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Swiss Re Economist: Inflation Risk Impacting Both Underwriting and Asset Management

Inflation risk is potentially quickening the Fed's rate hiking schedule becoming a key driver of downside economic risk, said Jake Meyer, senior economist with Swiss Re Institute.

Q: Could you update us on your economic outlook for the insurance industry for 2022?

Jake Meyer: The insurance industry should expect shifting challenges as the economy transitions from a pandemic recession to an overheating recovery. Economic growth has been very rapid in the past year — alongside job growth — and that's leading to the economy overheating and rising inflation as we start seeing job openings extremely high relative to job seekers and price increases as a result of that. That's leading to inflation risk. Where we have higher inflation, that's going to drive higher claims cost in areas like construction, wages, health care, and in autos. Additionally, we have increased economic risk as that rising inflation and quick growth is forcing the Fed's hand into an accelerated policy rate hiking cycle, which could potentially drag on growth and or even lead to the economy in a recession, which would drag on insurers as well. The key themes I would like to highlight would be the recovery transitioned to overheating, and then the onset of inflation risk and economic risk as a result.

Q: Could you expand on the role that inflation is playing?

Meyer: Sure, so inflation is directly impacting insurers by increasing the expected claims cost. This is something that is directly coming out-of-pocket for insurers as the cost of replacing auto parts and construction claims is increasing. Additionally, in a more indirect sense, inflation is the major driver of macroeconomic risk right now. So as inflation rises, what this does is it forces the Fed to potentially quicken their rate hiking cycle. And what that does is it raises the cost of borrowing. It reduces the issuance of credit, and it can drag on financial markets by things like reducing equity values, and just in potentially increasing corporate defaults, and a wide variety of other other issues. So what's happening here is with inflation risk potentially quickening the Fed's rate hiking schedule, this inflation risk is really the key driver of a lot of the downside economic risk that we see, which could affect both the underwriting and the asset management side of the industry.

Q: Could you tell us how you see the ongoing COVID-19 pandemic impacting the global economy?

Meyer: The major risks that we see is from the effects of the pandemic is in emerging markets, and in particular, export markets. For economies in which vaccination rates are high, and have sophisticated healthcare systems, the likelihood of increased lockdowns with the major economic effects that this entails are relatively low — the political tolerance of this is falling quickly. So we don't expect there to be to be a real escalation of lockdowns in the US, for example. Now, that being said, there are there are countries, particularly in East Asia, Southeast Asia, that are key export markets that are pursuing zero COVID policies or have low vaccination rates, where we could see farther lockdowns and farther major restrictions. And if these occur in this negatively impacts supply chains, and we could see a reescalation of the supply chain issues that we're still currently recovering from, and then that could also adds downside economic risk.

Q; What are the biggest challenges you see facing insurance asset managers today?

Meyer: The biggest challenges facing insurance asset managers I would say is the outlook for long-term interest rates remaining low for the foreseeable future. In our view, there are a number of structural sector factors — like high debt loads, demographics, falling long-term growth rates — that are keeping long-term interest rates low and this is a major asset class that insures invest in and so when the returns from these assets are remaining low, that has challenges to the industry. And when you pair that with current conditions where the claim side of it — the costs are rising due to disinflation — we have this dynamic where the need for higher returns is increasing, but the landscape for higher returns is actually worsening. And I would say that is probably the major challenge facing insurance investors today.

Q: How do you see insurers shifting their asset management strategies?

Meyer: One thing that's been happening for the past couple of decades is that insurers have been shifting more towards shorter dated securities, because the risk return profile is a little better and we expect that to continue as we expect long-term rates to stay relatively low for the next few years. Also, insurance investors have been shifting towards more alternative investments such as private equity and such. And we would expect us to continue as the returns from investing in the long-dated securities remains low.