1 / 39

Understanding Inflation and Deflation: Insights for Insurers and Investors

Join the Casualty Actuarial Society's seminar featuring expert Stephen P. D'Arcy, Ph.D., FCAS, MAAA, discussing critical aspects of inflation and deflation. This lecture covers the historical context, current trends, and future modeling, with a focus on implications for insurers. Learn why understanding inflation is crucial now, explore the different measures of inflation, and examine extreme scenarios. D'Arcy will delve into managing risks related to investments and underwriting, making this seminar essential for practitioners in the field of risk and insurance.

kamuzu
Download Presentation

Understanding Inflation and Deflation: Insights for Insurers and Investors

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript

  1. Casualty Actuarial SocietyExperienced Practitioner Pathway SeminarLecture 8 – Inflation Stephen P. D’Arcy, FCAS, MAAA, Ph.D.Robitaille Chair of Risk and InsuranceCalifornia State University – FullertonD’Arcy Risk Consulting, Inc.

  2. Overview • General discussion of inflation/deflation • Why inflation/deflation matters to insurers • Historical inflation/deflation rates • Modeling future inflation/deflation • Applications of inflation/deflation model EPP Lecture 8: Inflation

  3. Why Study Inflation/Deflation Now? • Recent inflation rates have been low • Potential for dramatic change • Recession could lead to deflation • Financial crisis of 2008 • Euro crisis • Expansionary policies could lead to high inflation • Quantitative easing in developed countries • Rapid growth in some developing countries • Increased uncertainty exists for inflation forecasts EPP Lecture 8: Inflation

  4. What is Inflation? • For consumers • Change in prices • Change in cost-of-living • For investors • Impacts purchasing power of investments • Real vs. nominal interest rates • For insurers • One of the most significant risks facing insurers • Affects cost of doing business, underwriting results and investment performance EPP Lecture 8: Inflation

  5. Inflation Measures • Consumer Price Index • Potential biases • Substitution effects • Quality changes • New products • Cost-of-living index EPP Lecture 8: Inflation

  6. Inflation and Insurance Costs • Expense component for all insurers • Wages • Cost of goods used in operations • Property-liability insurance losses • Replacement cost coverage for property • Medical cost inflation for injuries • Social inflation for jury awards • Life insurance and annuities benefits • Indexed policy benefits EPP Lecture 8: Inflation

  7. Extreme Inflation Scenarios • Deflation • During Depression • Japan 1980s-90s • Hyperinflation • European countries 1920s • Mexico 1974-2000 • Various Latin American countries EPP Lecture 8: Inflation

  8. Managing Inflation/Deflation Risk: Investments • Fixed income investments • Default rates rise during deflationary periods • Market values decline when inflation increases • Inflation indexed bonds • Limited availability • Current low real returns • Equities • Short term impact negative • Long term impact mixed EPP Lecture 8: Inflation

  9. Managing Inflation/Deflation Risk: Underwriting • Property-liability insurers • Loss reserves need to account for inflation • Policy terms • Adjust length based on economic conditions • Index deductibles and retentions • Adjust frequency of rate changes • Life insurers • Lapse rates increase with inflation • Index face value and premiums • Cap inflation indices for annuities EPP Lecture 8: Inflation

  10. Historical Inflation Rates • United States • Canada • Mexico • Japan • Other countries available at: http://tradingeconomics.com/ EPP Lecture 8: Inflation

  11. United States Annual Inflation Rate1914-2010 EPP Lecture 8: Inflation

  12. Canadian Annual Inflation Rate 1916-2010 EPP Lecture 8: Inflation

  13. Japanese Annual Inflation Rate1971-2010 EPP Lecture 8: Inflation

  14. Mexican Annual Inflation Rate 1974-2010 EPP Lecture 8: Inflation

  15. Proposed Regimes for Inflation Model Based on US and Canadian Experience • Deflation • Inflation rate is negative • Moderate inflation • Inflation rate from 0 to 6% • High inflation • Inflation rate over 6% EPP Lecture 8: Inflation

  16. Inflation/Deflation Discussion • How likely do you think it is that the U. S. will be in a deflationary regime within five years? • How likely do you think it is that the U. S. will be in a high inflation regime within five years? EPP Lecture 8: Inflation

  17. Historical Inflation/Deflation Experience EPP Lecture 8: Inflation

  18. Inflation Generator Model • Model documentation • http://www.soa.org/research/research-projects/finance-investment/research-effect-deflation.aspx • Provides details about using the model EPP Lecture 8: Inflation

  19. Using the Model - 1 EPP Lecture 8: Inflation

  20. Using the Model - 2 EPP Lecture 8: Inflation

  21. Using the Model - 4 EPP Lecture 8: Inflation

  22. Using the Model - 5 EPP Lecture 8: Inflation

  23. Using the Model - 6 EPP Lecture 8: Inflation

  24. Using the Model - 7 EPP Lecture 8: Inflation

  25. Using the Model - 8 EPP Lecture 8: Inflation

  26. Using the Model - 9 EPP Lecture 8: Inflation

  27. A Model of Inflation EPP Lecture 8: Inflation

  28. Discrete Process in Model • Model projects inflation process in monthly time steps • Future inflation process is weighted average of past inflation and mean reversion level EPP Lecture 8: Inflation

  29. Impact of Discrete Process EPP Lecture 8: Inflation

  30. Annualized Inflation Projections • Model projects a sample path for the monthly inflation process over next 50 years • User can enter number of sample paths • However, the “inflation rate” is based on the cumulative (compounded) monthly process EPP Lecture 8: Inflation

  31. From the Model… • Inflation “process” needs to be compounded to measure annualized rate of inflation EPP Lecture 8: Inflation

  32. Regime Switching • At any point in time, parameters of process drive future inflation • However, model can switch between three separate inflation regimes • “Normal” inflation • High inflation • Low inflation (deflation) • Switching between regimes is based on a probability matrix EPP Lecture 8: Inflation

  33. Initial Regime Parameters EPP Lecture 8: Inflation

  34. Initial Transition Matrices EPP Lecture 8: Inflation

  35. Transition Probabilitiesand Regime Duration EPP Lecture 8: Inflation

  36. Running a Simulation • User enters “ModelInput” parameters • Parameters of process for each regime • Transition probabilities across regimes • Initial inflation value • “DefineOutput” • Choose the inflation rates of interest • Start projections EPP Lecture 8: Inflation

  37. Output • Summary statistics for inflation output • Inflation values for all sample paths • Can export for further analysis EPP Lecture 8: Inflation

  38. Applications of the Inflation Generator • Model can be used as engine for other applications • Inflation component of an economic capital model • Medical claim inflation may be modeled from general inflation rate • Salary increases for pension projections • Interest rates may be correlated with some target inflation EPP Lecture 8: Inflation

  39. References • Inflation/Deflation Report available at: http://www.soa.org/files/pdf/research-2012-02-effect-deflation-report.pdf • User Guide available at: http://www.soa.org/files/pdf/research-2012-02-effect-deflation-user-guide.pdf EPP Lecture 8: Inflation

More Related