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Hartwig Discusses the Economics and P&C Insurance in the Time of COVID

“You need asterisks to actually understand what ultimately happened to the economy,” economist Robert P. Hartwig said of the years 2020 and 2021. These years are marked by their public policy responses to COVID-19 and several economic changes.

Hartwig was the sole panelist for “Pandemics, Politics and P/C Insurance: The Indelible Legacy of COVID-19,” a general session held during the virtual CAS Ratemaking, Product and Modeling Seminar on March 17. At the University of South Carolina, he is a clinical associate professor in the finance department and director for the university’s Center for Risk and Uncertainty Management.

Stressing that the P&C industry is “really joined at the hip with respect to economic activity overall,” he discussed changing economic conditions prior to COVID-19 and ever since. Before COVID-19 led to lockdowns in mid-March 2020, the United States’ economy was enjoying the longest economic expansion in U.S. history for 128 months. The public policy response to the pandemic abruptly ended that expansion. Pandemics happen periodically, he pointed out, but the global economy shutting down was unprecedented.

Thankfully, there are signs of a strong economic recovery in the United States. “The better-than-expected economic picture in terms of economic growth means that the economy is likely to have recovered its lost output (measured in terms of real GDP) by the end of the first quarter of 2021 relative to year-end 2019,” he said. “And then we’re looking at very strong growth in the second half of 2021 of about 8% to 9%.” These percentages are the largest numbers since post-World War II. A sharp boost in economic activity will help the P&C industry grow due to the increasing need for consumers and businesses to buy coverage.

There are also a few clouds on the horizon: The U.S. will be left with a huge “debt hangover” in the wake of trillions being spent on COVID relief. And unlike past periods of economic recovery, the debt-to-GDP ratio is not going to fall “unless we have some material tax increase, which is now being discussed.”

“The expectation is the debt-to-GDP ratio will continue to grow. This has little to do with COVID-19 and everything to do with the increased cost of entitlement programs — Social Security, Medicare and so forth — as the last of the Baby Boomer generation approaches retirement, the last of whom will turn 65 in the year 2029,” said Hartwig.

Meanwhile, unemployment remains a concern as more than eight million jobs lost since March 2020 have yet to return as of March 2021. The U.S. trade deficit is also a serious concern. “The U.S. economy is recovering, so we’re importing a lot,” he said. However, the nation’s export sector is hurting because the economic recovery in the U.S. is far ahead of most other advanced economies, including Europe, which is lagging behind in its vaccine administration. He predicts that the country’s trade balance will be out of sync for a while.

Concern about the growing U.S. debt leads to other concerns. “We are up to $27 trillion in debt. You can see it increasing exponentially even before COVID,” he said. And the question is, will these large deficits as a share of the GDP become unsustainable since they tend to generate higher inflation? Currently, there is a surge in inflation in 2021, up to 2% to possibly 2.5%. “The Fed [Federal Reserve Board] has stated that it is more concerned about deflation rather than inflation in recent years, so don’t look for the Fed to raise interest rates to try to head off any kind of inflationary surge, at least this year.”

The Fed is now looking to target a long-run inflation rate of 2% rather than trying to cap inflation at 2%. “That is a change in how the Fed is operating,” he said. “Nevertheless, we probably should start thinking a bit about maybe somewhat of an uptick in inflation over the shorter and intermediate term,” he suggested, which can lead to inadequacy in both rates and reserves.

“If you investigate the primary concerns of insurance CEOs in the 1970s, they said that high inflation was the number one menace of the P&C insurance industry at that time because it resulted in perpetual rate and reserve inadequacy,” he observed.

“I do think that the Fed’s policy of keeping interest rates low is creating a variety of other bubbles out there, certainly in real estate, in many commodities and in a variety of other places,” he said. These include asset prices such as the stock market. “We are no longer able to offset losses with investment earnings to the extent we were able to a year ago,” Hartwig said. The yield on invested assets dropped to an estimated 3% last year — “just a hair’s breadth away from the lowest number ever recorded,” he said. It was 2.8% in 1961.

To complicate matters, 2020’s investment environment was very volatile and interest rates have fallen materially, which will have a bad effect on investment income. Hartwig predicted that investment income would “take a pretty good dip in 2020” —from about $60 billion in 2019 down to about $50 billion in 2020. “That’s real money.”

On March 16, 2020, the Dow fell by about 700 points, which was one of the largest losses ever both in absolute point and percentage terms. “You would never know it looking at where we wound up at the end of the year — up 16%,” he said.


The extremes of volatility understandably make insurers cautious. On March 16, 2020, the Dow fell by about 700 points, which was one of the largest losses ever both in absolute point and percentage terms. “You would never know it looking at where we wound up at the end of the year — up 16%,” he said.

When asked for his opinion concerning the national debt during the Q&A portion of the presentation, Hartwig first explained modern monetary theory (MMT), which presumes that the nation’s debt or how much money the government prints does not have much of an impact on inflation. “This is kind of an economic experiment,” he said.

Plenty of warning examples abound throughout global history of various governments attempting to inflate their way out of situations and increasing their debt, usually causing severe economic situations. “I’m not saying we’re going to wind up like … Argentina or Mexico … [but] it’s pretty naive to assume we can rack up tens of trillions of dollars of debt and assume that there will never be any consequences.”

Hartwig posited that some public policy professionals and politicians believe that the U.S. can print as much money as it wants and accumulate debt without significant consequences. “That’s because they’re not thinking far enough down the road,” he said. “If you don’t care about your children and grandchildren that might be true, but ultimately, someone’s going to have to pay the bill.”

Insurance Industry Indicators

While discussing the state of the property-casualty insurance industry, Hartwig relied on third-quarter 2020 results, the latest at the time. The “steep drop” of about 9% in policyholder surplus in the first quarter of 2020 was due primarily to a collapse in asset prices, but the good news was that surplus recovered by the third quarter. Hartwig predicted a record high for the fourth quarter.

Unfortunately, the net income or profit after tax dropped 20% for 2020 based on annualized third quarter data. This change was in part due to declining investment income and low-interest rates. Elevated catastrophe losses also played a role. Hartwig expects the P&C industry’s return on equity (ROE) to be down to 4.1% for 2020 as of the third quarter of 2020. This is within the ballpark of the average 4.5% for recessions during the past half century.

The insurance P&C industry’s ROE has been tracking below the overall Fortune 500 since the early 1990s. Hartwig also looked at how the ROE for the P&C industry has changed in the last 70 years under different presidential administrations, including the last administration, and determined that the occupant of the White House doesn’t really matter. The industry’s ROE averages have been about 8.1% when Democrats are in office compared to Republicans at 7.8%.

Regarding specific presidents, insurers enjoyed the greatest ROE under Democratic President Jimmy Carter during the late 1970s at 16.43% and Republican President Ronald Reagan’s second term during the mid-1980s at 15.10%. On the other extreme, ROE was just 3.55% under Democratic presidents John F. Kennedy and Lyndon B. Johnson’s first term in the early 1960s and 4.3% in Johnson’s second full term mid-decade.

A.M. Best’s overall P&C pre-COVID combined ratio estimate of 99.1% in 2020 was impressively close to the actual 99.3% considering last year’s events. “Rarely do you actually get a forecast that is that on target,” he said. But the reasons are different than the organization could have imagined. Depressed claim frequency across many lines, which contributed to an improvement of underwriting results, was offset “almost to the exact same extent” due to elevated claim losses.

COVID-19’s impact on the U.S. P&C industry was not nearly as bad as estimated, with losses close to his prediction of about $30 billion. There are several reasons for this, including worst-case litigation outcomes that did not materialize and courts generally favoring insurers. Further, an explosion in workers’ compensation losses due to presumption expansions did not happen as many had feared.

Net growth did not increase as A.M. Best predicted with its pre-COVID forecast of 3.8% for the year 2020. Through third quarter 2020, premium for all P&C lines rose 3.1%, but Hartwig estimated a 1.8% uptick for full-year 2020. It was “below expectations but nowhere near as severe decline in premium that we saw back in the financial crisis just over a decade ago now.”

Regarding commercial lines’ performance, the market has been experiencing double-digit rate gains across businesses of most sizes, as reported by the Council of Insurance Agents and Brokers. Commercial property and business interruption costs contributed to the largest rate growth in years due to the cost of massive catastrophic losses.

Commercial umbrella later superseded commercial property losses due to “a lot of jackpot justice awards going on out there with the economy heating up,” resuming a trend that began even before COVID arrived. Directors & Officers insurance rates are rising due to increased merger and acquisition activity. Cyber is also seeing increases. Workers’ compensation is experiencing the flattest rate growth among all commercial lines, given current strong underwriting performance.

Despite the global pandemic, $1.5 billion in riot-related losses, a presidential election year and another record-breaking year of natural catastrophes, the industry was able to withstand such an exceptional year. Insured natural catastrophe losses cost $67 billion last year, ranking 2020 as the third costliest year in North America.

Hartwig expressed great concern about the impact of growing catastrophe losses on the P&C insurance industry worldwide. For the past four decades, frequency and severity have risen exponentially. On an inflation-adjusted basis, the average annual insured losses were about $5 billion during the 1980s, increasing to $15 billion in the 1990s, $25 billion in the 2000s and for the most recent decade, $35 billion. “Keeping with this very simple trend and ratcheting it up by $10 billion, we’d wind up at about $45 billion in average annual insured losses in the 2020s,” he predicted. While that may be thought as a high bar, considering 2020’s large losses and 2021 losses through March in the $15 billion range, reaching insured catastrophe losses of $45 billion is not an incredible stretch.

Hartwig does not place the primary cause of CAT losses on climate change, however; “some signature” of climate change are in these losses, but the “biggest signature” is the growing population of people moving to disaster-prone areas, which puts pressure on reinsurance pricing.

Actuarial Advice

During the Q&A session, Hartwig was asked about using the Consumer Price Index (CPI) as a measure of inflation. He answered that the CPI is biased a bit downward because it is not sensitive to some of the price increases that many people are experiencing, and it depends on location. For instance, many people, particularly lower income individuals, spend a higher proportion of their income on staples such as food and housing, which are rising at more excessive rate than the 2.5% expected for 2021.

He advised actuaries to seek additional measures. “For actuaries, I would keep a closer eye on health-care medical expenses,” There is likely to be a resurgence of that in 2021 and 2022 as demand for medical services recover because many people deferred health care, increasing medical severity because people were not getting preventative screening.

Looking at the numbers, he noted that actuaries will have interesting jobs because they will “see things that simply don’t exist historically anywhere in the data.” Hartwig predicted tremendous variation in the results across states. “You’re going to have to ask yourself whether or not any of these sorts of trends are going to carry over into the year ahead.” So, the question is, “How useful is your data for 2020 for the years ahead?”

Hartwig cautioned against cutting out results from 2020 despite its anomalies. “It has a tail on it and we’re going to feel that tail through 2021 and into 2022.” Anytime there is some sort of shock to the system, the effects of that shock ripple through that system for some period of time before there is new period of normalcy or stability. The same is true for COVID.

Thus, Hartwig’s observations do underscore the necessity of asterisks

Annmarie Geddes Baribeau has been covering insurance and actuarial topics for more than 30 years. Her blog can be found at www.insurancecommunicators.com.