Low-interest rates are designed to stimulate the economy. However, while low rates are supposed to make it easier for companies to borrow to invest, they also make life much harder for banks and insurers.
Insurers, especially life insurers such as Aviva(LSE: AV), Legal & General(LSE: LGEN) and Prudential(LSE: PRU) are facing a double blow from low rates. First of all, low interest rates are weighing on the returns these insurers can generate from their asset reserves. Insurers rely on the income from asset reserves to tide them over during tough underwriting years. With this revenue stream coming under pressure, insurers are going to find it harder to generate consistent profit.
The second significant impact low rates have on life insurers is on the products they sell. Low rates make it harder to sell products that offer investment guarantees, such as annuities. Other products will also suffer as insurers pass the market's low returns on to customers, who could be put off by these small returns and go hunting elsewhere for wealth management products or choose to manage their assets themselves.
These two repercussions from negative rates have forced insurers to adopt rather unconventional asset management policies. Legal & General, for example, has set up a £600m 'build-to-rent' fund to build large-scale rented properties, which may offer a higher level of returns than bonds in the current market. Meanwhile, Aviva has been devoting funds to infrastructure projects. The firm has plugged £4bn into infrastructure projects with a'social purpose' such as biomass recycling and public buildings.
With its Asian exposure, Prudential isn't as exposed as its European peers to falling interest rates and declining demand for long-term savings products. There's still a healthy demand for the company's products within Asia, and this is helping supplement falling European sales and investment income. The company's first-half earnings report showed that Asia operating profit grew by 15% during the period, and new business profit increased 20%. Prudential's UK operating profit for the same period only grew by a smaller 3%.
So, are these life insurers at risk of going out of business if interest rates remain depressed?
Well, the companies have shown over the past few years that they can manage the low interest rate environment. However, interest rates are now at their lowest level ever and with so much money around the world chasing a smaller number of assets capable of producing an above average return, it's going to become more and more difficult for these insurers to find the assets they require to maintain returns.
All in all then, it might not be time to abandon Aviva, Legal & General and Prudential just yet, but investors need to be aware of the pressures currently facing the sector.
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Rupert Hargreaves owns shares of Prudential. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.