Recession, slowdown, recalibration.
Whatever term is preferred, more challenging economic conditions are occurring in the United States, with many economists forecasting a full-blown economic recession by 2023. While the insurance industry is resilient, brokers and agents must be responsive to the needs of clients in industries that are less so. And they need to understand how recessionary conditions relate to other challenges they face.
Brokers and agents need to understand how recessionary conditions relate to other challenges they face.
Given recent events, the standard definition of a recession might not apply.
Unlike past pre-recession conditions, unemployment is low, and consumer demand is relatively strong.
The technical definition of a recession is two consecutive quarters of negative gross domestic product rates. That occurred in the United States in the first and second quarters of 2022. “While we are in a technical recession, the official designation of a recession in the U.S. comes from the National Bureau of Economic Research and requires a significant decline in economic activity that is spread across the economy and that lasts more than a few months,” says Thomas Holzheu, chief economist for the Americas at Swiss Re. “We’re not there yet.”
Some argue, however, that the economy, following two quarters of GDP decline, COVID-19, and an inflation rate that has not occurred in 40 years, might actually be in uncharted territory. Standard definitions, the thinking goes, should not be applied.
“If the pandemic didn’t happen and the supply chain issues weren’t still lingering, would prices be as high as they are?” asks Phil Trem, president of the Financial Advisory Division at MarshBerry. “Some of the inflationary pressures are being tied to the fact that there’s just not goods available. And some of that is tied to supply chain. So is inflation being artificially pushed up? I think we’re in a unique place where there’s not a perfectly historical period to which we can compare what we’re experiencing today.”
Matthew Moore, president of underwriting for Liberty Mutual’s Global Risk Solutions, takes a similar stance on the complicating factors. “The war in Ukraine, supply chain disruptions, an ebb in stimulus monies, and inflation have greatly darkened the anticipated economic situation for 2023,” Moore says. “There’s been a fundamental shift, and a recession is more likely. After recent historic highs of inflation, there’s clearly a process that economies in the United States and indeed around the world are going to have to go through. I think all of that will push to a slowdown.”
It’s Not Like 2008
While many agree that some sort of economic tightening is going to occur, the consensus is that it will not be anything like what the industry faced during the Great Recession in 2008-2009.
“We expect a challenge here, but we don’t look at this like we did in 2008, when we were truly in a global financial crisis that challenged even our ability to place policies,” says Michael Chapman, the national director of commercial markets for Hub International. “In 2008, there were certain areas of insurance where you simply could not get capacity.”
The conditions were very different 14 years ago, Holzheu says. “We don’t now have any of these systemic imbalances, such as financial over-leverage, that we had in the housing market and the financial sector in 2008, where you had a self-reinforcing financial crisis that caused a very severe economic downturn. Here, we are in an overheated economy. The central bank’s medicine will slow this down, but it does so from a position of resilience. We should add that there are scenarios under which events change and you could see a more severe recession.”
Unlike pre-recession conditions in the past, unemployment is low, and consumer demand remains relatively strong, if down from 2021. Financial indices such as Standard & Poor’s 500, while sharply down from the start of the year, are still higher than they were prior to the start of the pandemic. “So everything depends on the time frame we look at,” Trem says. Perhaps more significant than the impacts of the recession are forecasts of longer-term trends of slower growth, says Adam Garrard, global head of risk and broking for WTW. “From 2010, and 2020 and beyond, the world was probably growing at two and a half percentage points instead of four or five, which it used to,” Garrard says. “I think that reflects some deep-seated things, including emerging depopulation. Productivity is also not what it was in the 1960s, 1970s and 1980s when it was really booming. Depending on what you consider a slow-growth economy, we are going to have to live with just that for the next decade, at least. That’s not really to do with a pandemic or even geopolitical tensions but likely an underlying macroeconomic position that’s going to be hard to get out of unless there’s some transformational change.”
Line By Line
When thinking about clients, it is important to understand the economic conditions for different industries. Chapman says it may be useful to look at the impacts of a potential recession on both a line of business and a customer’s industry.
“Our conversation with healthcare-specific clients might sound very different than our conversation with places that are more dependent on discretionary spending,” Chapman says. “As an example, in the pandemic, hospitality got hit hard. But construction didn’t stop. For our construction teams, with all the money that was invested in infrastructure projects, the question really becomes less about the recession and more about whether this is going to change the investment that was intended for certain sectors. We do worry about that.”
It’s also important to understand the impact of recessions upon insurance products on a line-by-line approach, Chapman says. “When the head count of any business goes down, that means that the premium for workers compensation insurance is going down, because it’s directly correlated to how much compensation, how much actual money is being paid out. Right now, our biggest conversation on a property policy is, ‘You’re probably underinsured; you need to probably raise your limits.’ Add to that we’re going into a recession where they may not have the same available income stream. Those are difficult conversations, and that’s when, as a broker, you have to start talking about what structural things can we do and nearer-term deductibles, limits, different approaches to risk, maybe reallocating some dollars to higher-risk items. We have to look at that line by line.”
Chapman says better pricing and asset valuation will be important. “If your roof is destroyed on your industrial facility, it is probably 30% more expensive to replace it in this environment,” Chapman says. “We have to insure to 30% more value, right? I think we need asset valuation coupled with predictable loss valuation, such as what do we really expect your probable loss to be and your normal loss to be.”
Chapman expects requests from risk managers to sharpen pencils ahead as the economy slows. “From the standpoint of ‘let’s beat the recession,’ I think what you’re more likely to see is requests to make exposure adjustments midterm,” Chapman says. “There is a possibility we could see some people saying, ‘Hey, you know, I want an auditor to look at my policies and make sure I’m current from an exposure perspective.’ Maybe that’s where dollars shift and you say, ‘Hey, you should up your property limits to be proper valuations, but maybe we need to make some adjustments to your payroll on the workers comp side.’”
This process is already underway for many brokers and agents, Moore notes, given they are already talking about necessary steps with clients to try to address the impact of high inflation upon policies, such as through an emphasis on accurate valuation of assets. “That is really important because if assets get undervalued, when a claim comes, you’re in the situation of underinsurance because there was absolutely no appropriate value,” Moore says. “This is bad for the customer, it’s bad for the broker, and it’s bad for the carrier. No one wants to be in that situation. So we’re seeing the better brokers making sure that those valuations are up to date and commensurate with this particular environment that we’re in at the moment.”
In addition to the economic slowdown, Moore says, inflation adds yet another degree of complexity. “You’ve got at least three dimensions of inflation’s impact upon any carrier’s businesses,” he says. “You’ve got what it does on the investment side of the house, as they’ll get some higher new money rates, which is good. But then you think about the business that’s already written and on the books. In a harder market, as losses manifest themselves, it could be more costly to honor those obligations to customers than carriers thought it would be when the business was written. Finally, you’ve got the challenge of making sure that the prices on new business are sufficient to cover the costs in a higher inflationary environment.”
As brokers work to help clients find alternative solutions for risk transfer or retention during an inflationary period, those in the middle or smaller markets will be in most need. “I think for the Fortune 500 companies, brokerages have always been very good as to ways they can elect to manage risk, whether going into captives, taking a different risk structure, maybe putting up their own capital rather than just looking at an insurance transfer,” says Michael Chapman, national director of commercial markets at Hub International. “That doesn’t happen for smaller businesses and the middle market that are 90% of the customers that are out there.”
For midsize and smaller brokerages, recessionary challenges can be greater if a recession leads to cutbacks in employment at large companies that dominate a community.
“We have to be prepared for what could be coming towards us, because in Dayton, Ohio, we have gone through three or four pretty catastrophic recessions. We lost NCR, which was an anchor employer, and we’ve lost a General Motors huge truck and bus plant,” says Scott McGohan, chief executive of McGohan Brabender, a benefits brokerage with more than 300 employees within two organizations across seven Midwest offices.
“General Motors, for example, left our community in 2008, and there were close to 50,000 independent jobs that serviced General Motors,” McGohan says. “So it wasn’t just General Motors leaving. It was all the tool and die companies, the manufacturers, the caterers, all the other business that was attached to that large employer. So when the recession hit in 2008, frankly, we were already in our own recession. And we saw roughly about a 15% reduction in our customers.
“We learned through that recession, and when the economy gets hard, our customers need us the most. They need us fast, and they need us right by their side. They need us to be curious and brave to help carry them forward.”
With respect to benefits packages, McGohan says, with employers coming out of a tight labor market, any incremental changes that could cause a plan to be less generous, given less favorable economic conditions, should be gradual.
“Unfortunately, when the economy starts to slip, you often need to make changes, and if you don’t make small modifications, you’re going to be forced to make big ones later,” McGohan says. “So one key strategy is cost transparency tools that help navigate a workforce towards the highest-quality healthcare, which ultimately has the best outcome, which equates to the lowest cost.”
Though part of a longer-term trend, Garrard says, the economic pressures of a recession will place optimizing coverage of and between different risks at a premium. “The role of the broker in the next decade will be to go beyond making sure you have the right cover and will also focus on what we are calling ‘risk optimization,’” he says. “It will be about making sure that you’re optimizing your risk and that you understand, if you’re putting a budget of $20 million to risk, what to spend that on to get the best bang for your buck, be that mitigation, be that avoidance, or be that transfer. And when you look at the transfer, make sure you understand the correlations and dependencies not just within a single line of business but across the portfolios of insurance that you’ve got. You really need to model that, and while it’s a relatively simple thing to explain, it’s a very difficult thing to model.”
In 2019, WTW began offering some of its largest clients a new risk optimization model, Connected Risk Intelligence, designed to use scenario-based planning to decide what portfolio of coverages would be optimal for different sets of consumer operating conditions and preferences.
This model uses data to create what economists call an “efficiency frontier.” That’s a graph where the different plotted points on a line represent optimal combinations of choices for a risk portfolio, such as combinations of retained versus transferred risk. Combinations of choices that lie off the efficiency frontier are clearly inferior choices for a given set of preferences.
“If you take a company and you take eight lines of business risk—property, casualty, D&O, and cyber, whatever it is—and you take five limits for each and five deductibles, you’ve got a million-plus different program options across those eight risk types,” Garrard says. “You’ve got to make sure you’re optimizing across those eight risk types. If you’re going to plot those million options, it will be a cloud on a graph, and the cloud will go from top left to bottom right. The y-axis represents the residual risk, and the x-axis the cost of transfer. The more risk I retain, the less I’m going to spend. The less risk I retain, the more I spend. As long as you’re sitting on the efficient frontier, you’ve got the most optimum risk transfer program.”
What will brokers need to do next? “We are quite good at helping our clients understand the trade-off within a class of risk,” Garrard says. “Now we’re going to have to make sure that we can explain to them the trade-offs, including correlations and dependencies, between those risks in different lines, because it is going to be about optimization, it is going to be about making sure you are extracting the greatest value. Companies really should be doing this often, but it’s particularly important in a recessionary environment.”
Careful data analytics supporting good underwriting will pay off in a recession, Moore says. “We’ve all been talking about the great prize for better data and for enhanced data analytics, and it’s at this period, during a recession, that such efforts are really going to pay off, because looking at a portfolio on both a consolidated and a differentiated basis is going to be important.”
Managing The Store
For brokers, a recession will likely call into question their management of their brokerage as a business. Some brokers contend that “what if” scenarios, pairing macroeconomic conditions with responsive brokerage operational actions, can be a valuable exercise.
“We’re already living through some unlikely tail event scenarios, such as the very high inflation rate, the Ukraine War, and COVID,” Holzheu says. “We could see more shocks, and the recession could become a severe one.”
Or maybe it could lead to stagflation, where the downturn will not get rid of inflation and we end up with an extended recession with high inflation. Looking at these extreme negative scenarios is important for asset management, risk management and capital management. Insurance carriers need to be prepared for a situation where they would need to recapitalize after a large insurance loss but maybe the funding conditions are detrimental and limited, which is the case in some negative scenarios. For capital management and risk management, it is important to also include these negative economic scenarios and to have the capacity to be resilient to withstand severe underwriting risk scenarios.”
Chapman notes that Hub prepared for a variety of worst-case pandemic scenarios in March, April and May of 2020, though none of them came to pass, in part due to massive stimulus spending.
“Then, we saw, contrary to the scenarios, how good it was going to be,” Chapman says. “It was hard to believe what happened with organic growth in 2020 and 2021. We had two of the best years in our history.”
Chapman credits that growth with the continued active sales in industries like construction and transportation, which didn’t slow down during the pandemic.
WTW also continues to be in growth mode, despite the slowdown, Garrard says. “We always look at the macroeconomics of the environments in which we work and make sure that we are sizing ourselves appropriately. But nonetheless, at the moment, the insurance market is still in a strong growth mode. It is very profitable for carriers and, indeed, for brokers, with lots of opportunities.”
“Insurance brokerages grow in one of three ways,” Trem says. “For existing clients, they can grow or shrink based on the rates that they pay, the premium that they pay, and the exposure base, the value of what they are insuring. Over the last number of years with the exception of the recessionary periods of 2008, 2009, 2020, we were having tailwinds on both ends. They were getting rate growth, rate enhancement, and exposure base growth. However, in a recession, that exposure base growth could slow and switch from a tailwind to a headwind. They can also grow by acquiring new clients.”
“The price environment is still increasing. It’s still in a hard market session,” Trem adds. “And, typically, after an inflationary period, you tend to see a few years of higher premium rates, because in most cases, carriers don’t bake in the inflated cost of the replacement when there are claims…so they have to pick it up in the following years. So you are still going to see tailwinds on rates, but in a recessionary period,
you may see headwinds from exposure base. That could have an impact on the overall organic growth of the business.”
For those brokerages planning to cash out, recent conditions have been optimal, and there is some danger they will not continue to be this good, Trem notes. In particular, the risk may grow over the longer term as the recession accentuates existing trends, with clients demanding more consulting services powered by sophisticated data analytics. The recession may highlight the different services that a brokerage with a more robust consulting service can provide compared to one with more limited capabilities.
A recession could also increase the supply of entities on the block competing for buyer dollars, Garrard says, adding that many insurtechs and other market entrants funded by private equity and venture capitalists are not providing the profitability and the returns that were expected and are likely to be placed on the market in a recession.
Ultimately, Trem says, “Nothing is recession proof, but insurance is recession resilient. What we found in 2008, in the Great Recession, and what we found in 2020 is that, when the average consumer is tightening their belt and spending less, they still pay for their insurance. If a company exists and it has employees, it pays for its benefits and pays its property and casualty. If you look at its beta, which is the measurement of risk, there are only two or three industries that have a lower beta than insurance, such as grocery, transportation and utilities—the other things that people still buy when the going gets tough.”
Undergirding that resilience is not a consumer love of insurance but business and regulatory mandates.
“The very unique distinction with insurance is that we are a mandatory purchase in many lines of business,” Chapman notes.
And the impending recession will occur after a particularly profitable time, with many insurance companies financially robust after strong post-COVID pandemic-onset results. “Given the industry’s current profitability,” Garrard says, “we think on average they will be entering a recession in a fairly strong position, with strong balance sheets and with clients with generally strong balance sheets, which is also quite important when it comes to moving into a recessionary model.”