How a challenging environment is impacting insurance

Companies today are operating in a time of unprecedented uncertainty and there is no doubt that we are in one of the most challenging economic periods in history. The ongoing COVID-19 pandemic has pushed the world into the sharpest and deepest global recession we have seen in our lifetimes, where estimates today show that global GDP is forecasted to contract by more than 4% - more than twice as deep as compared to the 2009 global financial crisis.

There are four main factors that risk managers, insurance managers and brokers must consider carefully when it comes to the impact that the current crisis will have.

Impact on growth

The first factor is growth. We are experiencing the sharpest recession since the 1930s and that will inevitably have an impact on demand for insurance, with companies having less discretionary spending for insurance than they had in the past. However, the insurance industry was well-prepared entering the crisis and so it is likely to bounce back strongly when the economy recovers.

Swiss Re Institute says it expects the insurance industry to be back to pre-crisis levels in terms of premiums during the course of 2021. In fact, Irina Fan, Head of Insurance, Market Analysis, argues that the current crisis could actually accelerate demand for risk transfer products - in particular those in the alternative risk transfer solution space like parametric insurance, captives and structured multi-year solutions. Such products can provide longer term certainty with respect to price and capacity and fill the protection gaps left by conventional insurance products.

She explains: “Many companies were taken back by the extent of disruption caused by the COVID-19 pandemic which has really triggered a rise in risk awareness whether that is from the business side or is from the individual side. On the corporate side, we see risk managers relooking at their own risk registers for other risks that they might not have had on the radar and left uninsured. That’s why I would say it has the potential to create increased demand for insurance coverage.”

Low interest rates for longer

Low interest rates are hardly a new phenomenon, but rather than predicting when they will start to rise, experts are now broadly in agreement that they are here to stay for the foreseeable future.

Astrid Frey Kaufmann, Chief Economist Europe at the Swiss Re Institute said: “We will see negative interest rates cemented in the eurozone for the time being and interest rates in the United States have dropped below one per cent, central banks in Asia have kept interest rates at/near historical lows, so the challenges for insurers will be reinforced.”

The implications on the insurance market could be significant. Fan explains: “We recently carried out analysis which showed that non-life insurance markets are constantly operating with below average profitability. It showed that by 2019, all the major G7 markets had a profitability gap of about 6 to 9 percentage points if they wanted to meet the expectations of the investor for a reasonable ROE.

“From today onward up to 2021 we project further decline in the interest rates, which will actually widen this profitability gap so it will run for another 1-3 percentage points.”

That means that even though prices are increasing there’s a gap of seven to 12 percentage points before you can really meet the reasonable ROE, so more rate increases are needed to ensure sustainability of the industry. Where we’ve seen a hardening market trend since 2019, COVID-19 will accelerate this.

Massive central bank and fiscal actions keep a lid on systemic risk

The third factor that the industry must consider is those financial developments beyond interest rates – particularly in the form of Central Bank intervention. While equity and credit markets have shown remarkable resilience thus far, this has largely been as a result of fiscal and monetary stimulus. And today, the fiscal stimulus launched globally so far has been more than the aggregate of the last 50 years.

The status quo is extremely fragile, as it depends on future stimulus to be maintained.

Frey Kaufmann explains: “We do think that central bank involvement is here to stay and actually the Fed has just reinforced that put with its most recent framework change, which signifies a shift towards even more expansionary monetary policy.”

“In our baseline, we expect financial markets to be supported by monetary policy. But it’s a fragile situation, and the disconnect between the real economy and financial markets is a risk that we have to monitor.”

Inflation ahead

The final factor to consider is the risk of inflation. In the short term, the risk has decreased due to the massive COVID-19 shock to economic demand. However, medium- to long run inflation risks have increased given the unprecedented fiscal stimulus and potential debt monetization.

There are several ways in which inflation could affect insurers. Kaufman explains: “Everything that’s going on right now suggests that central banks will be tolerating some inflationary build-up before they tighten monetary policy. For insurers, an unexpected inflation spike is a key risk because they have long tail liabilities that have to be met in 10- or 20-years’ time and some of them are linked to inflation.”

Building resilience

Despite the challenges ahead, Fan says that the insurance industry is well-placed to weather the crisis and support economic resilience.

She explains: “For many parts of the world, economic growth is the main driver for insurance premiums. But despite the fact that that we are facing the deepest global recession in our time, the insurance industry is much more resilient thanit once was.

“We’re expecting a four per cent contraction globally due to the current economic crisis, compared to a contraction of less than two per cent that happened after the 2007 financial crisis. However, for insurance premiums we expect similar level of contraction as the global financial crisis. That shows that even though we have a more challenging environment we are able to take on the COVID-19 hit better.”

“More importantly, insurance can play a very important role in bolstering an economy’s resilience as insurance alleviate financial stress to household and business post crisis or disaster, which will also reduce the burden that governments face as you will have private funds coming in to help your economy recover, which help improve the overall societal resilience.”