Changing interest rates post-Covid-19 create a new world of opportunities and challenges for investment teams at insurance companies, says Thomas Holzheu, Chief Economist, Americas, Swiss Re.
Despite this, he warned that there will be repricing to consider.
“Our baseline is that there will be a relatively
shallow recession.”
In a recent Clear Path Analysis report, “Insurance Asset Management, North America 2022”, several senior industry players – including Holzheu – talked about the major trends in investment areas of insurance and what factors stakeholders need to consider throughout 2023.
Holzheu was asked about the credit and rate cycles – and whether interest rate and currency risks will see a “soft landing” after the rises last year, and, if so, how to prepare for it. “Our baseline is that there will be a relatively shallow recession,” he said. “Because interest rates will stay high and therefore not be supportive of growth, the recovery needs to happen against headwinds.” He added that he saw slow growth in 2024, which would eventually return to normal growth later.
However, these comments came before the recent shake-up due to the Silicon Valley Bank collapse and the UBS buy-out of Credit Suisse. A recent analysis from Morningstar predicted that even with these changes, a recession in the US was a clear possibility. “If the economy enters a recession, we still expect it to be short and shallow, with moderate growth returning by early 2024,” Morningstar said in the market comment.
Holzheu said that he foresaw the trend of higher interest rates and growth challenges becoming the new normal for at least a few years. “[This] will also be a positive development compared to the prior decade where the insurance industry had to deliver returns on portfolios in a repressive interest rate environment,” he continued.
“There will be repricing, so you get more yield for the neutral rate and
also more term and liquidity premium.”
“The economy will enter a phase where inflation needs to be contained and interest rates be higher than pre-Covid,” said Holzheu. The OECD agreed with this statement, commenting in March that inflation was “stubbornly high”, requiring further action to bring things under control. “This is good for the insurance industry overall, which is long in interest rate risk,” he said. “There will be repricing, so you get more yield for the neutral rate and also more term and liquidity premium.”
Along with these trends come other aspects of risk-return calculations, he said – which have been distorted for the last decade, but can now return to a more historically normal equilibrium. “The path to getting there is a bit ugly though and we may have more market-to-market losses,” he added.
Whilst this repricing phenomenon will mean new opportunities, there are other considerations as well. Investment decisions must take current market movements into account holistically, rather than only considering one set of macroeconomic factors.
“For asset allocation, asset liability management, and enterprise risk management, we look at economic scenario analyses as we feel it is quite critical in these times,” Holzheu said. “Currently, we live in two tail risk scenarios with Covid-19 and 8-10% inflation. These types of scenarios are part of risk, capital, and liquidity management.”
Holzheu added that insurance companies must be prepared for these extreme events on the liability and asset sides, learning to adapt business plans depending on how revenues and expenses change in such scenarios.
“We see that the profitability was severely affected if inflation would get stickier.
There is a rotation of inflation from goods to service inflation."
The wider economic impact of such changes throughout 2023 should also not be ignored. “There are the possible market liquidity risks, we have rising interest and policy rates which are designed to fight inflation and you have inflation risks, which is one of the key profitability drivers for non-life insurers,” he said.
“We see that the profitability was severely affected if inflation would get stickier. There is a rotation of inflation from goods to service inflation. We have seen the first signs of easing in energy and goods inflation and most likely, inflation has peaked in the US and some emerging markets.”
Sticky inflation means prices adjust slowly, and they do not adapt as quickly to evolving changes in supply and demand, which can lead to persistent inflation.
In February, ING said US inflation was remaining sticky but a slowdown was coming. The analysis added that US core inflation was continuing to track above the 0.2% month-on-month prints required to get annual inflation down to the 2% target over time.
Holzheu said he was especially concerned to see sticky inflation in the services sector, which could mean degraded economic confidence over time.
