“Recession coming faster than expected” – Swiss Re economist

Two weeks ago, Canada’s central bank raised its key interest rate by one percentage point to 2.5% to tame inflation, the biggest increase in 24 years. Inflation in Canada reached 8.1% in the year to June, its highest level in nearly three decades. Meanwhile, the U.S. consumer price index rose to 9.1 percent in June, a 41-year high that could prompt similarly aggressive policy tightening by the U.S. Federal Reserve.

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

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

“In the long term, there is a gradual increase in the return on investment, so that is a positive impact [for the insurance industry]. But the immediate impact is that bond portfolios are losing value at market valuation, so there is some stress on insurance companies’ balance sheets with equity indices going down and interest rates going up,” Holjew noted.

The alleged shock

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

Auto insurance remains among the most affected lines. Supply chain problems that began during the pandemic will continue to drive high costs for used cars and spare parts. Holzheu explained: “Car repair costs, and consequently car insurance claim costs, will continue to rise due to rising material costs and supply chain disruptions.

“The other sector that is specifically affected is construction. Part of this also has to do with rising material costs and supply chain issues. But there is also very strong demand for housing and home renovations – additional demand during and after COVID [lockdowns] that was unusual. That’s a lot of pressure on spending in 2022, but that’s expected to continue into next year.”

In accident queues, Holzheu pointed to wage inflation, health care costs and a tight labor market as key drivers of claims costs. Rate hikes are seen as continuing as insurers play catch-up with skyrocketing prices.

Read more: Swiss Re forecasts global insurance premiums

“We expect the rate increases we’ve seen going up for commercial lines over the past few years to continue. In personal lines, where the rise in claims costs has been more recent, we are also seeing an acceleration in U.S. rate filings,” Holjew said. Swiss Re set 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 speed amid the pandemic. Forecasts for more deals this year were upbeat after an upbeat 2021: total deal volume rose 40% year-on-year, according to Deloitte research, as insurance companies thrived amid the pandemic and sought to diversify their operations.

Read more: Does economic volatility affect M&A dealmakers? – WTW report

While it’s hard to predict how the coming recession might affect M&A activity, Holjew noted that times of economic uncertainty usually sow the seeds for consolidation.

“A time of high financial volatility does not lend itself very well to deal execution. But further down the line, if there is developing stress on the balance sheet due to market disruptions or insurance claims costs, that usually leads to further consolidation and strategic reorientation,” he said.

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