Theme 1. Inflation: An unwelcome blast from the past
For all the economic crises experienced over the past three decades, it’s safe to say that concerns about runaway inflation haven’t characterized any of them. From 1990 through 2020, the average annual rate of change in the US Consumer Price Index (CPI) was 2.4%, a far cry from the 7% run rate of the 1970s or the nearly 6% levels of the 1980s. Fast forward to 2021: Per the US Bureau of Labor Statistics, the 12-month change for the CPI was 6.2% as of 31 October (not seasonally adjusted), with inflation fears continuing to climb as the likelihood of inflation being just a “transitory” phenomenon (as opposed to a more “persistent” one) begins to wane.
The inflation story to date has largely been predicated on backed-up global supply chains that have coincided with rising consumer demand for goods and services (as much of the developed world reopened from COVID), coupled with a reduced labor pool that is driving wages up. Consumers have increasingly felt the pain of higher prices in recent months — and it may not get better anytime soon. In particular, elevated CPI components like rent may be indicators of inflation taking hold for the longer term and not being a mere “blip” on the screen. Insurers, with their often significant exposure to fixed income assets, along with liabilities that can grow as costs rise, now need to take stock of what this new inflationary paradigm could mean for their industry. Many have begun to do so, while looking for investment strategies that can help alleviate inflation’s potentially negative impacts on their business.
Given how much time has passed since inflation was front and center, our multi-asset team ran a regression analysis of different asset classes in which insurers have historically invested, going back to the early 1970s (Figure 1). This analysis shows the beta (correlation) of each asset class to the CPI, while holding real growth constant over the time period used. Directionally, the results are intuitive and likely what you would have expected. However, the relative betas for each asset class, particularly for lower-volatility insurance reserve assets, clearly demonstrate the need for most insurers to have some level of inflation protection in their investment portfolios.