Rising inflation continues to affect global markets and economists predict that a recession will begin by the start of 2024, if not sooner. Adding fuel to the growing fire of uncertainty are the lingering effects of COVID-19's business disruptions.
How can business leaders prepare for these uncertain economic conditions? How should they proceed when inflation upsets projections and shifts budgets? The insurance industry sees and feels market changes in many ways the same as other sectors, requiring executives to be strategic and agile in their approach. My first-hand experience has taught me this. As Chief Financial Officer of a billion-dollar brokerage, I have led preparation, forecasting, and budgetary restructuring during uncertain times.
We may not be able to predict precisely where the markets will go, but we can take steps to ensure our business is protected from detrimental loss and not caught flat-footed.
Inflation Impacts Expenses & Revenue
Inflation has hit both expenses and revenue within the insurance sector. Costs on a range of items have been greatly inflated, up to 20%, affecting everything from leased space to office supplies to travel expenses. Maintaining a workforce is by far the largest expense for insurance companies and brokerages nationwide, and inflation has significantly increased the cost of labor, necessitating salary increases and raising the cost of benefits packages.
In this environment, business leaders need to keep a more watchful eye on expenses and frequently ask: Do we need it? Is it worth paying the inflated cost? What is the return on investment?
Because insurance is based on the valuation of the risk, which is influenced by payroll and asset values, insurance premiums are going up, positively affecting the financial position of carriers and brokerages but likely not completely balancing out rising costs.
Navigating inflation requires vigilance, watching markets closely, and focusing on increasing efficiency within balance sheets.
Recession Impact Lags Within Insurance
The current economic landscape differs from what financial experts have seen before. Though a recession seems highly likely, many indicators suggest that this one will be a whole different animal.
Historically, when heading into a recession, employment rates are relatively low. Currently, employment rates are high, and many businesses are struggling to hire quality talent. Additionally, the stocks and bonds markets are moving in tandem when they typically move in opposite directions. If a recession does occur, Risk Strategies and our peers in the insurance industry will experience its impact later than other sectors.
At first, businesses may file more claims to cover risks related to RIFs or layoffs. Then, as sales drop, the number of insured employees decreases and insured assets decline in value, the exposure base will shrink, notably reducing premiums. Insureds may also choose to lower costs by decreasing coverage, further contracting insurer and broker revenue.
Understanding this cycle will help insurance executives properly prepare for the recession’s impact. As we begin to come out of the recession, the insurance space will also see a lag in rebounding business — even after revenues and employee bases return to pre-recession levels, businesses in other sectors may wait to renew/increase insurance coverage.
Preparing for a Recession
CFOs and executives should be listening to the forecasts of economists and taking steps to prepare for the potential recession. At Risk Strategies, we’re running analyses to assess how an economic downturn might affect our P&L, balance sheet, and operations as a whole.
I recommend implementing the following measures as soon as possible:
- Consider Debt and Access to Capital: Make sure that your business has reliable access to capital, especially if you have significant debt on the books. Locking debt and capital in at a target interest rate before conditions worsen will be valuable. Interest rates are likely to rise, so firms with variable rates on their debt should consider a hedge to better understand what their interest costs will be.
- Improve Cash Flow: CFOs and finance teams should be focusing heavily on managing net cash flow. This means making sure you’re not paying out things before you have to, moving revenue-generating activities along faster, and strategically protecting balance sheets.
- Cut Cost Base: Directly before and during a recession, businesses should cut costs in order to run efficient, lean operations. Every expense should be analyzed to ensure no money is wasted. Big, non-essential projects will have to be put on hold.
- Think Outside the Box: The best ways to weather a recession may not be obvious. Businesses should work to innovate and rise to the challenge financial hardship presents. COVID-19 taught us an enormous lesson in agility and championing new ideas. At Risk Strategies, we embraced a remote/hybrid work environment that improved employee retention and cut real estate costs. This improved our financial position overall and will help us navigate uncertain waters.
Adjusting KPIs and Forecasting Amid Uncertainty
KPIs (key performance indicators) are a valuable tool for measuring and forecasting business success. When markets are unpredictable, companies should perform a sensitivity analysis to determine how different variables might affect outcomes.
After analysis, business leaders should have a range of options at their disposal, including actions and KPI adjustments to move forward with depending on real-world economic movement. Having a single path forward with no alternatives could prove detrimental as market conditions shift.
Remaining fluid and agile is key, as is keeping a finger on the pulse of what is happening to global markets and within your specific industry. Businesses need to be ready to modify strategies as necessary. During a recession, that means having a plan, moving ahead with a portion of it, waiting to see what happens, then determining whether it’s safe to do more or whether to pull back.
Bracing for the Future
An economic downturn will affect businesses globally, the insurance industry, and the future of risk. Preparation, flexibility, agility, and innovation will help insurers, insureds and brokerages endure a potential recession and maintain financial stability.
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