Rising interest rates to benefit life insurers owing to funds parked in fixed incomes

The potential increase in interest rates in the economy could benefit life insurers as bulk of their assets are invested in government securities, which currently yield low returns due to historically low interest rates.

But the conditions could soon change as pressure is building up on bond yields to rise from the second half of the year on the back of the recovery in the private sector credit and the rising government borrowings, First Capital Research opined.

Life insurance companies in particular became better poised to benefit from the circumstances created by the pandemic as more people sought protection for their health and lives against potential ailments and decided to build pension schemes to look after them and their dependents when reaching retirement.

“Revival in private credit and rising government borrowing are to mount pressure on bond yields from 2H2021E resulting in higher investment returns for life insurers”, First Capital Research (FCR) said in their report, which looked at how the current conditions could upend the life insurance industry.

The data compiled by the research house showed that 41 percent of the life insurance fund assets was invested in government securities, much higher than the regulator mandated 30 percent while another 20 percent were invested in corporate debt by end of the second quarter of 2020.

The balance is invested in deposits, equities and a category identified as others.

Higher investment income is only one benefit out of the two favourable outcomes that could stem from the potential rise in the interest rates on the financial performance of the life insurers as companies with larger life funds could in particular benefit from potentially lower transfers to insurance contract liabilities, and third, the higher earnings could add more heft to their Risk Based Capital ratios via higher earnings.

First Capital observed a negative correlation between insurance contract liabilities and 5-year average treasury bond rates where transfers to insurance contract liabilities rose when the interest rates descended.

“Expected rise in interest rates is expected to lower the surplus transfer to life insurance fund due to the higher discount factor used to value the fund. This is expected to boost the profitability of life insurers in the period ahead”, said Hiruni Perera, the author of the report.

Ceylinco Life Insurance PLC has the largest life insurance fund with a fund value of Rs.106.5 billion by the end of 2020, followed by Union Assurance PLC and AIA Insurance Lanka Limited with fund sizes of Rs.42.9 billion and Rs.17.5 billion respectively.

The higher earnings resulting from the two events above could further improve their Risk Based Capital Adequacy providing them with more resilience to confront future adversities.

Currently all listed life insurance companies operate with significantly higher capital ratios than the regulatory minimum of 120 percent providing them with capital buffers to withstand potentially higher shocks.