What is Interest Rate?
The most significant character for insurance companies in determining profitability is Interest rate risk. Although rate is something that was never constant and is affected by many things which affect its operations, an insurer’s profitability sees a general and continuous rise and fall in concert which is directly proportional to the interest rate increasing and decreasing, that is, if the interest rate is increasing, then the profitability increases and vice versa.
The revenues from the risk pooling services are channeled through the insurance industry that provides for its clients and customers and uses this to help pay money and assets to economic activity through investing in real and financial assets. The insurance operators play a big and important role overall in the performance of the company financially.
How important is interest rate?
Insurers are associated with some, if not all, of the largest investment arms and groups in the whole world. Interest rates affect them immensely from the perspective of investment income making it very important to invest to insurers. Interest rates also play a major role in the discounting of liabilities, that also effects the insurers heavily.
Since the financial crisis struck, the interest rates all over the world that has already developed, have fallen into the record laws, and this noticeable shift has put increased pressure and problems to the insurers’ businesses and has also put it under terrible scrutiny. A mix and match of institutional factors, for example, a move towards the central bank independence and the adoption of inflation and demographic factors have played a major and immense role in lowering the interest rates much lower before the crisis.
How can changes in the interest rates affect the insurance companies?
The assets and the liabilities of a company focusing on insurance can be largely affected by changes in interest rates. Insurance companies have in stock, substantial investments in interest sensitive assets like bonds, as well as products for the customers that are market interest rate-sensitive.
- Lowers a company’s liabilities
A sudden and huge drop in interest rates can drastically play a hand in decreasing an insurance company’s liabilities by lowering its chances in holding future obligations to policyholders. On the other hand, lower interest can help in making the insurance company’s products less attractive, which will result in lower sales and thus, will ultimately result in lower income of premiums that will then be available to the company to invest in.
The overall net impact and result on the company’s profitability are ultimately decided on the factors whether the decrease in liabilities is lesser or greater than any reduction in assets that is experienced by the company.
- Impact negatively in an insurance company’s risk profile
An insurance company’s risk profile can be hugely damaged with lower interest rates as an equity investment if analysts believe that the company might have some sort of difficulty that has come up and they cannot meet future financial obligations. Lowering of the levels of equity investment would mean lowering of the levels of assets for insurers or insurance companies.