Diane Nesbit, CPA, is an Audit Partner specializing in insurance carrier audits. She is the leader of our Employee Benefit Plan Practice Group and the Quality Control partner at Larson & Company.

 

Bloomberg Economics say a recession is coming.  A U.S. recession is effectively certain in the next 12 months according to new Bloomberg Economics model projections. The Bloomberg Economics model uses 13 macroeconomic and financial indicators to predict the chance of a downturn at horizons of one month to two years. The deterioration in the outlook was driven by a broad-based worsening in the economic and financial indicators used as inputs to the model, Bloomberg Economics found.

The latest recession probability models by Bloomberg economists Anna Wong and Eliza Winger forecast a higher recession probability across all timeframes, with the 12-month estimate of a downturn by October 2023 hitting 100 percent, up from 65 percent for the comparable period in the previous update. But tightening financial conditions, persistent inflation and expectations of a hawkish Federal Reserve pressing ahead with rate hikes are raising the risk of a contraction. The model is more certain of a recession than other forecasts. A separate Bloomberg survey of 42 economists predicts the probability of a recession over the next 12 months now stands at 60 percent, up from 50 percent a month earlier.

The insurance industry should expect to see these general impacts during a recession:

  1. There will be less demand – As the economy slows down, businesses and individuals have less discretionary income to spend on insurance. As the demand for insurance decreases, the market will become even more competitive.
  2. Investment portfolio returns may decline – With a slowing economy, investment returns on insurance company portfolios will see a decrease.
  3. Companies could face more regulation – Insurance companies might find themselves being under greater scrutiny by regulators who are concerned with solvency of insurance companies. This will mean extra expenditures on compliance and regulations.

 

Recession impact on Property & Casualty insurance

Guy Carpenter tested how pre-defined scenarios could affect the performance of every US P&C company using the BenchmaRQ® capital modeling tool. This report indicates that the US P&C industry is well capitalized; however, a harsh recession could pose potential risks. Of the five scenarios evaluated in the report, the recession example resulted in the greatest depletion of insurance industry surplus, with a nearly 15% reduction compared to the baseline model.

The level of equities and other risk assets held on insurers’ balance sheets has increased steadily since the Great Recession of 2008. The industry’s latest exposure to high-risk investments was the highest it has been in at least the past 25 years–for every dollar of statutory surplus on insurers’ balance sheets at year-end 2020, 79 cents was invested into public or private equity.

This equaled 36% of the total cash and invested assets held by the US insurance industry. Mutual companies in particular should monitor their asset exposures carefully, as the scenario testing shows the typical mutual insurer faces greater exposure to recession risk than does an average stock company.

Recessions also can affect the premium base of an insurer. Based on historical premium changes during recessions over the past 25 years, the negative premium impact of a severe recession was estimated by line of business. Economically sensitive commercial lines could expect a greater impact, where exposure bases such as payroll or sales can decline quickly, sapping premium and enhancing risk of moral hazard from financially stressed policyholders.

 

Recession impact on Life insurance

During the 2022 Insurance Summit in September that was organized by the National Association of Insurance Commissioners, S&P Global Rating life insurance sector lead Carmi Margalit said storm clouds are gathering and it starts with the economy.

Life insurers are on very sound financial footing, Margalit said, which makes recession talk less worrisome. In fact, insurers are probably better equipped to handle an economic disruption than they were when COVID-19 hit in March 2020, he added.

“The industry is actually very well positioned to handle that,” he explained, “both in terms of just the capital that they have to withstand it and some of the actions that the industry has been taking to prepare in terms of the pivoting to higher levels of credit, higher levels of liquidity in anticipation of a potential recession.”

One noticeable trend is the shift in investment allocation among private insurers, Margalit said. The result is a more risky portfolio with a higher percentage of lower-rated securities and other investment options. Insurers simply cannot get the safe return they could 10-15 years ago from a portfolio based in high-rated corporate bonds, Margalit pointed out. There is a trend among more traditional insurers to invest in more risk, Margalit said.

“They do have to make up those earnings, those yields somewhere,” he said. “From a risk perspective, we do think that there is some value to doing that. But it does definitely bring more risk to the investment portfolio and through that more risk to the insurance company.”

While it is expected that a recession will have an impact on the insurance industry, it seems that with appropriate strategic planning,  the industry will be well positioned to limit any significant negative impacts as a result of an economic recession.

Sources:

https://www.bnnbloomberg.ca/forecast-for-u-s-recession-within-year-hits-100-1.1833622

https://www.spixii.com/blog/the-economy-is-slowing-down-what-does-it-mean-for-insurance-companies

https://www.guycarp.com/insights/2021/12/recession-preparedness-can-provide-advantages-to-insurers.html

S&P: Though recession may loom, life insurers in a good position