Insurance stocks poised to shine amid higher interest rates and inflation

Amid elevated interest rates and economic uncertainty, Fidelity's Fahim Razzaque is drawn to insurance stocks for their reliable business, sound fundamentals, and steady revenue.

• While many businesses and consumers have felt the sting of higher interest rates and inflation, Fidelity Portfolio Manager Fahim Razzaque says insurance stocks can do well in such an environment because the category is less sensitive to the health of the economy than most others.
• "Rising interest rates can be neutral for some segments of the insurance industry and beneficial for others, particularly life insurance," says Razzaque, who manages Fidelity^® Select Insurance Portfolio. "That's because when customers pay their premiums, the insurers take that money and invest it, primarily in bonds. As older bond holdings periodically roll off, new bonds bring better yields and boost the firms' investment income."
• The narrowly focused Select Portfolio primarily invests in U.S. companies engaged in underwriting, reinsuring, selling, distributing, or placing insurance, including property, casualty, life, and health.
• In helming the fund since 2022, Razzaque favors insurance stocks that he believes are well-positioned to increase book value over time, driven by return on equity, reinvestment opportunities, valuation, and avoiding downside risk.
• "Insurance companies are essentially intermediaries that pass on the higher cost of paying claims," he explains. "When claims costs rise, insurance carriers initially must absorb these higher costs, but they're usually able to raise premiums to offset loss costs and protect their profit margin."
• Recently, insurers have been raising premiums for property and auto policies to offset higher costs from inflation and more-frequent and costly natural disasters, but it can take a while to see the full revenue impact of higher rates, according to Razzaque.
• "First, state regulators must approve rate increases, and then it takes additional time for insurers to begin collecting higher premiums as existing policies wind down and are renewed at the new rates," he says.
• Razzaque believes it will take another year or two for property & casualty insurers to see the full benefit from raising prices, but he's confident that premiums will continue to rise and, over time, will exceed loss costs, which he thinks could benefit insurer profitability.
• P&C insurance was the fund's largest subindustry allocation as of December 31, at about 48% of assets, led by sizable stakes in Chubb, Travelers, Hartford Financial Services Group, Allstate, and American Financial Group—all top-10 holdings.
• Insurance brokers is another category that can benefit from inflation, says Razzaque, noting that they collect commissions on the insurance they sell, so their revenue goes up as life insurers and property & casualty insurers raise their rates to cover higher claims costs.
• At the end of December, brokers represented 26% of the fund. Marsh & McLennan was the fund's top holding, at roughly 11% of assets, while Arthur J. Gallagher was the fund's No.5 holding.
• With the economy potentially headed for a recession and the outlook for many sectors challenged, Razzaque believes insurance companies can continue to offer solid performance. "These are reliable businesses with sound fundamentals and steady revenue," he contends.