FTSE 350: Life insurers’ interesting times

Yet there are reasons to believe that the sector is better insulated from low or lower interest rates. Exhibit one is recent history: the FTSE 350 Life Insurance index rose when Threadneedle Street slashed rates in the summer of 2016, and has been under pressure since the base rate climbed to 0.75 per cent over the next two years (see chart).

The second reason for optimism is what the life insurers are saying themselves. Phoenix (PHNX), which specialises in rolling-up closed life insurance books, cites interest rates as a key risk to maintaining its solvency capital ratio, as changes in rates can lead to asset-liability mismatches on guaranteed income products. But proactive management of these risks in the first of 2019 allowed the group to boost surplus capital by £85m.

Still, an 80 basis point drop in interest rates would have the effect of reducing Phoenix’s Solvency II ratios by five percentage points. Similarly, Aviva (AV.) estimates that a 25 basis point drop would cut its group capital ratio by three percentage points. But with both companies’ capital ratios well north of 150 per cent, there is little prospect of stirring the regulatory ire.

At the same time, we expect some investors in Prudential (PRU) will be keen for the group to be unleashed from the European directive. Indeed, a switch to Hong Kong-led supervision was one of the selling points in the group’s demerger of its UK-focused asset management arm, M&G. On a pro-forma basis, Prudential thinks its surplus capital alone would be more than twice the local minimum requirement levels.

In turn, this should help the Pru to double down on investments in its fast-growing and lucrative Asian business, which already accounts for more than half of group profits. Investors will hope that chief executive Nic Nicandrou’s assertion that protests in Hong Kong will only have a “temporary” impact on business does not prove too bold.

Another of the sector’s bold bets – Legal & General’s (LGEN) ambition to replicate its stellar 10 per cent average annual EPS growth in the first half of the last decade – requires a lot of plate spinning. But the recent evidence is positive. In the first nine months of 2019, a string of passive and active mandates increased the group’s assets under management by 20 per cent, to £1.2 trillion, while individual annuity sales and pension risk transfer business comfortably beat expectations. That momentum is barely reflected in the group’s single-digit forward earnings multiple, or 6 per cent dividend yield.