How Does the Recession Impact Insurance

Everyone seems to be debating whether or not we are in a recession. Is one around the corner? What does this mean in the event of a recession?

Nobody wants a recession to happen in the insurance industry, but there is less agreement on what it would mean for the industry if one did.

Recessions have slightly different implications for property and casualty lines, as well as health and life insurance, and this report will explore some of those.

What is a recession?

It's difficult to get a straight answer to the question of what constitutes a recession. One witty response is that a recession occurs when your neighbor's job is lost, whereas a depression occurs when you lose your job.

A more common, but technically incorrect, answer is that a recession is defined as two consecutive quarters of GDP decline. While this is frequently repeated in the popular press and by commentators, it is not how official economic scorekeepers define a recession.

The National Bureau of Economic Research's Business Cycle Dating Committee is formally charged with defining a recession.

That committee takes an esoteric and holistic view of the economy, including data on jobs, consumer spending, business spending and inventories, industrial production, personal income and savings, and other variables. And, according to them, we are not in a recession right now. At least for now.

So, while there is no single quick checklist to define a recession, there is no denying that there is a general sense that things in the economy could be better.

And there are a few objective measurements to back up that intuition. For example, the S&P 500 Index is down about 15% from a year ago. Stock prices are swooning driven by shaky earnings reports and CEOs who all seem to be warning of impending recessions.

And the Federal Reserve is pushing the federal funds rate up to a target of 4.25 to 4.5%, which is higher than it has been in years.

Then there's the unanswered question of what will happen with the federal credit limit fight. If Congress' brinkmanship pushes markets to the brink of worry, or worse, panic, bond and stock prices in the United States and abroad could fall precipitously, resulting in severe job cuts.

On the other hand, there are currently signs pointing in a generally positive economic direction. For one thing, employment is currently returning to pre-pandemic levels. And consumer confidence is coming back according to the Conference Board's most recent measure.

So, what gives?

The Federal Reserve's fight against inflation is driving much of the economic push and pull. There are signs that rising interest rates are having an effect: the consumer price index is only up 6.5% for the year ending in December, which is significantly lower than the mid-year highs. However, there are no signs that the Fed will stop raising interest rates anytime soon.

So, what caused inflation to begin with? Again, the answer varies depending on who you ask.

Many economists point to the federal government's free pandemic spending, which was intended to keep the economy from tanking during the COVID-19 lockdowns. When Congress authorized stimulus payments to help households and small businesses during the initial pandemic shutdowns, household goods ranging from lawn furniture to appliances became scarce, and construction material prices skyrocketed as people embarked on home improvement projects.

Other economists point to the realities of the pandemic, rather than the stimulus payments, as driving up prices — factories had to shut down during waves of the virus, making goods less available. Containers were cleared by fewer workers at ports, and trucking companies had fewer drivers. There were fewer waiters in restaurants. All of this scarcity resulted in wage and price increases as employers competed to fill their workforces and retailers competed to keep their shelves stocked.

Then there were some out-of-the-ordinary variables. During the holidays, egg and poultry prices increased due to a wave of avian flu that killed millions of birds in farms across the country, not because of labor shortages or a lack of monetary supply.

Gasoline prices skyrocketed after oil producers cut supply in response to the pandemic, and then Russia invaded Ukraine, pushing them even higher.

The cost of reinsurance is one insurance-specific cost that has recently risen. These are policies that insurance companies buy to protect themselves from catastrophic losses, such as when Hurricane Ian swept through Florida. With the increased frequency of natural disasters, as well as global conflicts such as the Russia-Ukraine war, renewal rates for reinsurance policies are expected to rise in 2023, implying that underlying costs for most insurance will rise as well.

So, regardless of the cause, the end result is a slowing economy and a Federal Reserve actively working to dampen growth in order to lower prices through interest rate hikes.

How does this compare?

When comparing this economic moment to previous recessions, many economists point to the speed with which the market is responding to the Federal Reserve's rate tightening. This could be due in part to the Fed's efforts to signal its intention to raise interest rates, which appears to have moved longer-term maturity bonds sooner than they would have otherwise.

Another distinguishing feature is the pandemic's lingering shadow. With China recently abandoning its Zero Covid policy, much of the recovery will be determined by whether outbreaks disrupt supply chains.

The pandemic transition has also had an impact on the housing market, specifically the transition back from a work-from-home environment and the short-term rental speculation bubble.

When combined with rising interest rates, which make mortgages more expensive, the net effect is that existing home sales are down sharply compared to just a few months ago.

Of course, if Congress did the unthinkable and defaulted on a debt payment, the economy would be thrown into terrifying unknown territory.

Insurance impacts

In the property and casualty lines of home and automobile insurance, the most immediate effect of inflationary pressures on the insurance industry was seen. With supply chains making replacement parts for automobiles and materials for home repairs more expensive, insurers were forced to pay out more after claims. Higher labor costs were also a major factor.

Replacement costs for homes and automobiles have also risen in recent years.

All of this has resulted in higher claims costs and lower profitability, forcing insurers to raise premiums to cover those costs.

In some ways, insurance has a relatively inelastic demand curve, which means that even if prices rise, demand will not necessarily fall proportionally. This is because insurance is required by law in many industries.

However, there are limits, and higher prices do have an effect at some point. Higher prices tend to encourage people to shop more, and at worst, they may opt out of coverage entirely.

According to their recent survey, consumers appear to be primed to begin shopping around, according to Mark McElroy, executive vice president and head of TransUnion's insurance business.

"Carriers want rate increases across the board. And, with all of the macro pressures weighing on consumers' spendable dollars, we expect people to shop for a variety of products in the coming quarter," McElroy said.

In addition to shopping around, consumers should review their policies to ensure that all coverage line items are necessary and look for areas where they can cut costs, such as comprehensive coverage on auto insurance.

Shopping, on the other hand, may be less robust in the coming quarter due to lower demand for home sales and automobiles caused by higher interest rates. Buyers may not feel as compelled to shop for a new policy if those sales are not available.

Homeowner’s Insurance

Homeowner's insurance is one area that is usually required if the owner has a mortgage. As a result, even if the premium increases, the homeowner is usually unable to cancel the coverage and must instead look for another carrier. Furthermore, in some states, such as Florida and Louisiana, there is a shortage of companies writing policies in certain areas right now, so options may be limited.

While it may be tempting to forego homeowner's insurance if the house is paid off, doing so puts what is typically a family's most valuable asset at risk.

Flood insurance is also essential, even if it is becoming more expensive for many people this year.

Federal Flood Insurance Policies are undergoing a new risk assessment known as Risk Rating 2.0, which is re-evaluating the underwriting for each home and, in many cases, resulting in significantly higher premiums for many homes.

However, homeowners only need to look as far as California to see why they should not go without flood insurance. Earlier this year, a series of atmospheric rivers inundated the state, causing tens of billions of dollars in damage and killing dozens of people.

As the cleanup for that damage begins, it is becoming clear that only 2% of California homeowners have flood insurance policies, which is half of the national average of 4%. Furthermore, flood damage is not covered by homeowner's insurance.

Health Insurance

Health insurance is also technically required by the Affordable Care Act, so it should be less price sensitive in theory. However, Congress removed the financial penalty for not having health insurance, so while having health insurance is a legal requirement, there is no immediate financial penalty for not signing up.

By this time of year, open enrollment for health insurance has ended. Most employer-sponsored plans close their open enrollment periods before Thanksgiving, and the Affordable Care Act's open enrollment period ended on January 7. Medicare's open enrollment period ended in December.

Health insurance premiums, like many other aspects of the economy, saw average premium increases in 2023, but this did not mean that demand for Affordable Care Act plans fell. By the end of open enrollment, 16 million people had signed up for plans through the marketplace, a 13% increase over the previous year.

A few plans, such as Medicaid and the Children's Health Insurance Program, are still open for enrollment and can be joined at any time of year, depending on income eligibility.