Since the 2008 financial crisis, I've written numerous columns about how the Federal Reserve's monetary easing, exceeding the zero point and quantitative easing would hurt insurance companies. I've warned that it would hurt the firms' cash flow, balance sheets and, therefore, their stock prices. (Most of the columns reference past ones in the series, with links to previous columns, so if you're interested in reading the backstory you can start with "Cancel Your Insurance.")
Specifically, I expected that the flattening sovereign yield curve would render the structure of insurance operations nonviable and facilitate an exodus from their stocks. That, I surmised, would necessitate a federal bailout of the insurance sector, which I anticipated would include allowing insurance companies access to the Federal Reserve.
Such a fallout has not transpired. In fact, even though the sovereign yield curves have continued to flatten in the U.S. and Germany, the exact opposite has occurred. For U.S. and European insurers alike, stock prices have continued to grind higher from 2009 lows for firms involved in property and casualty, as well as in health and life.
I've wholly explained the rationale for my concerns in previous columns, but here's the gist of it. When sovereign yields flatten, this reduces the viability of short to long carry trades -- which, globally, comprise the industry's primary structure for creating investment income from insurance operations. This requires insurance companies to increase premiums to policyholders. That, in turn, forces those policyholders to reduce their use of insurance overall as they shift away from voluntary insurance like health and life in order to continue paying rising premiums on required insurance for autos, homes and the like.
The entire process should cause a net decrease in the use of insurance, thus reducing the sector's premium revenue, income and stock prices. There was no great insight in my observations. It's basic Finance 101.
The bottom line, though, is that it hasn't happened -- and I don't know why. That said, this column is not simply a mea culpa. I have no problem with being wrong, admitting when I am wrong and then explaining why. However, in this case, I can't explain it to my own satisfaction with anything other than retrospective anecdotal possibilities that don't comport with basic financial logic. For that reason, I'm not comfortable with them. However, I will offer them here regardless.
In essence, investors may be assuming that the Fed's monetary stimulus will eventually cause inflation and a rising yield curve, which would preclude crisis in the sector and firm up the viability of these firms. The stocks may also be benefiting from a kind of institutional flight to perceived safety. More to the point, investors may expect that, if a crisis were to occur, the government would provide a too-big-to-fail-style of bailout for the sector and for individual companies. It is possible, as well, that the first two issues are also causing institutional investors to consider the sector a safe place to park assets.
None of these reasons, however, is in keeping with traditional financial logic, given the industry's basic strategy: Maintaining short-term liabilities and long-term investments, with the principal returns predicated on the interest spread between the two. For now, I'm still not comfortable with the sector, and I've been increasingly troubled by the steady positive performance of the stocks it encompasses.