Industry outlook for the insurance market (Q2 2023)
Author: MAPFRE Economics
Summary of the report’s conclusions:
MAPFRE Economics
2023 Economic and industry outlook:
second quarter perspectives
Madrid, Fundación MAPFRE, April 2023
Revisions of the growth estimates for 2023 point to a downturn in the global economy that is less pronounced than initially expected due to various factors, including the reopening of China, the normalization of supply chains and a moderation in energy prices, with global growth that could be around 2.8% (3.4% in 2022), which, consequently, points to a more benign outlook for the insurance business. However, the profitability of insurance companies will remain under pressure from the rising cost of claims and other operating expenses, due to inflation that is beginning to show signs of improvement, but has not fully yielded and remains at high levels.
The normalization of supply chains and energy prices has boosted production in the automotive sector, increasing new vehicle registrations, with the positive effect that this entails for the auto insurance segment, although the tightening of conditions for financing the acquisition of new vehicles may weigh on the business in the coming months. Meanwhile, the rise in interest rates has revived traditional life savings and annuity insurance which, after a decade of low interest rates, had practically disappeared from the market. On the other hand, improved financial profitability for investment portfolios, the foreseeable moderation of inflation and the revision of rates applied in 2023 to offset the increase in claims costs and other operating expenses may help improve the insurance industry’s profitability throughout the year.
Estimated economic growth in 2023 for the Eurozone stands at around 0.6% (3.5% in 2022), once again surpassing the forecasts made throughout the previous year, which indicated a slight recession. Moderation in energy prices and the quick end to the confinements of the Chinese economy have improved the economic outlook for this year. However, this scenario assumes that economic activity in the Eurozone remains modest, as the effects of tightening financing conditions and credit restrictions are transferred to the real economy, which could complicate the outlook for the insurance industry as it materializes and as long as the European Central Bank (ECB) decides to maintain a restrictive monetary policy in its fight against inflation.
The ECB has continued to tighten its monetary policy with a new rate hike of 25 basis points in May, following the two rate hikes of 50 bp each in February and March, leaving interest rates at 3.75% for the main financing operations and 3.25% for the deposit facility, without ruling out the possibility of some additional increase for the next meetings, depending on the inflation data that, although beginning to moderate, remain at high levels for the Eurozone as a whole, standing at 7% in April (6.9% in March), compared to an average inflation of 8.4% for 2022. On the other hand, the ECB’s quantitative contraction program began in March, reducing bond holdings at a rate of €15 billion per month for four months, without altering its roadmap despite the turbulence suffered by the banking sector, but making it clear that if necessary it will use the means at its disposal to stabilize the financial system. This message helped reduce the tension in sovereign bond risk premiums in peripheral countries, which had begun to pick up significantly.
In its analysis of risk-free interest rate curves for March compared to December of last year, the European Insurance and Occupational Pensions Authority (EIOPA) observes a rise in interest rates on the short segment of the curve and a fall in all segments with maturities over two years (which are below the rates for December), which has led to a significant inversion of the risk-free yield curves that affects practically all of its segments, especially maturities of up to five years (see Chart 1).
The rises in risk-free interest rates continue to offering a favorable outlook for the Life Savings business, although the inversion of the interest rate curve has complicated the management of this business, which must adapt to a new environment in which the term premium is negative, more appropriate for products with shorter durations and periodic renewals and more complex for longer-term products such as traditional life annuities. On the other hand, the Euro Stoxx 50 index has gained 11.9% so far this year, through the end of March. In the US market the S&P 500 has gained 7.5%, and, to a greater extent, the Nasdaq Composite, at 17.7%. This improved performance of the indexes (after the drops experienced the previous year), can help the development of life insurance products in which the policyholder assumes the investment risk, which can also take advantage of the higher profitability offered by fixed income in the combination of products launched on the market.
On the other hand, the United States Federal Reserve has once again raised interest rates, with three additional increases in 2023 of 25 basis points each at the February, March and April meetings, remaining in a range of between 5% and 5.25%. Although additional hikes have not been ruled out if inflation does not subside, the probability of this happening has been reduced due to the problems arising in some small- and medium-sized banks in this country. In any case, the Federal Reserve has maintained its position that it will continue to apply a restrictive monetary policy as long as there are no solid indications that inflation is controlled at levels close to its 2% target, with data that continue to improve, but remain far from that goal.
Despite these increases in the monetary policy interest rates, the risk-free yield curve for the US market for March produced by EIOPA (see Chart 2) shows a relaxation in the interest rates in all segments of the curve, moving away from the maximum values set in 2022.
In any case, the high levels of risk-free interest rates continue to offer a favorable outlook for the Life Savings business, but the inversion of the interest rate curve has complicated the management of this business, which must adapt to a new environment in which the short-term rates are higher than the long-term rates (negative term premium), which could benefit products with shorter durations and periodic renewals, although more complex for longer-term products, as well as for traditional life annuities.
On the other hand, the S&P 500 index had gained 7.5% through the end of March and the Nasdaq Composite 17.7%. This partial recovery of equity indexes can help the development of life insurance products in which the policyholder assumes the investment risk, which is very common in the US market. This can also take advantage of the higher profitability offered by fixed income in the combination of products launched on the market.
Among the emerging markets, in Brazil, the tightening of financial conditions due to the restrictive monetary policy implemented by the central bank is being transferred to the real economy, which is slowing down, with inflation continuing to moderate. This may lead to a downturn in the insurance market, mainly in the Non-Life segment, although the normalization of supply chains and energy prices has boosted the automotive sector, increasing production and new vehicle registrations, with the positive effect that this entails for the auto insurance segment. Regarding the interest rate environment, which is highly relevant for the insurance business due to the extensive development of Life Savings insurance in the Brazilian market, it is worth noting that the central bank once again decided to keep interest rates at 13.75% in their meetings in February, March and April (the sixth consecutive time) with inflation that continues to decline, entering the upper part of its target range in March (for the first time in two years). This positive real interest rate environment is still favorable for conducting the life savings and annuities business, with interest rates offering returns significantly higher than the latest inflation data.
In the EIOPA risk-free yield curves corresponding to the end of March (see Chart 3), a drop is observed in the short and medium segments of the curve up to maturities of less than seven years. There is a small negative slope in its initial segments, which continues to favor the development of products backed with short-maturity sovereign bonds, very common in this market (VGBL and PGBL). The option of entering into bonds with longer durations is even more attractive, taking advantage of the increase in the level of interest rates in the longest segments, which remain above the short rates (positive term premium in the long segments).
In the case of Mexico, while still in a situation of weak economic dynamics, GDP growth expectations for 2023 improve slightly, estimated at around 1.2% (3.1% in 2022). Even in a fragile economic environment, the activity levels could improve by 2024 when GDP growth could be around 1.5%. The Mexican economy continues to feel the effect of the high interest rates raised again in the last meetings of the Bank of Mexico, maintaining a restrictive monetary policy as long as inflation does not show clear signs of returning to its target range. This may lead to a downturn in the insurance market, mainly in the Non-Life segment, although (as has happened in other countries) the normalization of supply chains and energy prices has boosted production in the automotive sector, improving exports and new vehicle registrations, with the positive effect that this entails for the auto insurance segment. Meanwhile, the moderation of inflation (6.85% in March, compared to 7.9% average inflation in 2022) and the higher profitability of investment portfolios could help improve the profitability of the insurance industry this year.
Regarding the interest rate environment, the Bank of Mexico decided to apply two additional increases in the reference monetary policy interest rate in February and March of 50 and 25 basis points, respectively, leaving it at 11.25%. Thus, in the risk-free yield curves produced by EIOPA (see Chart 4), a slight rise is observed in the shortest segments of the curve with maturities of up to four years, significantly inverted in these segments, as well as a slight drop and a flatter curve in the longer segments. Therefore, this interest rate environment continues to be appropriate for the development of Life Savings insurance, which can offer significantly higher remuneration than the latest inflation data. The inversion in the interest rate curve remains favorable for launching savings products with shorter-term rate guarantees and periodic reviews of guaranteed rates.
In Spain, economic growth expectations for 2023 are estimated at 1.7% (5.5% in 2022), which would lead to exceeding the pre-pandemic production level this year. The recovery of tourism, moderation of energy prices and normalization of supply chain problems are helping this improvement, particularly in certain sectors of activity, such as the automobile industry, improving exports and new vehicle registrations, favoring the recovery of the auto insurance business.
However, it is still an environment of weak economic activity, as a result of the tightening of financial conditions for households and companies, which will continue as long as inflation shows no clear signs of easing throughout the Eurozone economy. This environment points to more moderate growth for the insurance business and better prospects for its profitability throughout the year if inflation continues to moderate. The forecast for 2024 is that the Spanish economy will continue to slow down, with estimated growth of 1.4%, as the effects of the tightening of financing conditions are transferred to the real economy, which may also weigh on the growth of the insurance industry.
Full analysis of the economic and industry perspectives with additional information and interactive charts on the Eurozone, Germany, Italy, Spain, the United Kingdom, the United States, Brazil, Mexico, Argentina, Turkey, Japan, China and the Philippines can be found in the report entitled 2023 Economic and Industry Outlook: Second Quarter Perspectives, compiled by MAPFRE Economics and available at the following link:
