How Do Changes In Interest Rates Impact Travelers’ Earnings And Valuation?

by Trefis Team
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To understand how the Fed’s rate hike process directly impacts the financial performance of the insurance companies, we have created a series of interactive models that quantify the gains or losses in the insurer’s revenues and profits based on whether or not the Fed follows through on its plan to hike interest rates three times in 2018. This article captures the impact on The Travelers (NYSE: TRV). You can access our interactive model for TRV here. You can modify assumptions such as investable assets, premiums and other income, earnings margin, P/E multiple and others to see how sensitive TRV’s shares are to the Fed’s rate hikes.

The analysis above assumes that each 25 basis point (0.25%) rate hike by the Federal Reserve results in a 5 basis point (0.05%) increase in investment yield for TRV, which represents a sensitivity factor for the insurer’s investment yield figure of 20% (5/25).

Think the sensitivity factor, or other figures that are a part of our estimates are off? You can create your own estimates by changing the inputs in our interactive model.

Why Does The Pace Of The Fed’s Rate Hike Process Matter To Insurers?

Interest rates play an important role in determining the profitability of insurance companies. This is because the companies invest the premiums they get from policyholders, primarily in fixed income securities. Yields on fixed income securities – such as corporate and municipal bonds, and loans – are largely dependent on the prevailing interest rate environment. Accordingly, changes in interest rates can have a substantial impact on insurance companies’ investment yields, and in turn their earnings. The U.S. insurance sector has seen a notable improvement in investment income over the last few quarters, as the Federal Reserve has stuck to its plan of raising benchmark interest rates at least three times each year over 2017-19 as of now. The Fed laid out its rate hike plan in late 2016, and given the positive outlook for the U.S. economy, there is little reason to believe that benchmark rates will not be raised three times again in 2018. This bodes well for insurers moving forward.

However, the Federal Reserve keenly monitors key economic metrics including the growth rate, unemployment rate, and inflation and ensures that they are at acceptable levels before each interest rate hike. Therefore, any unexpected macroeconomic events could potentially derail the rate hike process. While the Fed’s decision to delay any rate hikes will affect all industries, the country’s insurance sector would be significantly hurt. This was already seen post-recession, when low interest rates eroded profits across the insurance space.

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