‘Recession coming faster than expected’ – reinsurer economist

Two weeks ago, the Bank of Canada raised its key interest rate by one percentage point to 2.5% to rein in inflation, the largest hike in 24 years. Inflation in Canada hit 8.1% in the year to June, its highest level in nearly three decades. Meanwhile, the US consumer price index rose to 9.1% in June, a 41-year high that may prompt similarly aggressive policy tightening from the US Federal Reserve.

Swiss Re has cut its annual GDP growth forecast for the US to 2.0% this year, from a 2.8% forecast in June. It also predicted just over 1% GDP growth in the US in 2023 amid tighter financial conditions and softer consumption activity.

The reinsurance giant also expects the Fed to raise fund rates by 3.50-3.75% as the central bank fights inflation. Higher interest rates will gradually bring benefits to insurers, but the short-term effects pose challenges.

“In the long run, there’s a gradual increase of investment yields, so that’s a positive impact [for the insurance industry]. But the immediate impact is that bond portfolios are losing value on a market-to-market valuation, so there’s some stress on insurance companies’ balance sheets with equity indices down and interest rates up,” Holzheu noted.

Claims shock

The biggest shock to the insurance industry stems from claims costs. The skyrocketing prices of goods will continue to put pressure on underwriting profitability. In its outlook for July, Swiss Re forecast a combined ratio above 100% in 2022 for the US property and casualty (P&C) sector due to inflation.

Auto insurance remains among the worst-hit lines. Supply chain issues that kicked off during the pandemic will continue to drive high costs for used cars and replacement parts. Holzheu explained: “The cost for car repairs, and consequently claims costs for motor insurance, will continue to rise due to the rising materials costs and supply chain disruptions.

“The other sector that’s specifically affected is construction. Some of that also has to do with rising material costs and supply chain issues. But there is also a very strong demand for housing and home repairs – extra demand during and coming out of COVID [lockdowns] that was unusual. It’s very much high-cost pressure in 2022 but that will also be expected to continue into next year.”

In casualty lines, Holzheu pointed to wage inflation, healthcare expenditures, and a tight labor market as key drivers of claims costs. Rate increases are seen to persist as insurers play catch-up with spiking prices.

“We expect that the rate increases we have seen going up for commercial lines for the past couple of years will continue. In personal lines, where the rise of claims costs was more recent, we are also seeing an acceleration in US rate filings,” said Holzheu. Swiss Re pegged premium growth at 8.0% for the year but said growth would slow to 6.3% in 2023 as the US enters a likely recession.

M&A activity

Mergers and acquisitions in the insurance industry have picked up steam amid the pandemic. Forecasts for more dealmaking this year were optimistic after an upbeat 2021: total deal volume rose 40% on-year according to a Deloitte study, as insurance companies thrived amid the pandemic and sought to diversify their operations.

While it’s difficult to forecast how the imminent recession may impact M&A activity, Holzheu noted that times of economic uncertainty usually sow seeds for consolidation.

“A time of high financial volatility doesn’t lend itself very well to the execution of deals. But further down the road, if there’s balance sheet stress developing because of either market disruptions or underwriting claims costs, that usually leads to further consolidation and strategic reorientation,” he said.