Swiss Re's economists predict that growth in the insurance and reinsurance industry will continue to accelerate in 2011 but warn that financial turmoil could derail the global economic recovery. Industry capitalisation exceeds pre-crisis levels; premiums are growing in most segments and most countries; and many emerging market countries are performing particularly well. Profitability is set to remain under pressure, however, since investment returns are dampened by low interest rates. Reinsurers will need therefore to maintain underwriting discipline. Looking ahead, a key problem is that regulatory factors will force insurers into low-yielding government bonds, increasing the risk that they miss out on a market upturn.
"The global economy expanded modestly in 2010 and is expected to show moderate growth through 2011," Kurt Karl, Swiss Re's US Chief Economist, will say at the company's Economic Forum conference call this morning. "Developed and emerging markets have parted ways on growth, with emerging markets booming while developed economies are growing at a more modest pace – a situation that is set to continue in 2011 and 2012. Monetary policy in the major economies is not expected to tighten substantially next year, because inflationary pressures remain subdued and certain EU economies face fiscal crises."
Growth in developed economies is expected to accelerate slightly in 2011 and 2012, but will remain close to its long-run averages of 2.5%-3% in the US, 1.5% in Japan, and approximately 2% in Europe. Emerging markets are forecast to grow rapidly next year, leading to increasing inflationary pressure in several markets. Benchmark interest rates in developed economies are expected to remain low through the end of 2011 but long-term interest rates will rise gradually as the world economy improves.
Financial market turmoil remains a risk to recovery
A risk remains that the economic recovery will be derailed by renewed financial market turmoil, resulting in part from a potential widening of the Euro zone debt crisis. Kurt Karl will say: "Although the recovery is nearly 18 months old and broadening, investor trust in its continuation is still weak. Instability continues in several important real estate markets including the US, Ireland and Spain. Despite the support received from the International Monetary Fund and the European Union, there are still concerns as to whether Greece and Ireland can cope with the problems they face."
Low interest rates as a result of expansionary monetary policy in developed economies remain a key challenge for insurance companies. Thomas Hess, Swiss Re's Chief Economist, will say: "Insurers, pension funds and private savers are paying for the cheap financing of governments, and for households and corporations that borrow."
According to Swiss Re's economists, the risk of over-regulation in the insurance industry also remains high. While the EU Solvency II regulatory initiative is generally welcome, it is likely to lead to higher capital requirements for many insurers if the implementing measures stray too far from the original economic-based principles.
"Regulators' overly conservative view of the insurance sector is not justified: insurers emerged from the crisis largely unscathed and banks were found to be the source of the problem. While the insurance industry does not object to being part of systemic risk monitoring efforts as a means of averting future crises, it opposes the systemic risk supervision of insurance groups because its core insurance activities are not a source of systemic risk. Efforts should be dedicated instead to enhancing group supervision," Kurt Karl will add.
Primary insurers’ balance sheets improved further in 2010; non-life market seen hardening as early as 2012
Premium growth in non-life and life insurance is expected to accelerate in 2011, benefiting from the economic recovery and further improvements in financial markets.
Expected growth for non-life insurance in developed economies is 3% after inflation and in emerging markets between 7% and 8% after inflation. Non-life premium rates have been deteriorating now for several years. "Current rates are not sustainable even when interest rates start to correct. A correction in premium rates is overdue but we may have to wait until 2012 for that to materialise," Thomas Hess will say.
The primary Life & Health sector is recovering. Global premium income in this sector was up by 4.3% in 2010. The primary life insurance industry will be back on track in 2011 but low interest rates will continue to weigh on profitability.
Moderate growth seen in life and non-life reinsurance
Non-life reinsurance is currently faring better than the primary non-life insurance industry. For 2010, a combined ratio for the industry of 96% is estimated, helped by releases from prior year claims reserves. Insured losses in 2010 are close to the long-term average for the industry – high losses during the first half of the year were offset by a benign US hurricane season. Growth expectations for the non-life reinsurance industry are moderate but profitability is expected to erode as rates decline. Companies that can deploy superior underwriting skills to navigate towards the right segments and risks will have a competitive edge in the coming years.
Life reinsurance is expected to grow moderately overall, with stagnation in industrialised countries offset by annual growth of around 10% in emerging markets. Longevity and large transactions are particularly interesting potential growth areas for life reinsurers operating in mature markets.
Booming emerging market growth set to continue
"The emerging market countries performed well during the financial crisis of 2007-2009, partially due to the strength of China, which continued to import raw materials and was only minimally affected by the global downturn," Kurt Karl will say. "Because these countries have been growing well and recovered robustly, they are now close to their growth potential, so inflationary pressures are rising."
The outlook for emerging market economic growth remains favourable in 2011, with rising consumer sentiment, supportive government policies and improving labour market conditions all set to boost domestic demand in the near team. Over the next decade, the global economy is expected to expand on average by 3.8% annually. In the period 2011-2021, emerging markets as a whole are forecast to grow twice as fast as industrialised economies – at 5.9% versus 2.4%.
Insurance industry has recovered from crisis but faces asset management challenges
Insurers applied increased discipline in asset management in the wake of the financial crisis and successfully reduced the risks in their asset portfolios. A confluence of forces – mark-to-market accounting, risk-free discounting, and heightened capital, regulatory and ratings standards – is pressuring investors to allocate more to lower-risk, lower-return assets. Focus on disciplined underwriting has not been fully able to compensate the decline in investment income that results from lower interest rates. Regulatory standards that require insurers to invest more in such assets could ultimately lead to higher premiums for policyholders. The cost of reduced insurance asset diversification will also eventually be felt in the real economy.
"Insurers are pivotal institutional investors, accounting for USD 22 000 billion in global financial assets," Thomas Hess will say. "To efficiently and optimally manage these assets, insurance asset managers need the flexibility to prudently diversify their portfolio. Excessive regulatory restrictions could compromise investment performance, also for policyholders, and prevent insurers from fulfilling their role as long-term providers of capital and as investors that support financial market stability."