The importance of supporting resilience in times of crisis

The world is being shaken by the second severe global shock within two years, with deep consequences for the global economy, international relations and societal resilience. The war in Ukraine is significantly negative for both economies and geopolitics and a new world order is emerging from it.

The war has created stagflation-like effects in major economies, intensifying already-high inflation and weakening economic growth, as we forecast. With food and energy prices most impacted, it is exacerbating a cost-of-living crisis for people worldwide. We are concerned about rising food insecurity, particularly in emerging markets. The World Food Programme estimates that 276 million people globally face acute food insecurity this year, more than double the number in 2019.

Central banks are aggressively hiking interest rates to fight inflation, but this is choking off economic growth. The risk landscape today is substantially worse than it was three to six months ago because of this daunting inflation-growth trade-off, across all advanced economies but particularly the UK, where inconsistent monetary and fiscal policies are exposing the country to very high risk of “fiscal stagflation”.

Elevated inflation is creating pain points for parts of the insurance industry. For P&C insurers in many economies the inflation shock means higher claims, particularly in property and motor, as price rises in construction and car parts outstrip the wider economy. If wages and healthcare costs rise, claims in longer-tail lines of business such as liability are expected to increase as well. Interest rate rises may bring some relief, as higher investment yields will in time benefit insurers' profitability, but volatile capital markets will likely weaken investment returns in the short term.

For life insurers, sustained high inflation has primarily indirect effects, as rising interest rates support profitability. Investment results benefit as bond portfolios roll over into higher yields, while the profitability of saving products with guarantees – a large legacy book of the life industry – improves. The nature of fixed-benefit products insulates them from claims inflation, though indemnity-based health insurance is exposed to claims pressure in the near-term. However, the erosion of consumers’ disposable incomes, and the value proposition of (in-force) saving policy benefits, result in higher rates of lapse and surrender. This would decrease societal resilience to mortality and health risks.

We see a growing risk that inequality within countries will widen, with consequences for societal cohesion. Economic shock events tend to disproportionately affect lower-income households and poverty rates – seen today as households feel the pinch from higher food and energy prices and the gap between the "haves" and "have-nots" widens.

Our research into income inequality finds that it challenges the concept of fairness at the heart of the social contract - the implicit agreement between a country's citizens and state over the rights, duties and expectations of each in order for society to live peacefully together. This can open the door to more extreme politics and episodes of unrest.

Sustained high income inequality is negative for economies, as it reduces productivity and aggregate demand and thus growth; it is negative for financial markets, which benefit from more equitable division of income across societies; and for financial stability, for example as it can lead to households becoming more indebted.

We also find that higher or rising inequality impacts insurance demand. In advanced economies that have become more unequal since the 1990s, there has been almost no growth in insurance penetration. We find that in advanced economies, household insurance protection would have been about USD 252 billion higher than actual in 2019 had equality remained at 1990 levels.

The reverse is also true: higher income equality and insurance form a virtuous circle: higher insurance coverage supports a more equal society by helping households recover from a financial shock. Growth, in turn, boosts insurance demand.

The geopolitical ramifications of the war in Ukraine are likely to be more far-reaching, long-lasting and significant than even the macroeconomic impact. This year has dramatically disrupted international relationships, security decisions and the global balance of power.

We see a new world order emerging, one with a much stronger focus on defence and energy security. We expect revisions to national defence budgets and restructuring of energy supply chains, especially in Europe, to redefine global relationships. For example, Germany has pledged to reach the full NATO spending goal of 2% of GDP on defence. The EU is discussing joint bond issuance to fund energy and defence spending.

Such transformation has immediate implications for insurance companies in their roles both as risk absorbers and investors. This new world order will be more cautious about extending global supply chains worldwide, given heightened geopolitical and security risks. We see the trend to reshoring of supply chains, begun in the financial crisis and accelerated during the COVID-19 pandemic, evolving further. We expect the concept of "friend-shoring", in which supply chains rely on countries that are trusted allies, to take hold to reduce uncertainty around commercial activities.

As long-term investors, insurers play a vital role in allocating capital to investment opportunities with strong performance on ESG criteria as well as financial returns. While the E in ESG – for environmental issues – has taken precedence so far, we expect the new world order to balance environmental awareness with greater emphasis on the “S”, for social issues, and the "G", for governance.

The current crisis poses a challenge to resilience for policymakers worldwide. The global economy is less resilient to shocks today than it was in 2007, before the global financial crisis. Countries with higher income inequality and lower levels of economic resilience are at higher risk of food insecurity because in these countries, a greater share of household expenditure is spent on food. We advocate governments rebuilding their fiscal and monetary buffers against future shocks, while enacting a progressive mix of policies to support those in need and narrow inequality.

The insurance industry can support resilience by ensuring households are protected from shocks that could leave them poorer, such as the death of a breadwinner or damage from a natural catastrophe. Working with governments and other public sector stakeholders, the insurance sector can play a role in expanding insurability, broadening access to insurance protection, and supplementing social security systems with private sector-based solutions.

The environment we are in now may offer the insurance industry one silver lining, as rising interest rates will in time benefit insurers' investment returns. The most recent rate hikes have lifted the last European countries out of negative nominal interest rates, and we believe this era is now over for good. Finally, "risk-free" does not mean "return-free" any longer.

_{Article first published in the 2022 magazine of the Portuguese association of insurers (APS).}