Every time people talk about the Fed interest rates increasing, the market freaks out. Everyone understands just how much of an impact an increase in the interest rates could really affect the markets. Yet, despite everyone overreacting to the possibility of an increase, many people are missing the effects of our current low interest rates. Companies that make money on interest are being hammered. These include the obvious financial sector and the less obvious insurance sector. This is especially true in the life insurance sector.
Why is this more true in the life insurance sector? For a more thorough explanation on the effects of rates on life insurance companies, check out the National Association of Insurance Commissioners' explanation of the effects. To put it simply, life insurance companies invest the vast majority of their assets into fixed-income securities. When these rates are lower, the companies are not able to make as much money off investing these premiums. This leads to a few choices for companies like MetLife (NYSE:MET), none of which are good: a) Increase premium rates to cover the lack of compounding accrued value; b) Decrease the benefit of policies; or c) Take serious losses on its income statement. None of these sound very appealing for a life insurance company. The first two will lose customers (and in turn long-term profits), and the third will lose money.
Yet, despite the consistently low interest rates that should be hurting MetLife, according to Zacks Investment Research, the its EPS is supposed to grow 17 cents over the last quarter. However, when a company like MetLife collects a premium, it immediately invests it in bonds that are based off the current interest rates. Therefore, while it may have been receiving more favorable rates in the past, this is not true today. In addition, for the first few quarters of low rates, MetLife was more able to compensate for this loss of return potential with its past investments, which were keeping the average return fairly favorable. Unfortunately, this QE reality we now live in has persisted way longer than any insurance company can sustain.
Yet, despite this decreased ability to invest its premiums in a lucrative fashion, the company's earnings are supposed to increase... seems hard to imagine. As its earnings have fallen, the stock price has not reflected this to the proper degree. As the chart above shows, MetLife's earnings have lowered significantly in comparison to its stock price. Maybe there is some forward hope that everyone is relying on? I believe there is. However, it won't manifest as early as we hope.
For those who already own MetLife, I believe you should get out. The potential earnings increase is overstated for this quarter. Due to the effects of the persistent low rates, the company's earnings will stay as low as they have fallen, and possibly even lower. I think when earnings are released, we will see a drop in the stock price. However, while I don't think investors should hold MetLife through the earnings release, I would recommend buying it after.
Despite this, however, I see some serious long-term potential. With the consistent possibility of a rate hike, we can expect a jump in stock price when it is finally announced. While many are skeptical, recent remarks of Fed officials and the general sentiment of our economy make it likely. When this happens, it will alleviate many problems associated with low interest rates, and hopefully, help the company's income statements hugely.
In addition, earlier this week, MetLife managed to shed its "too big to fail" distinction, which is great for the company. This distinction was hurting its balance sheets by forcing it to have a certain amounts of assets available at all times, in addition to other restrictions on how much debt it can have. This inability to leverage above certain levels impacted the company's ability to get good returns on its equity. While this came pretty late in the quarter, and won't greatly affect this quarter and its earnings (supporting my belief on a bad earnings quarter), it will have an effect on the next quarter (supports buying after earnings release).
In addition to the rate hike and the shedding of the "too big to fail" designation, we are seeing another reason to like the life insurance industry. People are living longer and giving MetLife more time for its money to compound. Therefore, each policy ends up being worth more than it used to be. It also makes it so policies opened long ago might be paying for much longer before their payout than MetLife had planned for, making old plans more lucrative. This also lowers the number of people who will get to act on their life insurance. Older people must pay so much for life insurance that they often end their policies. This means all the revenue the company earned from these policies end up being cost-free.
- Persistent low rates will hurt the company's earnings more than expected.
- This will see the stock price lower on earnings day.
- After the earnings release, the stock price will go up due to improving conditions.
- Shedding the "too big to fail" designation will prove valuable for MetLife's cash flow and ROE (return on equity).
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.