Analysts at Swiss Re have warned that a severe ‘stagflation’ event, similar to that seen in the 1970s, would hurt re/insurers due to weakening premium revenues and poor investment returns.
The reinsurer defines stagflation as persistently high inflation coinciding with weak economic growth and high unemployment.
A surge in US Consumer Price Index (CPI) inflation to 6.2% year-on-year last month has revived fears of such a scenario, and Swiss Re forecasts that stagflation risks will rise in the second half of 2022 and beyond.
Around this time, US growth is expected to slow materially, due to cyclical forces and the large fiscal drag from lower government spending, with inflation predicted to be structurally higher post-COVID-19 than before.
According to Swiss Re, a severe stagflation event would be challenging for the insurance industry as premium revenues would weaken in a stagnant US economy, while persistently high inflation would pass through to insurers as claims inflation, particularly in long-tailed non-life business.
Investment returns would also suffer, due to negative real returns across major asset classes, although profitability would improve for in-force life savings products with guarantees, assuming central banks would raise interest rates in this scenario
There is also a rising stagflation risk from external supply shocks having persistent negative impacts on economic activity and prices, which may drive businesses to re-shore or invest in parallel supply chains
Additionally, geopolitical trends and shifts to greener economies will likely lead to structurally higher prices and could also weigh on household consumption in the long term if the move towards less cost-efficient production causes prices to rise faster than wages, Swiss Re notes.
The global energy price crisis is another key supply shock, especially as it is due to longer term structural drivers such as decarbonisation efforts besides short-term supply-demand imbalances, which implies energy prices could remain high for a protracted time.
And finally, the physical and transition risks from climate change, like economic losses from weather events to input shortages in agriculture, or the cost of funding green transitions, may also risk persistent stagflationary supply shocks.
That said, Swiss Re believes that technology – a key source of disinflation and productivity growth – should partially offset these risks.