Understanding the biggest risks when operating in a low interest rate environment

Jakob Carlsson, Chief Financial Officer at Lansforsakringar discusses the impacts of consistently low interest rates on insurance investing

Insurance Investorposted on Thursday, September 12, 2019

This article is taken from the research report Insurance Asset Management, Europe 2017. To download the full report click here.

Insurance Investor: What are the challenges you face operating in a low rate environment?

Jakob Carlsson: For us, offering savings to businesses with long term guarantees and low rates is a major challenge, mainly because it eats risk capacity and reduces the ability to be flexible on the asset management side.

Thus, with the current regulatory framework, low rates counterintuitively will force us to invest more in fixed income. Low rates therefore decrease expected future returns from two angels.

In our modern products, with lower guarantees, we do not face the same odd incentives to increase investments in low yielding bonds when rates fall, but along with other long term savers, we will suffer when low rates reduce expected returns in all asset classes.

II: What is your opinion regarding the current monetary policy and its effect on rates?

Jakob: It is easily forgotten that low rates will reduce returns on all long-term savings. Therefore, I think it will increase the burden on future generations to cope with pensions.

I must say, I am very critical about the ultra-light and experimental monetary policies that we see in the EU and in Sweden, with artificial rates and quantitative easing.

I think it will soon be obvious that such policies are not working when savers should save more and consume less to compensate for lower future expected returns driven by ultra-low rates.

I am afraid these experimental policies eventually can destroy what is most important for the economy – confidence.

II: Which asset classes look the most attractive in a low interest rate environment and why?

Jakob: More than ever it will depend on future scenarios. In an optimistic slow but steady growth scenario, with some inflation, I think equities and artificial intelligence - after some volatility – will outperform, driven by positive cash flow from increasing profits.

In a low demand environment, a muddling through scenario with low rates, corporate bonds, properties and alternative intelligence will do relatively well, but long term returns will decrease on all investments.

In a stress scenario situation, with decreasing demand, all risky asset classes will suffer, with higher volatility in liquid assets. Only supposedly ‘risk free’ assets will stand.

II: What are the chances of the Brexit impact being a minimal one?

Jakob: I am concerned about the political implications should Brexit result in a weaker EU. I think we need a strong EU and a robust political platform to solve all long-term threats.

Unfortunately, Brexit will drain energy in a time when more is needed.

II: Looking internationally, can we expect the U.S. and emerging markets to continue to improve?

Jakob: Yes, according to our base case, we think we can expect value growth in the U.S. and even more so in emerging markets, but as I said earlier, there are several potential risks hanging over the world economy.

For the U.S., the negative alternative scenario is one of fragile growth that will be broken by slower consumer demand that could be kicked off by unpredicted events. For emerging markets, the negative scenario could be the same slow- down in the U.S., or rapid hikes that drives the dollar to unfavourable levels.

This article is taken from the research report Insurance Asset Management, Europe 2017. To download the full report click here.