A new report by Swiss Re Institute has warned of the risk posed to insurance and reinsurance companies by the prospect of inflationary recessions and financial instability.
Analysts note that insurers and banks alike are finding it difficult to re-adjust to the new economic reality after a decade-long market reliance on ultra-low and negative interest rates, which have exposed financial stability risks.
“Insurers will need to watch for inflation remaining stickier, even if peaking, and the rise in systemic risk in the economy,” they cautioned, despite seeing some longer-term positives for the industry.
The current outlook poses risks both to insurers’ assets and liabilities, with more persistent inflation risks imply higher claims costs.
At the same time, financial market volatility and potentially higher defaults linked to rising interest rates could hurt both insurers’ assets and specific lines of business, for example credit & surety, Swiss Re says.
However, looking ahead, the reinsurer believes that higher interest rates are expected to eventually be a silver lining for the industry, as insurers reinvest maturing bonds into higher yielding bonds.
Swiss Re’s inflation forecasts expect CPI inflation to stay above central bank targets next year, with risks of upward revisions to the forecasts, particularly in Europe.
Against this backdrop, central bankers have vowed to remain resolute in raising policy interest rates in the near term and hold them high for longer, prioritising the return of price stability over growth.
But there are currently concerns about a lack of global policy cooperation, with countries each pursuing different policy objectives.
“More targeted and tailored fiscal measures are needed to address the energy crisis without inflaming inflation, but governments do not have the instruments ready to deploy so are facing a deja-vu of the inflationary blanket cheques sent to all households in the US during the pandemic,” analysts explained.
Another growing concern over Europe is that monetary and fiscal responses are addressing the demand-side of the economy when the continent is facing a supply-side shock, with Swiss Re recommending more supply-side structural reforms such as energy infrastructure investments to deliver secure, long-term supplies.
Furthermore, there are concerns that current policy approaches could also amplify financial instability risks, as the unwinding of the past ‘low interest rate, low volatility’ regime is leaving little cushioning of risk available to the world economy.
“We are also watching for interest rate tightening spillover effects on countries such as in emerging markets or the EU periphery, where sovereign debt concerns could reawaken if bond yields climb too far and too quickly,” Swiss Re said. “If market dysfunction leads to systemic concerns, we would expect central banks to address financial stability, but this in turn could slow the fight against inflation.”