Funding conditions and insurance stock returns: Do insurance stocks really benefit from rising interest rate regimes?

• Author: Tyler K. Jensen,Robert R. Johnson,Michael J. McNamara
• Published date: 01 December 2019
• DOI: http://doi.org/10.1111/rmir.12133
• Date: 01 December 2019

© 2019 The American Risk and Insurance Association

Risk Manag Insur Rev. 2019;22:367–391. wileyonlinelibrary.com/journal/rmir

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367

DOI: 10.1111/rmir.12133

FEATURE ARTICLE

Funding conditions and insurance stock

returns: Do insurance stocks really benefit

from rising interest rate regimes?

Tyler K. Jensen

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Robert R. Johnson

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Michael J. McNamara

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1

Ivy College of Business, Iowa State

University, Ames, Iowa

2

Heider College of Business, Creighton

University, Omaha, Nebraska

3

Carson College of Business, Washington

State University, Pullman, Washington

Correspondence

Michael J. McNamara, Carson College of

Business, Washington State University,

Pullman 99164‐4746, Washington.

Email: MJMcNam@wsu.edu

Abstract

We examine funding conditions and U.S. insurance

company stock returns. Although constrained funding

conditions, signaled by restrictive Federal Reserve monetary

policy, correspond with increases in the future payouts of

fixed‐income securities held by insurance firms and

potentially provide value through the liability side of insurer

balance sheets, they also decrease the values of securities

currently held in insurer portfolios. Prior research finds that

restrictive policy has a negative effect on equity returns in

general. Our results suggest the negative impacts of

constrained funding environments outweigh the potential

positives, as insurance company stock returns are signifi-

cantly lower during periods of constrained funding. This

effect varies within a given funding state and also across

insurer type. The effect is strongest during the first 3 months

of a constrained funding environment and for life and

health insurers—insurer types with longer portfolio dura-

tions. For property and liability (P&L) insurers, lower stock

return performance only exists in the first 3 months of a

constrained funding environment. In the subsequent

months, P&L insurers actually have higher stock returns

during constrained periods, consistent with their typically

shorter duration asset portfolios, which are more quickly

rolled over into new higher‐yielding securities.

KEYWORDS

funding conditions, insurer, stock returns

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INTRODUCTION

The recent unprecedented low interest rate environment has focused attention on the Federal

Reserve (the Fed) and whether the nation’s central bank will increase interest rates, and if so,

when. When potential beneficiaries of a rate hike are discussed, insurance companies in general

and life insurance companies in particular, are often highlighted. While there is some evidence

that rate hikes (or higher levels of interest rates more generally) may be beneficial for certain

aspects of insurance company balance sheets, we believe that further empirical study of how

this association is manifested in stock returns is needed.

Several studies document that monetary policy (or the funding conditions it signals) is

associated with how investors price stocks, as well as certain firm characteristics or risk

factors (Brunnermeier & Pedersen, 2009; Garcia‐Feijoo, Jensen, & Jensen, 2018; Jensen,

Mercer, & Johnson, 1996; Jensen & Moorman, 2010; Patelis, 1997; Thorbecke, 1997). In a

comprehensive analysis, Johnson et al. (2015, 2016) found the broad stock market

performed markedly better over the long term during expansive Fed monetary policy

periods than during restrictive periods.

1

Given the importance of funding conditions in influencing stock returns, it is important

to assess whether certain types of firms are particularly sensitive to changes in the funding

environment. Thorbecke (1997) documents that shifts in funding availability are

particularly impactful for small firms, while Brunnermeier and Pedersen (2009) and

Jensen and Moorman (2010) identify an association between firm‐level illiquidity and

aggregate funding availability. More directly related to our study, Johnson et al. (2015)

find significant differences in the long‐term performance of various stock market sectors

across different states of Fed policy. Similar to Garcia‐Feijoo et al. (2018), in our paper, we

use directional changes in Fed policy to indicate states of funding conditions. In

particular, the first restrictive (expansive) Fed policy action initiates a period of

constrained (unconstrained) funding conditions.

2

Given that the holdings of insurance companies typically include a high percentage of fixed‐

income securities, there is a direct connection between Fed interest rate policies and the asset

side of insurer balance sheets. However, most financial press suggests that this association runs

in a singular direction. Recently, a number of sources (e.g., Business Insurance,Yahoo Finance,

Fortune,Market Realist, and Investopedia) posited that insurance company stocks would benefit

from a Fed rate hike.

3

The intuition is that rising interest rates provide increased future income

from the fixed‐income securities purchased by these insurers.

This theory, however, discounts that rising interest rates also put downward pressure

on the value of fixed‐income securities currently held. Furthermore, given the extended

nature of their liabilities, insurance companies are typically “cradle‐to‐grave”bond

investors. Life insurers, in particular, have especially long‐duration portfolios (Becker &

Ivashina, 2015). Because of this practice, increased income from rising interest rates is

1

For an overview of monetary policy in financial applications, see Kidwell et al. (2016).

2

We provide a more formal definition of our funding conditions variable in Section 2.

3

For example: “…an interest rate increase helps insurers ‘in terms of being able to invest their portfolio and achieve higher yield on their new monies that

they’re putting into work and the markets’”—Shachar Gonen, vice president and senior analyst Moody’s, Lenihan (2017), Business Insurance, February 28,

2017. “Life insurance companies are eagerly waiting for the Fed to start raising interest rates. The life insurance sector is a direct beneficiary of a rise ininterest

rates.”—Keats (2015), Market Realist, June 1, 2015. “The long suffering for insurers seems to be finally over […] the insurance industry is one of those sectors

that stands to gain from higher interest rates.”—Yahoo Finance, December 28, 2016. “Insurance stocks, especially, tend to flourish as rates rise”—Andrew

Bloomenthal, Investopedia, May 15, 2014.

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