Analysts at Berenberg have examined the recent data on inflation and its potential impact on profit margins in life and non-life insurance.
While the COVID-19 crisis is associated with weak and falling GDP, and with deflation rather than inflation, analysts note how correlation works in reverse too: deflation is a risk for life insurers and a positive for non-life insurers.
Berenberg forecasts benign inflation in Europe and in the US for the next two to three years, which it says is very supportive to the non-life insurers it covers.
It’s also expected that the corresponding low interest rate environment will maintain the transition of life insurers shifting to capital-light products, and offloading capital-intensive back books.
It’s analysts’ overall conclusion that inflation is bad for non-life insurers and good for life insurers. Essentially the liabilities of life insurers are set in nominal terms and if inflation rises, its assumed interest rates do too; hence the discounted value of the liabilities drops, which is good for shareholders.
The opposite is true when interest rates fall, analysts note. Life insurers with very long-dated guarantees like the German life companies are highly exposed to deflation and to falling investment returns as a fall in investment yields means that the guarantees on some savings policies are more difficult to meet.
But the second-order effect of deflation is positive for life insurers. Life insurers change their business model away from traditional life policies with spread investment margins, and towards protection (ie death and disability) contracts and unit-linked saving policies, where the policyholder bears the investment risk.
Berenberg says this is clear when analysing the ROE of life insurers in France, which have increased despite falling inflation, as French life insurers have refocused away from traditional life savings products.
By contrast, non-life insurers are at risk from high inflation. Analysts say this is because claims are mainly set in real terms as non-life contracts are indemnity contracts.
This is most a risk for liability policies, because the claim is paid many years after the policy premium is received, and the effect of inflation compounding, particularly for medical costs, is exponential.
Berenberg continues to view Munich Re as a clear winner in the current environment.
Low interest rates combined with the high catastrophe and large losses of the previous three years, plus ongoing COVID-19 uncertainty, are fuelling a hard reinsurance market that Munich Re is well placed to take advantage of.
Analysts expect at the very least a low-single-digit percent decrease in the combined ratio on the back of these rate movements.
