Interest rate risk for insurance companies is a significant factor in determining profitability. Although the rate changes in either direction can affect its activity, profitability of the insurer, as a rule, rises and falls with the interest rate increases or decreases.
Changes in interest rates can affect the assets and liabilities of the insurance company. Insurance companies have significant investments in interest-sensitive assets, such as bonds, and is also sensitive to changes in interest rates on the market of products for its customers.
Falling interest rates would reduce the liabilities of the insurance company by reducing future obligations to policyholders. However, the decline in interest rates also can make the products of the insurance company less attractive, leading to lower sales and thus reduced income in premiums that the insurance company has available to invest. The net effect on the company’s profitability is determined by the reduction in liabilities greater or less than any reduction in the assets that is experienced.
Lower interest rates may also adversely affect the profile of the insurance company risk as the equity investment, if analysts believe that the company may face difficulty meeting future financial obligations. Lower levels of equity investment means a reduction in the level of assets for insurers.
Although the exact impact of changes in interest rates on certain insurance companies may be uncertain, the historical analysis shows that the overall trend in profitability of the insurance sector to improve in the face of rising interest rates. In General, the price-income (P/E) for shares of the insurance company usually increase in direct proportion to the increase in interest rates.