Economic uncertainty is high, with recession and inflation risks still elevated, which highlights the value of scenario planning for re/insurers, according to a recent report by the Swiss Re Institute.
The world economy is expected to continue to slow gradually, growing only 2.2% in real terms next year, down from 2.5% in 2023, and 3% in 2022. At the same time, they expect inflation to remain above central bank targets through 2024.
Amidst these challenging conditions, analysts believe the insurance industry will demonstrate resilience over the next two years.
In this context, a “severe global recession” and “1970s style stagflation” are two key alternative scenarios that re/insurers should think about, with each of them posing different challenges.
“A global recession would generate unfavourable macro and financial conditions, with sharp slowdowns in economic growth, falling interest rates and significant financial market losses. A scenario of 1970s style stagflation would bring severe inflation amid stagnating growth,” the analysts explain.
Noting: “As of now and based on our monitoring of scenario signposts, the risks of either scenario playing out appear contained. Still, developments that could portend a shift to one of the alternatives include unanticipated inflation persistence or reacceleration, renewed energy price pressures, monetary policy mistakes, and/or financial market distress.”
According to the report, a severe global recession would hit both sides of insurers’ balance sheets and raise solvency concerns.
“Contracting demand would lead to falling nominal premium growth in both non-life and life insurance. At the same time, lower interest rates, widening credit spreads and asset price declines would generate negative investment returns,” said the Institute.
“In addition, for life insurers falling incomes and rising unemployment would likely see premium volumes contract with savings products most affected due to the added impact of low interest rates. In non-life, however, lower inflation and economic activity would reduce claims relative to our baseline.”
In the case of a 1970s-style stagflation scenario, underwriting performance would be the one feeling the most pressure, according to the report.
Analysts stated: “Demand for both life and non-life insurance would be curbed, and non-life insurers would be most exposed to the inflation shock through increased claims severity and weakened profitability. As rates rise to meet claims costs, nominal premium growth would be strong, but high inflation would result in lower real premium growth than in our baseline scenario.
“The adverse impact on investment income would depend on the degree of ALM matching (ie, the extent to which higher reserves are immediately matched with additional assets, which lose value with higher yields). Reinvestments in higher-yielding bonds, however, could support longer-term investment income.”
The fact that the insurance sector entered 2023 with solid capital buffers, and solvency and liquidity positions well above 100%, only slightly below pre-COVID levels, are good news, analysts claim.
Monetary tightening has brought the end of financial repression, and new business can be written on more profitable terms. Reserve adequacy, however, is more of a concern, the report warned.
The report concluded: “But mitigating potential downside scenarios is not about capital and risk management alone. It is also about recognising that strategic actions can come with long lead times.
“For example, when facing inflation pressures, mitigation options include repricing risks and steering new business to lower-risk products, both of which take time. And, while asset allocation and other hedging tools enable more agile management of investments risk, repositioning still has to consider capital requirements and liquidity needs.”
