The Bank of England’s key lending rate is at its lowest level ever, a policy designed to stimulate borrowing and economic growth. However, while low rates help borrowers, they also punish savers.
The insurance industry is one that relies on savings to survive. Insurance isn’t a precise business, and in some years insurance claims will exceed premiums income, which means the insurer will have to draw on its savings to fill the gap. Insurers also rely on income from savings to boost profitability during the good times.
Due to the unpredictable nature of the business, insurers often keep the bulk of their savings in fixed interest securities to help reduce income volatility. But with interest rates near all-time lows, rates available from fixed income are falling. The result? It’s becoming harder and harder for insurers to generate an acceptable return on their savings.
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What’s more, long-term savings and pension providers such as Aviva (LSE: AV) and Legal & General (LSE: LGEN) are under even more pressure as these companies can only offer clients returns in line with interest rates. These low returns could put customers off savings products offered by these firms.
Dodging bullets
The good news is that the pressures mentioned above do not yet appear to be impacting Aviva. For the first six months of 2016, the company reported a 13% increase in operating profit driven by a 7% increase in general insurance net written premiums and 7% increase in the value of new business for life insurance.
Nonetheless, there are some signs that Legal and General’s business is coming under pressure from low interest rates. For the first half of the company’s financial year the firm reported an 8% decline in savings assets under management from £111bn to £102bn. Further, insurance profit before tax slumped from £138m in the first half of 2015 to £46m for the first half of 2016 due to negative investment performance of -£92m following a 1% reduction in UK government bond yields.
Legal is offsetting these pressures by diversification into other lines of business such as the provision of mortgages, pension management for employers and international asset management. Also, the group is diversifying its investment portfolio out of traditional assets such as shares and bonds and into assets such as property, infrastructure and private businesses to boost returns. Legal’s housing profit more than doubled to £39m during the first half of 2016, profit from infrastructure investment rose 60% year-on-year, and the company’s new SME finance arm reported a 150% year-on-year increase in operating profit.
The bottom line
So overall, while smaller insurers may be coming under pressure from the Bank of England’s interest rate regime, Legal and Aviva appear to be avoiding any adverse effects. These two businesses continue to see strong sales growth and asset diversification is making up for the dismal returns in the fixed income market.
