March 8th, 2012

State of the Reinsurance Market, Part I: Deleveraging Cycle, Growth Expectations

Posted at 1:00 AM ET

2012 Macroeconomic Themes

As we bid farewell to a tumultuous 2011 and enter 2012, it is becoming very clear that the (re)insurance sector will remain exposed to profound changes in the global economy. The coming year promises to be one of economic, monetary and political transition.

The specter of global recession again threatens (re)insurance industry growth and profitability. High unemployment, lower production and weak property values translate to fewer and lower-value risks in need of protection, directly impacting insurer revenue. Meanwhile, interest rates in much of the developed world hover at or near post-war lows, while assets, particularly those impacted by the European sovereign debt crisis, are in turmoil. These conditions are simultaneously reducing investment yields for higher credit securities while weakening balance sheets exposed to lower credit instruments. Additionally, conflicting signals of economic disinflation and claims inflation create menacing challenges to insurers.

Key macroeconomic challenges facing the global insurance sector in 2012 are summarized below and in following posts:

  • Deleveraging cycle
  • Changes in growth expectations
  • Changes in inflationary/deflationary expectations
  • Low investment returns
  • High investment volatility

Deleveraging Cycle

The global deleveraging cycle that began nearly four years ago with the bursting of the global credit bubble will continue to advance through 2012. Deleveraging will occur through credit defaults, write-downs, repayments and rising savings rates. Frugality by consumers, businesses and governments will affect most developed parts of the world. As the deleveraging cycle that is ongoing in the United States continues to engulf Europe, the re-emergence of deflationary risks will act as a counterbalance to inflationary trends elsewhere.

The reality of a secular credit contraction may be coming into sharper focus with the general public. It will therefore be necessary to stay ahead of broad-based changes to consumer behavior in 2012. As we have seen with the spreading of the debt and banking crisis to Europe, these challenges are global in nature.

Growth Expectations

The underperformance of advanced economies will hurt global growth in 2012. Real GDP growth is projected to slow from 3.8 percent in 2011 to 3.4 percent in 2012 (1). Global emerging markets will experience a slowdown in exports to their wealthier counterparts. Many emerging markets will face issues such as rising inflation, currency appreciation and real estate bubbles. Growth in emerging markets will slow by 0.8 percentage points from 6.3 percent to 5.5 percent and shave off 0.4 points from overall global growth (2).

The economic downturn has prompted most economists to cut growth forecasts. Moreover, unemployment throughout most developed economies runs high with little hope of rapid near-term growth as austerity measures are replacing stimulus packages.

In an economic downturn, general insurers normally retain more risk in order to offset reductions in gross revenues, underwriting margins and investment income. While this was evident to a degree in 2011, several factors weighed against this tendency. Insurers are keenly aware of recently increasing catastrophe occurrence rates, while uncertainties around inflation and asset values leave less tolerance for severe or frequent underwriting losses. These factors contributed to a continued high demand for reinsurance protection.


The US government and consumers are still paying the price today for aggressive lending and borrowing behavior during the credit bubble of 2002-08. There is still an abundance of mortgage and public sector debt that needs to be unwound and a lingering huge excess supply of single-family homes yet to be absorbed. It could well take another five years for debt-to-GDP ratios to revert to the mean as well as for national housing inventory levels to establish a definitive floor under real estate values. Frugality has again been manifest in the broad retail sector, a deflationary force, at a time when the US unemployment rate remains stubbornly near 9 percent.

The long-term trend in US output growth has been roughly 3 percent per year for the past 40 years - 1 percent from population increase and 2 percent from increased output per capita. The output gap of roughly USD1 trillion could be recovered by 2016 if the United States reaches 3.6 percent GDP growth over the next four years. Unfortunately, projections are for 2.4 percent growth (3). There is a very real risk that the United States will slow permanently below trend. Such a trend could create significant changes to insurance and reinsurance purchasing behavior.


In Europe, behavior by governments, banks and households during the bubble era were equally aggressive. The current problem of sovereign credit defaults and weak banking structures within the EU, which constitutes a larger economic region than the United States, has taken the global debt crisis to a new and potentially more dangerous level than we experienced in the aftermath of the 2008 Lehman collapse.

Although longer-term (15-year) EU and US growth patterns are similar, recent European growth trends are somewhat lower than those of the United States. Tight government budgets and slow demand growth will hold back EU economies in the medium term. EU countries will struggle to increase levels of investment in the human and physical capital needed to boost innovation and demand. This development, like those elsewhere in developed economies, will impact (re)insurance purchasing behavior.

Emerging Markets

Emerging economies must also face the immediate risks related to the 2012 growth slowdown in advanced economies. In the medium to longer term the rebalancing of these economies between exports and domestic consumption, industry and services and government and business investment will be challenging. In China, property prices are now starting to deflate, which may be the next leg to break, especially given all of the anecdotal evidence of strains within the country’s state-owned banking system. All of the above will create challenges for insurers in emerging economies over the next cycle.


1 Source: OECD Economic Outlook Volume 2011/2.
2 Imputed from OECD area growth forecasts.
3 The Conference Board.

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