Swiss Re’s Chief Economist on the State of the Global Economy

By | September 14, 2012

“The European debt crisis is affecting the global economy, definitely,” said Kurt Karl, Swiss Re’s chief economist in an interview at the recent Reinsurance Rendezvous in Monte Carlo.

He did indicate that it’s affecting the U.S. a bit less, as the country is “not very dependent on exports. The big problem in the U.S., when you look at the drag on growth, it’s actually government spending that’s going down.”

In contrast Karl pointed out that “business investment is up, consumer spending is up, even home construction is now up.” Both state and local governments, however, face fiscal difficulties, “squeezed by lower property tax revenues, and also the federal government with the big deficits.”

The European crisis has also resulted in reducing sales of Asian products. “Exports from Asia to Europe are actually negative at this point,” Karl said; “in fact they’re down year.” This specifically impacts China, and in turn countries, particularly Australia, that sell raw materials to China. It has affected all of the Asian countries that sell goods to Europe, which is, “after all very close to 25 percent of the global economy, and a big importer.”

Growth has also been “dampened by credit transmission” as the banks are deleveraging in Europe, and “they are pulling back their assets overseas and their lending overseas.” Australian banks have been particularly affected, as they are more dependent on financing from European banks.

As insurers and reinsurers are irrevocably linked to the economies in which they operate the global problems coming out of Europe has had an impact on them. “What we’re seeing globally is a slowdown in growth, a slowdown in premiums,” Karl said. He cited auto insurers – less vehicle sales mean less policies issued – and the construction industry,”which has been “unwinding since 2008,” meaning fewer homeowners polices, as examples of how the slowdown affects the insurance industry.

“On the business side what we find is an enormous amount of pressure from the large corporations to resist pricing, and[they are] taking larger amounts of insurance risk on their own books.” As a result, despite the call to raise prices, it’s very difficult for the industry to do so. He did point to some exceptions, where prices have been raised, particularly in the property sector in the wake of catastrophe losses.

In casualty lines the prices have stabilized, albeit at an extremely low level, which remains “quite worrisome for the industry. That will turn around very slowly we expect.” As a result, and with the prospect of diminishing reserve releases, it will be “very difficult to get major price increases to get to a profitable book of business – underwriting profits – out of the casualty book right now.”

The situation is a bit different for the reinsurance industry, which Karl described as “particularly well capitalized.” Their approach is a cautious one, allocating capital only in situations they have fully analyzed and where they see positive prospects. In many areas the natural catastrophe property sector is attractive for reinsurers, while “the casualty lines are looking like they should be turning around, so that should be a potential opportunity.”

Emerging markets offer another growth prospect for reinsurers, but Karl said it could “be a struggle if we all jump into it.” These are “high growth markets,” notably Asia – India and China – Latin America, especially Brazil, and to some extent Russia. “Growth and premiums should be available there,” he said, but they might at first be less profitable markets. Corporate solutions in the commercial field also offer growth opportunities,” but Karl said he wasn’t in a position to go into the details.

Expanding on his opening remarks that the U.S. economy wasn’t particularly export driven, Karl did indicate that “it’s coming back quite strongly.” He noted a shift in the global economy, as China’s low cost advantages are “eroding with rapid wage gains and a 25-30 percent appreciation in the value of renminbi over the last 5 or 6 years.” As a result “Mexico is doing a lot better competing against China at this point.”

Karl pointed out that any solution to the euro zone crisis would by nature have to be a political one, which is quite logical give the structure of the European Union. “Pretty much everything’s been figured out that needs to get done,” he said; “unfortunately it’s not getting done very rapidly. They [euro zone and EU leaders] know they have to get together on fiscal union and get tighter there,” which would require writing fiscal disciplinary measures into the constitutions of euro zone countries.

It would also require some form of a banking union. “You can’t have one country having political influence on the Landesbanks in Germany and Cajas in Spain, so that you get excessive lending with problems later. You have to have some banking authority monitoring that for all the banks.” It also should have the ultimate power not only to lend to banks, but also to close them down if necessary.

Such a system would require “a lender of last resort for sovereign debt. The ECB [European Central Bank] is prepared to step up to the plate to do that, but it requires a memorandum of understanding from the Spanish and the Italians in this case, but we don’t have that because of political reasons.”

He considers it probable that Spain will eventually sign on to such a memorandum. However he said “The Italians don’t need to, as they can tax their way out of it; it’s a very wealthy country, and they can come out of this without such a memorandum of understanding. Maybe this threat of losing their sovereignty will be the trigger for finally getting the taxes in place, and to actually collect them.”

Aside from the overall difficulties arising from the shaky global economy, Karl said the reinsurance industry is also concerned about the impending changes in several areas of regulation – In Europe Solvency II – in the U.S. the solvency modernization initiative.” Regulatory changes are also in the offing in Australia, India and China – “tightening up the capital requirements both on the liability side and higher capital restrictions on the asset side.” That kind of capital environment inhibits re/insurers from “delivering to their clients.” It could also result in companies “pulling back from the market.”

The low interest rate environment, which was presented in Swiss Re’s latest sigma report, is “another stress on the global economy.” In addition the value of assets in Europe has been adversely affected by the ongoing crisis, losing significant value and creating concerns over “an eventual default.”

The re/insurance industry is subject to the vagaries of the global economy, about which it can actually do very little. It can only mitigate some of the factors that directly affect it, such as taking as many steps possible to assure profitable underwriting. Otherwise it can only abide the interesting times with which it is now faced. At least having those perils analyzed by people like Kurt Karl helps to understand them.

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