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Higher returns, higher risks: industry adjusts to new interest rate era 

The end of the era of “financial repression” will transform the general insurance industry as it achieves higher returns from investments, but further market hardening is still expected, a global report from Swiss Re warns. 

Almost 95% of central banks have raised interest rates since 2021 to counter soaring post-pandemic inflation – marking the end of a period of extreme low interest rates that followed the global financial crisis. 

The benefit of higher interest rates on insurers’ investments far outpaces the increased cost of capital that accompanies it, the sigma study, “Raising the bar: non-life insurance in a higher-risk, higher-return world”, says. 

This improves profitability and incentivises growth. 

"Our analysis shows that non-life insurers’ profitability is set to improve strongly in the coming years as higher interest rates and rate hardening more than offset higher claims costs from persistent inflation,” Swiss Re Group Chief Economist Jerome Jean Haegeli said. 

Swiss Re expects “a transition year” of improving profitability for most non-life businesses, as underwriting measures adjust to claims trends and higher portfolio yields boost net investment income. 

Despite this, the global industry’s profitability level is “still too low” and demand for protection still outweighs supply. 

“This suggests that further rate hardening and constraints on capacity are likely to continue throughout 2024,” Swiss Re says. 

Demand for insurance coverage has risen since 2017, due to increased natural catastrophes and inflation and higher replacement values raising exposures and losses. 

These factors have particularly affected property lines and have contributed to a hard market in property catastrophe reinsurance as well. 

Profitability in long-tail lines may come under pressure too, with evidence of social inflation and a shift in inflation pressure to services and wages. 

Insurers are also facing heightened modelling uncertainty and investor concerns that the industry is not accurately quantifying loss trends. “Successive years of above-average catastrophe losses have crystallised those concerns.” 

Swiss Re Institute estimates in the US, property and casualty insurance industry capital has grown by 5% annually on average for the past 10 years. Over the same time period, the natural catastrophe protection need has grown at about 7% per year on average. 

The reinsurer warns available risk capital and capacity will remain constrained as “higher interest rates cannot be separated from the inflation surge that prompted them”, as well as social inflation, shocks such as the war in Ukraine, and uncertainty around claims trends, reserves and other risks.

“Capacity restraints are also partly driven by model uncertainty after years of above-average natural catastrophe losses.” 

Given higher demand, elevated risks and limited capacity, more efficient use of capital becomes key for primary non-life insurers.  

Swiss Re says reinsurers can offer primary insurers access to their balance sheets “at costs below insurers' capital costs as their portfolio is diversified across a broader range of geographies and risks”. 

"In the current capital-demanding environment, reinsurance can enable primary insurers to write new business more efficiently, provide certainty for legacy liabilities and support the growth of new business,” Chief Underwriting Officer P&C Reinsurance Gianfranco Lot said. 

“The elevated risk landscape calls for more frequent adjustments to underwriting practices. Focusing on portfolio quality and margins as well as contractual clarity in the whole industry will be key in this respect." 

The report considers worse outcomes under alternative scenarios, including that a renewed inflation surge offsets the benefits of higher investment returns, or a severe recession sees banks sending interest rates back towards zero. 

“Beyond the current cycle, the long-term level of interest rates is also uncertain. A long-term downward trend in rates since the late 1980s is often debated as a guide to the medium- to long-term. 

“It remains to be seen how long the recent inflation episode may tilt future policy trade-offs towards price stability.” 

Click here to read the full report.