Interest rate sensitivity of US property/liability insurer stock returns

Abstract

Purpose The purpose of this study is to investigate interest rate sensitivity of the US property/liability (P/L) insurers stock returns using various return generating process models incorporating different interest rate changes such as actual interest rate changes, unexpected interest rate changes and orthogonalized market returns. Design/methodology/approach The study follows the 1974 two‐index model by Stone. In the two‐index model, three different interest rate indices are tested one at a time to examine if interest rate sensitivity of the insurers stock returns, if any, is vulnerable to an interest rate index used. Findings It is found that the US P/L insurers' stock returns are sensitivity to interest rate changes. The impact of actual interest rate changes on the stock returns is little different from that of unexpected interest rate changes, which is consistent with findings in the banking literature. When orthogonalized market returns are used in the models in lieu of actual market returns, the statistical significance on the estimated interest rate sensitivity of the returns improves. Consistent with extant studies of financial institution's interest rate sensitivity, the paper also reports that the interest rate sensitivity of insurer stock returns is time varying. Research limitations/implications Due to the data availability, the period studied is between 1992 and 2001. However, the sample period does not weaken the findings of the study. In addition, future research could incorporate the insurers' balance sheet items to investigate which balance sheet items (i.e. investment in bonds, stocks and other items on asset side and reserves and other items on liability side) explain most interest rate sensitivity. Practical implications Investors can adopt the findings of this study in creating or adjusting their portfolio with the US P/L insurers in it. The insurers stock returns are more sensitive to changes in long‐term interest rate when the underwriting profit increases and the stock returns are more sensitive to changes in short‐term interest rate when the underwriting profit decreases. Social implications Although generalization is difficult and the conclusion is not as convincing as it could be because only one underwriting cycle is sampled, it is still noteworthy to recognize that the insurers' interest rate sensitivity is closely related to the insurance industry's underwriting cycle or performance. Originality/value This is the first study reporting the association between the interest rate sensitivity of the US stock returns and the underwriting performance.

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