➤ Negative impacts from the coronavirus outbreak are expected to hit the U.S. in the second and third quarters, but the economy should recover going into 2021.
➤ Insurers are expected to be resilient in the face of a downturn especially because, in part, there were not as many systemic imbalances as there were during the financial crisis in 2008.
Restaurants, bars and stores have already begun closing across the globe in an effort to limit exposure to the coronavirus. Swiss Re expects the situation caused by the pandemic will get worse in the U.S. and Europe before it gets better.
S&P Global Market Intelligence caught up with Thomas Holzheu, Swiss Re's chief economist for the Americas, to discuss his outlook for a global recession and how insurers might be impacted by the rapidly changing environment. The following is an edited transcript of that conversation, which took place March 13.
S&P Global Market Intelligence: I understand you expect a global recession this year. What might that look like?
Thomas Holzheu: Global recession is our base view at this point and means that we will have a technical recession or a decline in GDP in certain G-7 countries, particularly in the Eurozone, Italy and Germany. These are countries that were already going into the situation with weak growth. At the point of writing our report, we stated that in the U.S. and China we don't call a recession at this point, but a very high risk of recession. We’re basically at the cusp. China has obviously already had negative impact in the first quarter. For Europe and the Americas, we would see that negative impact hitting here in the second quarter through the third quarter and then we would get a recovery from that going forward into 2021.
Just to clarify, you're not predicting yet a recession in the U.S., is that correct?
We had our forecast out on [March 6] and things are developing rapidly right now ... we said 40% chance for a recession, which is really high, and maybe at this point we are moving into that scenario.
Obviously a lot has changed since then, but you have not come out with a new percentage. Would it be fair to say it is higher?
It is probably higher. I'm just not restating because we just came out with this. We might be in that risk scenario, I mean 40% is a pretty high probability.
And the negative impact that you speak of is not a recession, but just the impact of everything that has been happening will show in the second and third quarters?
Right, otherwise we would have had stronger growth right now and for the rest of the year. We lowered the U.S. forecast by half a percentage point for the full year, and for the second and third quarter, it's more than that, so the impact is really happening.
What might the impact to insurance companies look like?
The impact to insurance companies comes very much on the financial side, as we have interest rates dropping dramatically. All reinvestment and new investment in cash flows happen at a lower rate, which is a challenge for the profitability of that business. The other aspect is we see some volatility in the credit space. The insurance industry is heavily invested in corporate credits, so if there’s widening of spreads, that affects the value of these corporate bond portfolios on the balance sheet of insurance companies.
Generally speaking, the global insurance industry was relatively resilient in the last global crisis, with the exception of AIG. What is different this time?
Insurance companies have to pay when there’s a claim, not when customers get worried. And insurance companies are long-term investors, so their liabilities and assets are long-term, so that makes it much easier for them to steer through these times of volatility, particularly as we expect this to be not really a long-term event. The difference from the financial crisis is that we don't think that we have seen those imbalances in the financial sector we saw before: systemic risk coming out of credit, credit derivatives and a housing bubble. The conditions that triggered the financial crisis are not here ... This situation is a real-time, real economy event. There are disruptions in the supply and in the demand, but they’re very low-tick. Stuff doesn’t get shipped or produced, you’re not going to work because they are shut down, so this is very different. It didn't originate in the financial system. It has reverberations right now, but we still don't see these systemic imbalances that we had seen or that were prevalent in 2007 and 2008.
What are the implications of a global recession for insurers' investment portfolios?
There will be surprises, but overall we expect this to be a temporary situation, but hit life insurance companies more since they are long-term investors. We expect this to not cause a major issue. The interest rates, that's something the industry has had to deal with already. That has been a trend that's been going on for a while. We will have one or two more years of even lower rates. As a result, it forces a shift in products away from guarantees ... toward more shorter-term products to mortality or morbidity protection, health coverage and so on.
The nonlife industry will need to force more pressure on the pricing front. If there’s less yield in the cash flow than there is on the underwriting cash flow, then there's more need to get adequately enumerated for the underwriting risk ... depending on the volatility there will be credit losses, but that's not another surprise.
Direct insured losses from the coronavirus outbreak are expected to be relatively low. But how could a recession affect insurance claims more generally? For example, in recessions, insurers can receive more opportunistic claims, and there can be an increase in litigation.
There's more anecdotal evidence around this than hard evidence. Overall, the level of economic activity is a bigger driver. So if there's shutdowns or more people working from home, there will be less driving and we will see fewer accidents possibly from that. Beyond that, I don’t feel comfortable speculating. It hasn’t really played out. Particularly if it's not a prolonged, severe recession, then I wouldn’t expect a lot to rise there.
What could be the most extreme outcome?
There are different scenarios around the epidemiological development — how many cases you have and how severe is the spread and that depends on all these responses, like government action. The best case is that it will be benign and fill out quicker as a pandemic and then we have less disruption. We do have a worst-case scenario in our publication; the implications for the U.S. would be that we flip into a recession with two or three negative quarters and less growth for 2020 and a recovery in 2021, but everything starting a bit later and from a lower, weaker level.