The Spectre of Protracted Inflation – How insurers can prepare and respond
The first in-person gathering of The Geneva Association Economic Forum (GAEF), hosted by SCOR in Paris, brought together chief economists and chief strategy officers from 20 major re/insurance companies and trade associations. The meeting was dedicated to the return of inflation, exploring the following questions: How persistent will inflation be? How can policymakers tame it? How are re/insurers affected and how can they respond?
Dinner address: François de Varenne
Member of the Executive Committee, Investments, Technology, Transformation and Group Corporate Finance, SCOR; CEO, SCOR Global Investments.
François de Varenne set the scene by highlighting the alarming nature of inflation’s return. The fiscal and monetary policy mix over the past few years has proven favourable to inflation, with geopolitics and the resultant energy and food crisis further exacerbating the phenomenon. With conditions for structural inflation such as deglobalisation already met, the shock is expected to persist. Sovereign interest rates increasingly reflect the uncertainty surrounding the inflation outlook and public debt stress indicators are sharply up. Corporate debt is characterised by widening spreads and increasing default probabilities. Equities, after an initial plunge, have recovered on the back of resilient earnings but remain vulnerable to interest rate hikes. Home prices also continue to increase, despite rising mortgage rates.
Session 1: Inflation Outlook and Scenarios
Jérôme Haegeli, Group Chief Economist, Swiss Re (chair); Constance Hunter, EVP - Global Head of Strategy and ESG, AIG.
There was general agreement that inflation will ultimately come down, in response to more restrictive monetary policies. Policymakers should not lose sight of existential threats such as the climate crisis, geopolitical dislocations and increasing economic inequalities which, of course, are linked to inflation and the subsequent erosion of real wages and savings as well as the energy crisis in Europe.
In order to tame inflation – which is a prerequisite to economic stability – a recession may be inevitable, especially in countries where inflation is demand-driven such as the U.S. It was also emphasised that during the pandemic, governments spent three times more (in terms of quantitative easing and fiscal stimulus) than in response to the Global Financial Crisis. However, it remains to be seen whether central banks will make use of their powers and assert their political independence in fighting inflation if a recession is the price to pay. The European Central Bank in particular might favour higher inflation to maintain stability in the Eurozone’s highly fragmented sovereign debt markets.
A repeat of the multi-year elevated inflation experience of the 1970s was not considered likely as current monetary policies differ fundamentally from half a century ago. However, inflation expectations need to be monitored and managed closely.
This session also touched upon the key distinction between cyclical and structural drivers of inflation. Cyclical factors include the post-pandemic pent-up demand for goods, supply chain bottlenecks and the war in Ukraine. Structural drivers include demographic shifts (which, for example, push up wages for home care workers), deglobalisation (e.g. the reconfiguration of global supply chains (‘onshoring’)) and decarbonisation associated with a more asset-heavy type of economic growth.
Session 2: Policy Options to Control Inflation in Times of Mounting Public Debt
Ludovic Subran, Chief Economist, Allianz (chair); Gilles Moëc, Chief Economist, AXA & AXA IM.
This session further explored the challenges facing central banks. On one hand, the need to restore their (damaged) credibility and bring inflation down fast and on the other hand, the need to consider the trade-off between interest rates and economic growth.
The session also highlighted the differences between the U.S. and Europe. In America, surging inflation reflects excess demand as a result of an aggressive fiscal stimulus in response to the pandemic. In addition, wage increases are driven by declining labour market participation, and inflation expectations are de-anchoring. By contrast, in the EU, there is no excess demand, no overstimulation and no wage inflation so far. A major defining determinant of monetary policy is the fragmentation of government debt and keeping public debt sustainable for a number of Eurozone countries.
Michael Grady, Head of Investment Strategy & Chief Economist, Aviva Investors; Uwe Siegmund, Chief Economist, R+V Versicherung; Jad Ariss, Managing Director, The Geneva Association.
Despite monetary tightening across the globe, real rates remain clearly negative and far from their neutral level of 2–3%. Therefore, monetary policies continue to be accommodative.
It was also stressed that monetary policy is not the only ‘game in town’ when it comes to fighting inflation. Trade policies resulting in tariff cuts, competition policies driving decartelisation and a further deregulation of labour markets could, in principle, all help bring inflation down. Unfortunately, the trend towards protectionism is doing exactly the opposite.
Also, with fiscal resources strained precisely when people expect more fiscal action to prop up the economy, taxation becomes ‘the elephant in the room’, especially as zero interest rates have benefited the rich.
Keynote speech: Laurent Rousseau, CEO, SCOR
Laurent Rousseau, CEO, SCOR SE.
In his address, ‘Building Resilience in a Transitioning Macro-economic Environment’, Laurent Rousseau, CEO, SCOR, pointed to the suddenness of the current bout of inflation. Central banks now concede that ‘they know that they did not know’, having misread the threat of inflation. Now they are under pressure to take forceful action against inflation which makes a recession ever more likely.
For insurers and reinsurers, there are particular challenges presented by the current environment such as the fact that P&C claims inflation (e.g. the cost of motor maintenance, repair, parts and equipment) often exceeds consumer-price inflation. The risk of recession needs to be monitored very closely as the profitability of P&C business is very much correlated with the economy, given its shift towards ‘economically sensitive’ lines of business such as D&O, credit & surety and business interruption.
Laurent Rousseau also argued that the current inflationary environment and normalisation of monetary policies will favor re/insurers that prioritise risk-taking over risk-trading as well as price-making over price-following. As a result, re/insurers would get closer to their customers’ risks.
Session 3: The Insurance Industry Perspective: Implications and responses
Philippe Trainar, Director, SCOR Foundation for Science (chair); Vinicius Marinho da Cruz, Group CFO, Bradesco Seguros; Olav Jones, Deputy Director General & Director Economics and Finance, Insurance Europe.
The final session took a deep dive into the insurance ramifications of rising inflation and interest rates. From a global perspective, inflation is not an entirely new challenge for insurers, given persistent double-digit inflation regimes in a number of emerging markets. Historically, low interest rates are a phenomenon the industry is less familiar with. From that perspective, the normalisation of interest rates is a very positive development. It makes high, in-demand, guaranteed life insurance products more feasible and pension investments more attractive. On the other hand, inflation has a negative impact on P&C claims ratios, given the repricing lag. For life insurers, increasing lapse rates present challenges. More generally, the current cost-of-living crisis weighs on discretionary insurance-buying as it makes insurance less affordable. Also, a protracted inflationary environment can diminish the perceived value of insurers for customers, with negative effects on market growth and insurance penetration.
In terms of insurer responses, the session discussed asset-liability management (e.g. a shift to inflation-linked investments), reserve adjustments, repricing, the use of reinsurance, product innovation (e.g. a shift to fixed payouts), more emphasis on loss prevention and improvements in operational efficiency.
In general, the insurance industry is well-equipped to cope with the current inflation challenges, having shown its resilience to the Global Financial Crisis, the increasing frequency and severity of natural disasters and the COVID-19 pandemic. What’s more worrying are the socio-economic implications of inflation, such as rising economic inequalities and a potential delay in the green energy transition.