March 12th, 2012

State of the Reinsurance Market, Part II: Inflation/Deflation Expectations, Investment Returns

Posted at 1:00 AM ET

Inflation/Deflation Expectations

Expansionary monetary policy has fueled concerns that inflation could increase in the medium term, but the picture is less clear in the near term. While consumer price indices in Brazil, Russia, India and China (BRIC), the United States and the rest of the G7 currently exhibit positive trends, consensus forecasts show borderline disinflationary trends in the nearer term in the United States and many developed markets.

Figure 1 shows historical consumer price indices as well as the University of Michigan’s survey of US inflation expectations for one year ahead. As is evident, inflation moderated in most regions, and trends even became disinflationary in the G7 after the first leg of the credit crunch in 2009. Inflation has since picked up, but as can be seen in Figure 2, inflation forecasts for the global economy are mixed. While BRIC countries are largely expected to continue to exhibit relatively high levels of inflation, most of the G10 is expected to revert to normal or even disinflationary trends. This presents significant challenges, particularly for international carriers with balance sheets that may be in a disinflationary region, but that may be underwriting increasingly in inflationary regions.

Figure 1

4_European Sovereign Credit

Figure 2

4_European Sovereign Credit

US medical cost inflation has been and continues to be an area of concern for (re)insurers. The medical care services inflation growth rate is moderating but is still higher than core inflation. Higher medical cost inflation is of particular concern for (re)insurers in medical malpractice and related lines of business.

4_US Medical Care Services Inflation

Investment Returns

Reinsurers’ balance sheets generally have low allocations to equities (see Figure 19) and minimal/manageable direct exposure to Eurozone debt. Furthermore, most (re)insurers de-risked their investment portfolios after the 2008 financial crisis and entered 2011 in defensive positions. They are, therefore, invested in short-duration, low-yielding fixed income securities.

4_Investment Mix at September 30, 2011 for the Guy Carpenter Glo

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