Interest rates are likely to rise slowly near-term, giving a moderate lift to insurers’ investment income and balance sheets.
The currently low inflation rate will keep growth in claims payouts in check. And a successful transition by China from an export- to consumer-driven economy could prove to be a boon to U.S. insurers do business there.
These were three of the more optimistic forecasts aired during a kick-off panel discussion among economists at Standard & Poor’s 2014 Insurance Conference, held on June 4th at the New York Marriot Marquis in New York. Three experts — chief economists from Standard & Poor’s, HSBC and Swiss Re — explored the likely direction and impact of key economic indicators, as well prospects for continuing growth in advanced and emerging economies.
The panelists concurred that economic growth globally will hover in the two to three percent range, a level measurably below that of previous growth periods. What accounts for the economic drag?
Kevin Logan, the U.S. chief economist at HSBC, attributed the current “secular stagnation” to the 2007-2009 recession, which continues to “cast a long shadow” over the post-crisis recovery. Among the reasons: A continuing deleveraging of mortgage and commercial debt accrued during the real estate bubble; overly restrictive credit/lending policies by banks; and a hesitancy among businesses to invest in new plant, equipment and labor. The cautious business environment is contributing to historically high unemployment levels and to depressed wages.
“Yes, the stock market is up, but investment gains are not generating enough new business spending,” says Logan. “Wealth is concentrated among the affluent. The vast middle class is not spending. Once business investment picks up, then we’ll see more economic optimism.”
Turning to monetary policy, Logan added that interest rates should remain low for “an extended period.” Though the Federal Reserve’s goal is to “normalize” (raise) rates, the Fed is moving slowly because of continuing “slack” in the economy (i.e., a higher than desirable unemployment rate and subpar economic growth).
The near-term outlook, then, is for the Fed to continue to buy Treasury notes, thereby increasing the money supply and keeping short-term interest rates close to zero. Any update in short-term rates, he added, will happen “very slowly.” Thomas Holzheu, chief economist of North America at Swiss Re, forecasted that interest rates will begin to rise by year-end. Though the rise will be good for insurers by availing them of additional investment income, the moderate increase will happen at a “measured pace” over a two- to three-year time frame.
Paul Sheard, executive managing director and chief economist at Standard & Poor’s Rating Services, added that interest rates, both short- and long-term, are “headed in the right direction.” Among them: the benchmark Federal Funds rate (the interest rate at which banks actively trade balances held at the Fed), which Sheard expects to rise to 2.25 percent by 2016 from the current 0.09 percent. But echoing the other panelists, he agreed the Fed will “move cautiously” in raising rates so as not to negatively impact the economic recovery.
Another variable affected by monetary policy, inflation, has remained since the end of the recession below the central bank’s objective: a rise of two percent annually. Logan attributed the below-target increase to deflationary pressures affecting goods and services.
“Global economic integration and a vast increase in the supply of goods and services is keeping inflation low,” said Logan. “For insurers, this means that policy premiums are likely to remain at or near current levels. As long as inflation remains below target, the Fed will have room to let the economy grow through an accommodating monetary policy.”
Sheard added that recent Fed policy, notably several rounds of “quantitative easing” (purchasing a predetermined quantity of bonds or other assets from financial institutions without reference to the interest rate) has not, as many observers have feared, boosted prices to unacceptably high levels. The policy has, rather, forestalled a deflationary spiral.
“There’s a misunderstanding about quantitative easing,” he said. “The Fed’s expansion of the money supply doesn’t necessarily lead to credit creation. The money supply is context-dependent. And in the current economy, the challenge is to battle [undesirably] low inflation.
“The Fed has the tools to achieve its monetary objectives,” he added. “But these tools are not magic bullets. They have to be used judiciously and with discipline.”
Holzheu observed a “loose correlation” between the inflation rate and the valuation of policy claims, particularly in the property and casualty arena. Factors underpinning the growth in claims payouts are wages and healthcare expenditures.
Holzheu expressed optimism that growth in claims will remain at tolerably low levels near-term.
“As long as wage and health care inflation remain low, claims growth will stay low as well” he said. “If and when economies return to full employment, then we’ll see higher wage growth and health care expenditures, and thus a pick-up in claims payouts.” The panelists prognosticated as well on growth prospects in the Eurozone, an economic and monetary union of 18 European Union (EU) countries that have adopted the euro as their common currency. Sheard said he expected the region’s growth to hover at a subpar one percent level, below the two percent pre-crisis peak.
Buffeting the Eurozone countries is a continuing drag from the Continent’s sovereign debt crisis: economic and financial woes resulting from the perceived inability of Eurozone countries (including Greece, Italy and Spain) to make good on their government bond obligations.
Complicating the Eurozone’s recovery is an unwieldy governing framework. While sharing monetary policies through a common European Central Bank (ECB), the Eurozone countries have no fiscal union. Result: Often conflicting and fiscally irresponsible policies.
“This arrangement has limited the ECB’s ability to carry out aggressive policies needed to address the Eurozone’s economic problems. Because of constraints on the ECB, the central bank is playing catch-up.
“The region’s economic situation is still severe,” he added. “Unemployment, particularly in southern Europe, remains quite high.”
Turning to the Far East, Logan observed that China — which now boasts the world’s second largest economy — is contending with challenges of its own. Chief among them: China’s plans to maintain growth by transitioning from an export- and manufacturing-driven economy to one fueled by domestic consumption.
Should China falter in the process, he warned, the repercussions would be worldwide owing to the country’s increasingly tight integration with other economies, both advanced and developing.
If China succeeds in the effort, however, the benefits will also be far-reaching — not least for U.S. insurers looking to do business in the country.
“The shift from an export-dependent to a consumer-driven economy has interesting implications,” said Holzheu. “A one percent increase in economic growth could yield a two to three percent gain in demand for insurance products.
“China’s insurance sector, already among the top 10 worldwide, is enjoying double-digit growth,” he added. “I see a very bright future for Chinese insurance market.”