Despite a volatile market over the past 14 months, Kinsale Capital Group's (KNSL -1.24%) stock has rallied over 40% since the start of 2022. That's no surprise -- the specialty insurance company has done an excellent job growing its business for several years.
Insurance companies can be solid investments in challenging economic conditions because sales generally increase with inflation. They also benefit from higher interest rates, and in the fourth quarter, Kinsale saw its net investment income double from the year prior. Read on to see why insurers benefit from higher rates and why you should consider investing in Kinsale today.
Why higher interest rates are happening
In December 2021, inflation reached 6.8%, its highest level since 1982. Inflation wreaks havoc on the economy, increasing individuals' cost of living and hurting lower-income earners the most. To bring it down, the Federal Reserve is raising the benchmark federal funds rate, which determines banks' overnight borrowing cost.
Inflation hasn't been an issue for several decades, and interest rates drifted to near zero following the COVID pandemic. Now that inflation has flared up, the Federal Reserve must take action to bring it down and achieve its dual mandate. Since March 2022, the Federal Reserve has raised its benchmark interest rate by 4.5 percentage points.
Changing this rate has a ripple effect across interest rates on things like Treasury bills, savings accounts, mortgages, and other loans. In theory, raising interest rates encourages people to save money rather than spend it removes excess cash from the economy.
Target Federal Funds Rate Upper Limit data by YCharts
How higher interest rates affect insurance companies
Higher interest rates are a double-edged sword. Higher rates make everything more expensive if you want to borrow money or mortgage a home. If you're a saver looking to put your cash somewhere safe, you welcome higher rates with open arms. Insurance companies are savers. That's just the nature of their business.
Insurance companies make money in an opposite manner from most other industries. These companies collect payments up front, called premiums. They then hold on to these premiums and use them to pay out customer claims. Because there is a period between when money is collected and paid out in claims, insurers can use this cash to invest in assets. This cash is called float and, as Berkshire Hathaway CEO Warren Buffett puts it, it's "money we hold and can invest, but that does not belong to us."
As policies lapse and new ones begin, insurers that turn an underwriting profit can put this cash to work in investments from bonds to stocks or other assets. The decade of low-interest rates in the 2010s hurt insurance companies, especially those with interest rate-sensitive products like life insurers. Insurers used to rely on interest income as part of their business, but ultra-low interest rates put pressure on their profit margins. Now that rates have risen to levels not seen since the Great Recession, insurers are finally seeing yields on their portfolios come up.
Kinsale Capital's investment income rocketed higher in 2022
Higher rates have boosted interest income for insurers like Kinsale Capital. Last year, the insurer saw net investment income jump 65% to $51.3 million, and in the fourth quarter, it jumped 107%.
Thanks to its rapidly growing, profitable insurance business, Kinsale's investment portfolio has expanded over the years. Last year it got an added boost from higher interest rates, and the average investment returns on its portfolio went from 2.5% to 3%. Its newer investments yield up to 5%, and include government bonds, asset-backed and mortgage-backed securities, and municipal and corporate bonds.
Data source: Kinsale Capital regulatory filings. Chart by author.
Is it a buy?
Investors expect interest rates to stay "higher for longer," which could be good for insurers, as it means they can put their cash into higher-interest-earning assets.
Kinsale gets an added boost from rising rates over competitors because net investment income makes up a larger share of its earnings -- 6.3% of total revenues. In comparison, fellow specialty insurer Markel (MKL -1.17%) made $447 million in net investment income, or 3.8% of total revenue. And Progressive (PGR -0.85%), the second-largest publicly traded insurer in the U.S., produced $1.3 billion in net investment income, or just 2.5% of its total revenue.
While rising interest rates have been a tailwind to Kinsale's business, it's important to understand that this is one aspect of its business. At the end of the day, its insurance business produces vastly more revenue than its investments.
Data Source: Kinsale Capital regulatory filings. Chart by author.
The good news for investors is that its insurance business is hitting on all cylinders. When it comes to writing insurance policies, Kinsale is one of the best, with its impressive profitability and growth since going public in 2016. The company is well-positioned to perform well if inflation stays elevated, and it's ready to capitalize on higher rates -- making this insurance stock a solid one for you to consider adding to your portfolio today.
