Rising interest rates and bond returns may be a boon for investors in the insurance industry in the coming years, experts say. That’s because the sector’s heavy regulation requires insurance companies to invest conservatively to have funds available to pay claims.
Low returns from bonds and banks over the last decade as growth stocks skyrocketed meant insurance companies were stable but not cash cows, says David W. Barnett, principal of registered investment advisory Grand Arbor Advisors in Richland Hills, Texas. Most insurers invest at least 8 percent of their reserves in corporate bonds for guaranteed interest rates, for example.
“Insurance companies are famous for being dull and boring,” Barnett says. “It’s a good thing.”
The insurance companies that get in trouble are typically those that have some sort of aggressive or quirky ownership and make rapid acquisitions, he says.
[See: 8 Boring Stocks With Soaring Potential.]
In any market, insurance stocks often experience less volatility than others — if you choose carefully, Barnett says. “I would be comfortable with 100 percent [of my portfolio] in insurance if it was spread out [over several] subsectors. But that would be a very conservative portfolio overall,” Barnett says. “It won’t be quite as yield producing, but for what you lack in overall yield you make up for in greater stability.”
Plus, insurance companies tend to pay dividends — rather generous ones. Because they have risk limitations in how they can invest, insurers often raise capital by selling preferred stock that can yield up to a 7 percent dividend. “Insurance securities are often great for income investing and balanced strategies versus primarily capital appreciation strategies,” Barnett says. “Insurance companies are super long term in their view.”
The insurance sector isn’t without risk, of course. The economy and underwriting affect every type of insurance differently, whether life, annuity, property and casualty, long-term care or health. So before you start picking insurance stocks, experts have the following tips.
Know the insurance business. Regulations and other factors greatly affect how an insurance company performs, says Barnett, who before becoming a registered investment advisor spent 11 years as a senior executive of a national life and health insurance company. He says most insurance companies have little or no corporate debt, so analytics from traditional outlets such as Moody’s can be spotty. Instead, there are other nationally recognized statistical rating organizations, like A.M. Best Co., that specifically review insurance companies. Because the industry handles its accounting differently, an investor needs to do a special fundamental analysis.
[See: 7 of the Best Health Care Stocks to Buy for 2018.]
Diversify with different types of insurers. “Insurance is not a homogenous group: There are life insurers, property and casualty insurers, and reinsurers,” says Mark Armbruster, president of Armbruster Capital Management in Pittsford, New York. The nice thing about this variety is that different insurance stocks can help diversify one another since they are subject to different risks, he says. Life insurers could face significant losses if there is a pandemic but won’t necessarily be hurt by events that are significant for property and casualty insurers. Insurance is probably the most stable sector, because mortality tables and risk factors are clearly defined, Barnett adds.
Don’t settle for what only meets the eye. How an insurer underwrites policies affects its future viability, so it’s important for an investor to pick stocks after carefully looking at the insurer’s “book of business,” says Jim Holtzman, a financial advisor with Legend Financial Advisors in Pittsburgh. A long-term care insurer, for example, could experience lesser returns if it is heavily underwritten in New York, where nursing home costs are high compared to other parts of the country. If a property insurer is heavily invested in coastal areas, it may be more prone to losses.
Embrace smaller companies. The largest insurance stocks generally move with the overall stock market, Armbruster says, so adding only the largest insurers to a domestic stock portfolio may not offer much diversification.
The best values and opportunities for growth usually exist in small to medium-size insurers, Barnett says: “Don’t get focused on the big boys with familiar names because there’s a lot of other stuff out there that is going to be just as stable.”
Opt for an exchange-traded fund. There are many ways to invest directly in individual companies that are risk-reasonable, Barnett says, but you can hedge some of the risk exposure of individual insurance stocks by buying an ETF that tracks the sector.
The SPDR S&P Insurance ETF (ticker: KIE) trades at about $30.87, up from about $28.35 a year ago and $17.67 five years ago. Top holdings include Validus Holdings Ltd. ( VR), XL Group Ltd. ( XL), Everest Re Group Ltd. ( RE) and American Financial Group ( AFG).
[See: 7 ETFs to Buy as Interest Rates Rise.]
Trading at about $64.33, the iShares US Insurance ETF ( IAK) is up from $60.18 a year ago and $37.99 five years ago. Top holdings include Chubb Ltd. ( CB), American International Group Inc. ( AIG), MetLife ( MET) and Prudential Financial ( PRU).
More from U.S. News
8 Steps for Investing a Tax Refund
10 Investing Themes to Remember for 2018
7 Great ETFs for Millennial Investors
5 Pointers for Picking Insurance Stocks originally appeared on usnews.com
