even under the same sector label.
The link breaks if yields rise so fast and so far that they cause a credit crisis or a recession. That could bring a wave of cancelled policies, credit losses on insurers' bonds, or a collapse in annuity demand as households struggle. Warning signs would be the extra yield on investment-grade company bonds rising above 150 basis points, or the VIX fear gauge jumping above 30. Either would mean higher rates have turned into wider financial stress.
If yields of 5% or more last long enough, insurers' bond holdings could show big paper losses, as regional banks' did in 2023 with SVB. That would shrink book value and draw regulators' attention to capital. The weakest assumption is that insurers' promises to customers run as long as their bonds. If customers cash out policies early to chase better yields, insurers may have to sell bonds at low prices. Watch quarterly reports from the big insurers for lapse and surrender rates, the share of customers dropping policies or cashing out annuities. A clear rise above normal would turn this from a gain for insurers into a cash squeeze.
The 2004-2006 rate increases are the closest match. As the Fed lifted rates from 1% to 5.25%, life insurer stocks clearly beat banks and the wider financial sector. MetLife (MET) and Prudential (PRU) saw their investment income catch up with their long-term promises. After stocks fell from their 2000 peak, with 10-year yields still near 5%, sales of fixed annuities climbed as savers fled stock swings for guaranteed income. When safe, guaranteed returns can compete with stocks, cautious money moves, and the insurers that take it in gain.
The 10-year Treasury yield reaches 5.11%, near a 20-year high. Investors sell financial stocks across the board on a blanket view that higher rates hurt financials, and the financial sector fund drops 2% in a week.
Life insurers and annuity sellers see the opposite effect. New premiums are invested at much higher yields, and annuity margins widen. Pension funds that match bonds to future payouts must buy more long-term bonds under their rules. Demand for what insurers sell grows just as investors sell insurer stocks.
Big US life insurers and fixed annuity sellers, which earn heavily from the spread on premiums, see the value of their policies and their return on equity rise if yields stay at 5% or more. Their shares are being sold alongside banks that rates hurt, so they may be valued too low for investors who tell the two apart. Required bond buying by pension funds also supports long-term Treasury prices. That limits how far yields can rise and lowers the risk of an extreme outcome for insurer stocks.
Earlier connections in the same sector that share a theme with this one.
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