How inflation can become a ‘silver lining’ for the insurance industry

Interest rates will keep going up. But that won’t be entirely negative for the insurance industry, or the longer-term fundamentals of the broader economy, suggested a new Sigma report from Swiss Re.

Its authors called for two fundamental changes on the financial side of the global economy. The first—pushed by central banks’ efforts to fight inflation—is an end to the ultra-low, and even negative, interest rates that have characterized much of the last three decades.

And, they predicted, that change should shift investment away from companies that derive value from intellectual property and brand perception, and toward companies that make actual goods.

“This shift is likely to contribute toward reallocating private sector investment away from intangible and towards tangible assets, bringing the financial and the real economies closer together,” Swiss Re said in Maintaining resilience: the role of P&C insurers in a new world order.

That’s positive because it means private investment will ramp up in ways that complement existing public-sector spending on infrastructure, the transition to a green economy and national defence.

“This will improve investment momentum and promote capital-intensive growth and higher productivity,” Swiss Re’s report said. “The private sector, including the insurance industry, will be particularly important in ramping up investment in green infrastructure projects that contribute to a sustainable future.”

And, it cited a World Bank estimate that every US$1 investment in infrastructure that contributes to the green transition has potential to unlock US$4 worth of economic opportunities and jobs.

This transition won’t be inflation-free but it will be driven by more traditional and understandable price-increase drivers, like higher input costs to shift to green power (and rising consumer demand for energy from green sources) as well as rising costs for fossil fuels.

For these reasons, Swiss Re estimates headline Consumer Price Index (CPI) increases in the U.S. will average 0.6% in the years 2024 through 2033. While not in lockstep, Canada’s CPI tends to track similarly to the U.S.

Plus, an “unwinding of ultra-loose monetary policy” in response to inflation is expected to push yields on 10-year U.S. Treasury bonds to 3.5%, from the current 3.2%, by the end-2023.

And those higher yields will create a ‘silver lining’ for the insurance industry.

“Insurers will, over time, benefit from improved investment returns as their bond portfolios gradually roll over into higher yields,” said the Sigma report.

Swiss Re noted the past decade’s low-interest-rate environment has put underwriting results under pressure, “even though the sector profited from mark-to-market gains in risky assets and fixed income investments.

“For 2023, the anticipated increase in interest rates may help ease the pressure on underwriting results.”

Feature image courtesy of iStock.com/joreks