While an inverted yield curve is a warning of recession, it will likely increase the profits of property-casualty insurers as their investments climb. It could hurt life insurers, though.
Property casualty insurers invest in the short end of the yield curve, such as the two-year US Treasury note, where yields have been rising. On December 28, they briefly rose above the 10-year note, creating an "inversion."
"It makes us all look like idiot savants," said Robert Hartwig, chief economist for the Insurance Information Institute.
Normally the longer-term note offers a higher yield because of the increased risk taken by the lender for the longer-term payback.
If a recession follows the inverted yield curve, analysts are of two minds as to how it will affect insurers.
"Bad economic times are bad for insurers, because life insurance is a discretionary product," said Donald Light, an insurance analyst with Celent LLC.
But Nick Pirsos, managing director of Sandler O'Neill Equity Research, said a recession could lead the stock market to favour "defensive stocks" with steady earnings and secure cash flow - exactly what the insurance industry offers.
For the property casualty industry, which faces $60 billion in claims from three hurricanes that wreaked havoc on the US Gulf Coast this season, the year-end inversion is helping it recoup.
"Insurers benefited from the rising short-term interest rates to generate $40.7 billion on their investment portfolio in the first nine months of the year," said Hartwig.
Because they can be hit with huge claims on short notice, property casualty insurers generally invest in notes that don't go beyond five years. Their investment income is up 14.6 percent this year compared with a 2.4 percent gain last year, a six-fold increase, III figures show. Health insurers also invest for the short term.
By contrast, life insurers face tougher decisions, analysts said. They count on long-term investments to match their risks, knowing that retirees expect them to provide income for 20 to 30 years.
"It's already a challenging environment, and the inverted yield curve will make it even more challenging," said Douglas Meyer, an analyst with FitchRatings.