The new head of the Federal Reserve surprised many on Wednesday by taking a slightly less dovish stance on when interest rates may begin to rise than previously expected. But there are a number of companies that will profit from an advancing timeline of rising rates.
Though she is still far from being considered a hawk, the new Federal Reserve Chairman Janet Yellen indicated that the regulator and its members support a shorter timeline for the rise of tightly controlled interest rates.
Based on the current rate of the Fed's tapering of asset purchases -- it cut another $10 billion from its purchases following the most recent meeting -- the purchases could cease altogether in less than eight months. With Yellen's comments that it may be an additional six months following the end of the asset purchases for the Fed to raise rates, that means the long-awaited rise could come as soon as 12-14 months.
Yellen also stated that the Fed was aiming for a 1% increase by the end of 2015, meaning the Federal Funds rate could hit 3% by the end of the following year.
Of course there are plenty of companies that stand to gain from higher interest rates, but some of the biggest winners are likely to be life insurers. Since the heavily controlled interest rate have been held near zero, both groups of firms have dealt with compressed interest margins and lower investment returns. When rates rise, that could all change.
With the low interest rate environment, each insurer has had a strain on earnings thanks to lower reinvestment rates. For AIG, the impact as of Sept. 2013 was nearly $50 million each quarter.
Since insurers collect premiums on policies well before any payout is necessary, they invest those funds in order to support future payouts and capital distributions to investors. In addition to the returns that insurers can collect now, as interest rates rise, the future claims are discounted, allowing current investments to make a bigger impact.
With the low interest rates, insurers have had trouble finding investments that can match their past returns. AIG and its competitors have relied on alternative investments, including real estate and hedge funds, in order to boost their overall returns.
As rates rise, there will be some temporary losses as these alternative investments drag a bit and current bond holdings decrease in value, but more traditional investments should help prop up the insurer's income. If the insurers hold onto their bonds until maturity, the price drop will be irrelevant.
AIG has really pushed its return to life insurance, with assets under management topping $315 billion -- a solid 10% increase since 2012. If the insurer can maintain its growth in AUM, higher premiums will provide plenty of funds to invest in higher return vehicles going forward.
Long time coming
Chronically low interest rates have put a ton of pressure on companies' bottom lines. Insurers have had some of the toughest challenges since investment income is such a crucial part of its earnings. But with a new Fed Chairman touting a faster track to higher rates, insurers are set to benefit from flusher investment opportunities and increased interest earnings.
Jessica Alling has no position in any stocks mentioned. The Motley Fool recommends American International Group. The Motley Fool owns shares of American International Group and has the following options: long January 2016 $30 calls on American International Group. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.