Sheltered from the storm: insurance and the macroeconomy

Macroeconomics, by its very definition, touches every sector of the economy and its primary indicators – GDP, inflation and unemployment – are relevant to virtually every business, from the largest banks to the smallest coffee stall.

Broader economic patterns affect the insurance sector differently – demand for many insurance products does not vary much during economic downturns and insurers are less vulnerable to shifts in credit markets and asset prices than other parts of the financial sector.

However, insurers are only partly insulated from the business cycle. Inflation has been a serious drag on insurers’ profits as claims have risen. Low growth limits business expansion. And the shocks that shape the wider economy – the Covid-19 pandemic, multiple potential or actual wars and climate change – have specific costs for insurers.

What follows is a short tour d’horizon of the contemporary macro­economic picture, with commentary from leading economists and analysts working in the insurance sector.

The big picture and insurance

The near future promises a more stable, if not especially vibrant, economic environment. Macroeconomic forecasts for 2024 and 2025 tend to foresee moderate growth. The International Monetary Fund’s (IMF) World Economic Outlook report for April 2024 predicted the global economy would grow 3.2% both in 2024 and 2025, the same rate as in 2023. Advanced economies will grow more slowly at 1.7% in 2024 and 1.8% in 2025.

The Swiss Re Institute is slightly more pessimistic. In its July 2024 sigma report, it predicted global growth of 2.7% in 2024 and 2.8% in 2025, with the 2024 figures for the US and eurozone at 2.5% and 0.7% (the IMF expects 2.7% and 0.8% respectively).

Insurers are more protected from the business cycle than other parts of the financial services sector. Demand for insurance (or at least some kinds of in­surance) is more inelastic than for bank credit or securities and insurers tend to carry large reserves and invest conservatively.

Ludovic Subran, chief economist at Allianz, says insurers sell more policies when the economy is growing, just as other businesses see higher sales. Nadja Dreff, senior vice-president at rating agency Morningstar DBRS, says: “In [a] mature insurance market such as the US, Canada and western Europe, the variation on insurance demand is mostly tied up to population and GDP growth.”

But, Subran continues, “when the going gets tough, premium growth decouples from the general economic development”, because individual and business policyholders cannot drop most kinds of insurance. “That’s why insurance is, to a great extent, immunised against liquidity problems, even in a severe downturn, and stays resilient.”

Jérôme Haegeli, group chief economist at Swiss Re, says the insurance sector is “moderately sensitive” to the business cycle through rises and falls in demand. However, demand for general insurance may rise when the economy does poorly. “Non-life insurance lines of business are in some ways counter-cyclical, as demand for insurance tends to increase when uncertainty is high or households and businesses feel less secure about the economic outlook,” Haegeli tells Insurance Day.

Brandan Holmes, vice-president and senior credit officer at rating agency Moody’s, says commercial insurers may be “more susceptible” to business cycle fluctuations, “particularly when firms downsize during an economic downturn”. Insurers with geographically dispersed operations or broad portfolios are less exposed, he adds.

Federico Faccio, senior director at Fitch Ratings, agrees insurance “is a bit anticyclical”. Life insurers and pensions are more exposed to the business cycle, Faccio adds, since the unemployed do not pay into private pensions and workers may reduce their savings during a downturn.

Faccio says life insurers can benefit during downturns from “some flight to quality” because they are so conservatively governed and resilient. “Essentially they are receiving money because they are seen as safe organisations,” he says.

Inflation

The early 2020s have witnessed the biggest inflationary shock in 40 years, in large part because the Covid pandemic and the Russia-Ukraine war have so disrupted global supply chains. Year-on-year consumer price inflation reached double digits in the eurozone and the UK in the autumn of 2022, while US inflation peaked at 9.1% that June.

Inflation has eased across the developed world – the IMF expects it to average 2.6% this year and 2.1% in 2025. Swiss Re estimates inflation will average 2.7% in the eurozone, US and Japan in 2024, falling to 2.4% in the US, 2.1% in the eurozone and 1.7% in Japan in 2025.

However, inflation remains a bit above the 2% target set by most central banks in several jurisdictions. The June 2024 year-on-year consumer price index reading for the US was 3%, while the eurozone recorded 2.5%.

Ludovic Subran, Allianz

Dreff says carriers can usually pass on inflation costs to policyholders, “provided the insurance business cycle is not soft”. She says insurers are more concerned about whether “inflation expectations are matched to actual inflation levels” than they are about current inflation readings. “Inflation predictability is more important since it allows the insurers to pass on the cost increases to consumers through higher premiums,” she says.

According to Haegeli, disinflation has eased pressure on general insurers by “reversing the spike in claims severity seen in the past two years”. This is most pronounced in the two biggest sectors of the property/casualty space: motor and construction.

“When the going gets tough, premium growth decouples from the general economic development… that’s why insurance is, to a great extent, immunised against liquidity problems, even in a severe downturn, and stays resilient”
_{Ludovic Subran
Allianz}

Subran says the main challenge for the insurance sector was the sudden spike in inflation in the period from 2021 to 2023, caused by supply chain disruptions, Russia’s invasion of Ukraine and “very generous fiscal support measures”. Allianz expects “a more constrained, less volatile inflation environment for the foreseeable future”, although “inflation might be structurally higher – or more sticky”.

Inflation is falling slowly in the US and could resurge more generally, Haegeli says, either because of renewed external shocks or premature interest rate cuts. “Services inflation is still above what is compatible with a return to 2% central bank targets,” he observes.

Faccio says insurers do not seem concerned about a recurrence of inflationary pressures in developed countries. In part, this is because they expect central banks to keep policy rates relatively high, but Faccio points out premiums have risen sufficiently to compensate for higher prices. However, in its 2023 report, Swiss Re warned disinflation had not overcome “challenging claims dynamics”.

Holmes tells Insurance Day “while lower inflation generally benefits the insurance sector”, it can also make it easier for customers to reject necessary increases in premiums, “potentially working against insurers”. He adds personal and commercial lines insurers have been able to adjust prices to compensate for inflation.

Dreff believes insurers have little to worry about from inflation “as long as there are no surprises in terms of actual versus expected inflation”.

Monetary policy

Central banks in advanced and emerging markets have raised their policy interest rates to slow the circulation and expansion of money and thus dampen inflation. In the US, the Federal Reserve raised its fed funds rate from between zero and 0.25% to between 5.25% and 5.5%, with other central banks in developed countries making increases on a similar scale.

These increases mean insurers may enjoy higher returns on some assets, but they also devalue the underlying value of some long-term government bonds. High interest rates also make credit more expensive and dampen investment. This should allow central banks to begin cutting their rates, because central banks in developed countries generally try to steer inflation to a target of 2% annually. The European Central Bank and the Bank of Canada have already lowered interest rates this year, albeit modestly.

Jérôme Haegli, Swiss Re Swiss Re

In the banking sector, monetary policy is an important determinant of credit capacity – higher interest rates reduce the amount of credit available by making it more expensive. Interest rates do not exercise a similar influence over capital availability in insurance. Faccio tells Insurance Day: “If you think about reinsurance or companies that underwrite risks, the capacity they provide has to do with the pricing and to a lesser extent the level of interest rates.”

Holmes adds: “Higher interest rates… can enhance insurers’ economic capital levels – for example, Solvency II – and boost investment income.”

“Non-life insurance lines of business are in some ways counter-cyclical, as demand for insurance tends to increase when uncertainty is high or households and businesses feel less secure about the economic outlook”
_{Jérôme Haegeli
Swiss Re}

Faccio says high interest rates give insurers the cushion of added investment income. This can subsidise somewhat lower premiums if insurers want to expand market share, although in general insurers in mature markets will maintain fairly strict underwriting discipline. In the end, insurers rely primarily on premiums. “I don’t think companies in developed markets heavily rely on investment income,” he adds.

Haegeli argues interest rates will probably not return to the unusually low levels of the 2010s. “We expect advanced markets’ interest rates to remain higher for longer, with monetary policy normalising rather than easing this year and next,” he says, adding services inflation has remained fairly high. “Emerging markets, in contrast, have loosened policy earlier than advanced markets, given more muted inflation pressure and greater headroom to stimulate economic growth,” Haegeli continues. Chile, for example, has lowered its policy rate from 11.25% to 5.75% since last year.

Subran agrees interest rates will remain relatively high, but at “a level where we don’t see major impacts on our business”.

Fiscal policy

Since 2010, many discussions of fiscal policy have been dominated by “austerity”. This term refers to a government policy aimed at reducing fiscal deficits and public debt by cutting public spending and (perhaps less often) raising taxes.

Austerity policies often struggle to attain these goals, especially during recessions because, by depressing economic demand, austerity may reduce tax revenues, increase social spending and cause increases in debt-to-GDP ratios. In any case, the pandemic and subsequent supply shocks forced governments into expanding deficit spending and taking on more debt.

Some expect these heavy debt loads to force states to adopt austerity anew. EU rules usually limit deficits to 3% of GDP and debt to 60% of GDP, although these rules were suspended between 2020 and 2023. Other states may be compelled to adopt austerity if they cannot easily borrow or devalue their currency or as a condition of loans from agencies such as the IMF.

Federico Faccio, Fitch Ratings

Subran argues the insurance sector is somewhat exposed to shifts in fiscal policy. While “monetary policy and extreme weather events have a more direct, immediate impact”, fiscal policy is a factor over longer terms because of the centrality of the state in investment. Haegeli cautions some of this spending may be announced, but the resulting infrastructure or programmes may never be fully realised.

Haegeli says he expects “fiscal tightening will be a key theme of the coming years as the large fiscal deficits that funded major stimulus during the pandemic and recovery years have to be unwound.” He does not expect any major fiscal policy changes in the US before the presidential election in November and its “fiscal deficit is projected to remain high for the next two to three years”.

“There are always discussions about to what extent the insurance industry can substitute services provided by individual states and the answer generally is they cannot in full or they cannot absorb risks that do not imply a solution”
_{Federico Faccio
Fitch Ratings}

Subran identifies a dilemma – “fiscal discipline should be the order of the day”, but states cannot afford it because they must address global warming, cyber security and geopolitical problems. Nor can politicians embrace cuts, as “2024 is an election year”, so “there are no serious plans on the table”. The Allianz economist expects the US to “muddle through”, while he foresees renewed conflict between northern and southern EU member states over spending policies.

Thomas Torgerson, managing director for global sovereign ratings at Morningstar DBRS, does not expect a wave of austerity packages. “Several major economies – for example, the US and France – are likely to need to take actions to reduce structural fiscal deficits in coming years,” he says, but few governments will want to take action during a busy electoral calendar.

Faccio says austerity can create opportunities for insurers to provide cover that substitutes public provision. However, he agrees insurers cannot substitute for government action in many policy areas because there is no feasible business model for providing solely private insurance cover.

“There are always discussions about to what extent the insurance industry can substitute services provided by individual states and the answer generally is they cannot in full or they cannot absorb risks that do not imply a solution, which is a core sharing of some of these benefits between the public and the private,” he says.

Downside risks

According to its 2023 report, Swiss Re sees “(geo)politics playing a dominant role in driving the outlook”, mentioning the Middle East conflict and “more assertive industrial policy” among these risks. The re/insurer also warned of general economic sluggishness across many developed and emerging markets.

Munich Re’s Economic Outlook 2024 came to a similar conclusion, saying “risks to the growth outlook are tilted to the downside” and “geopolitics will remain an important risk factor for the world economy”. It also mentions recession and stubborn inflation as potential dangers.

Haegeli cites “recession risk as the major downside macro risk in the near term”, alongside a renewed acceleration of inflation. “Lower economic growth and higher unemployment would hinder insurance premium growth and raise corporate defaults,” he says.

He is also concerned about political instability, pointing out how divisive politics have become a feature of much of the West. “The potential for higher trade tariffs, violence and less global co-operation challenge insurers’ operating environment,” he says.

Torgerson says Morningstar DBRS expects geopolitical risks to increase “only modestly”, adding the US elections could create instability should the results create doubts about the superpower’s role in the world.

Subran’s list of major downside risks is perhaps more concise: “Climate change, of course.”