Economic uncertainty is high, with recession and inflation risks still elevated, an environment which underlines the importance of scenario planning for insurance and reinsurance providers, according to a recent Swiss Re Institute report.
The world economy will continue to slow gradually, growing only 2.2% in real terms next year, down from 2.5% in 2023, and 3% in 2022. Still, the report expects inflation to remain above central bank targets through 2024; the tenuous growth outlook is rooted in advanced economies.
Amidst these challenging conditions, the Institute expects the insurance industry to demonstrate resilience over the next two years. Nevertheless, slow growth, elevated inflation and the resulting uncertainty around the economic outlook will present challenges for insurers, and risks are to the downside. Hence, two distinct and more adverse scenarios should be considered: a severe global recession and 1970s-style stagflation.
“A global recession would generate unfavourable macro and financial conditions, with sharp slowdowns in economic growth, falling interest rates and significant financial market losses. A scenario of 1970s-style stagflation would bring severe inflation amid stagnating growth,” said the report.
For now, the risks of either scenario playing out appear contained. Still, developments that could portend a shift to one of the alternatives include unanticipated inflation persistence or reacceleration, renewed energy price pressures, monetary policy mistakes, and/or financial market distress.
The report said that a severe global recession would hit both sides of insurers’ balance sheets and raise solvency concerns. Contracting demand would lead to falling nominal premium growth in both non-life and life insurance. Together, lower interest rates, widening credit spreads and asset price declines would generate negative investment returns.
The report said, “For life insurers falling incomes and rising unemployment would likely see premium volumes contract with savings products most affected due to the added impact of low interest rates. In non-life, however, lower inflation and economic activity would reduce claims relative to our baseline.”
A 1970s-style stagflation scenario would stress underwriting performance most. “Demand for both life and non-life insurance would be curbed and non-life insurers would be most exposed to the inflation shock through increased claims severity and weakened profitability. As rates rise to meet claims costs, nominal premium growth would be strong but high inflation would result in lower real premium growth than in our baseline scenario,” the report said.
The good news is that the insurance sector entered 2023 with solid capital buffers and solvency and liquidity positions were well above 100% and only slightly below pre-COVID levels.
However, mitigating potential downside scenarios is not about capital and risk management alone. It is also about recognising that strategic actions can come with long lead times, such as repricing risks and steering new business to lower-risk products, both of which take time. And, while asset allocation and other hedging tools enable more agile management of investments risk, repositioning still must consider capital requirements and liquidity needs. M