S&P Global Ratings forecasts Latin America's economic growth to stagnate this year, which will weigh on insurers' business and operating conditions. This reflects our expectation of lower demand for the region's manufactured products and commodities from key trading partners--particularly, the U.S. and China--as the world' largest economies lose steam. We also expect slowing consumption amid fraying consumer confidence and employment levels to act as a drag on Latin America's economy. Inflation in the region reached its peak during 2022 and we expect it to recede gradually this year, assuming commodity prices don't jump. This will encourage central banks in Latin America to start lowering interest rates this year. However, the lag between rate hikes and their full effects means that prices could stay elevated--dwindling consumer purchasing power--curtailing the economic activity. Finally, the governments' fiscal response to slower growth is likely to generate jitters among investors about the risk of fiscal slippage. Given all these factors, we assume that GDP growth in the region will plummet to 0.7% this year from our estimate of 3.4% in 2022 and to return to its traditionally low rate of about 2% in 2024.

This scenario will pose complications for the regional insurers. For instance, as the global economic slump spills over to Latin America, we expect demand for insurance products to sag. This is because economic woes could hit corporate profits and households' purchasing power. Moreover, insurers' technical results could take a hit from potentially higher claims (in frequency and severity). This because the lifting of pandemic-related restrictions could increase insurers' claims, while high inflation and the potential deterioration of employment could increase incidents of fraud, social unrest, and crime levels across the regions. In addition, we should also consider physical risks from climate change that are increasing in the region. Finally, if high inflation persists and Latin American currencies undergo episodes of high volatility, insurers' claims could jump. This could lift costs of insurance premiums and, consequently, lapse rates within policies in-force, shrinking insurers' customer and premium base.

However, we believe insurers' healthy balance sheets, sound capitalization, and sufficient liquidity will cushion the blow. We expect the companies to maintain conservative underwriting and investment policies this year, enabling them to preserve profitability amid potentially high financial-market volatility. Moreover, we believe the experience that insurers gained from operating during previous times of economic stress--with significant fluctuations in market conditions and foreign-exchange rates-- will help the industry players to navigate the upcoming obstacles.

Rating Activity For 2023

In our opinion, the gloomy economic outlook will test the currently stable rating trajectory across the insurance sector. As of this report's date, 91% of the rated Latin American insurers have a stable outlook and the remainder is negative. The 2022 outlook revision on Mexico to stable from negative set the trend, given that about 64% of insurers we rate in Latin America operate in this country and that the ratings on about 90% of these companies are at the same level--or above--the credit rating on the sovereign. In addition, credit quality of 89% of the rated insurance companies in the region is the same as--or above--their respective sovereign ratings. Most of these entities operate in countries with a stable outlook (with the exception of Argentina), contributing to a mostly stable insurance portfolio. However, we don't rule out a rising negative outlook bias in 2023 for Latin American insurers because subdued economic growth and fiscal challenges could erode credit quality of sovereigns and companies in the region, and shrink households' purchasing power. Weather-related events could also weaken credit quality of several industry players.

Top Risks For Latin American Insurers In 2023

Lagging Inflationary Effects And Disrupted Supply Chains

Although we expect a stabilization in pricing for insurance products in most of the region, Argentina's high inflation, volatile exchange-rate policy, and foreign-exchange controls are generating uncertainties in pricing and reserve adequacy. Moreover, in some countries like Mexico and Colombia, delays in imports of auto parts and a slow recovery of new-vehicle sales are keeping repair costs and used-vehicle prices at high levels, raising the volume of insurance claims. These factors could lift premium costs, which could also increase lapse rates and sap demand for non-life insurance. The latter, along with the higher frequency and severity of claims, would diminish the insurers' internal capital generation capacity, pressuring credit quality. Moreover, high interest rates might constrain fiscal policies of highly indebted governments and undermine insurer ratings, which are at their respective sovereign levels, as well as the companies' stand-alone credit profiles (SACPs) due to weaker liquidity and credit quality of investment portfolio that heavily depend on government instruments.

Further U.S. Monetary Tightening And A Sharper Slowdown Of The World's Largest Economies

Latin American countries are approaching the end of their rate-hike cycles, but this doesn't mean policy rates will go down soon. The Federal Reserve could still raise its policy rates further than expected, and interest rates could remain high for a longer period, prompting a similar trend for interest rates in the region. Therefore, downgrades, rising defaults, or distressed exchanges could occur among speculative-grade issuers in the region, depressing credit quality of insurers' investment portfolios and, consequently, their capitalization and liquidity positions. In addition, the U.S. dollar's strength could prolong the inflationary squeeze, raising claims costs mainly for auto and accident and health (A&H) insurance providers, since auto parts and medical equipment are usually imported. Moreover, weaker global macroeconomic conditions could act as a drag on insurance subsidiaries of international groups, primarily those that rely on capital injections. All these factors could worsen insurers' business and financial conditions, straining their credit quality.

Increasing Geopolitical Tensions And Difficult Domestic Sociopolitical Conditions

The Russia-Ukraine military conflict has reached a stalemate, with no visible short-term resolution. Further escalation and a continued rise of energy and food prices could sap investor confidence and global growth. In Latin America, food prices have risen rapidly in 2022 and may increase at a similar pace this year, hammering households and potentially resulting in social unrest and higher crime rates that could cause physical damage to properties, depressing insurers' technical results. Moreover, global reinsurers' losses have widened due to the conflict between Russia and Ukraine and due to the more frequent and severe natural disasters. In this sense, we expect reinsurers to transfer part of the impact to insurers through higher prices and adjustments in reinsurance schemes, denting Latin American insurers' technical results.

Country-By-Country Key Expectations In 2023

Paltry Economic Growth And Higher Non-Life Claims Will Squeeze Mexican Insurers' Profits

We forecast GDP growth in Mexico to plummet to 0.8% in 2023 from 2.6%, mostly due to lower U.S. demand for Mexico's manufactured exports. Services activity will also sharply cool as unemployment rises. Continued strong remittances from the U.S. would offset a weaker economy and boost consumption in Mexico. Given the difficulties that the Mexican insurance sector has faced historically to expand its operations, particularly during low economic growth, we forecast the gross written premium (GWP) growth of about 6.4% in nominal terms for the next two years, but about 1.0% in real terms for 2023 and 3.5% for 2024, mostly driven by the non-life insurance segment.

We expect the industry's profitability to approach pre-pandemic levels in 2023-2024, given that COVID-19 restrictions have been lifted. The A&H segment's combined ratios will stabilize at about 95%, returning to pre-pandemic claims levels. Life insurers' profitability will tighten due to tepid economic growth but offset by the normalization of claims as the pandemic subsides and still high interest rates will keep supporting investment income. In contrast, we expect the auto insurance sector's profitability to erode as supply-chain bottlenecks raise the cost of claims and as crime rate increases, resulting in a combined ratio of 91%-92%. The scale and business diversification could position larger insurers to weather the downturn better than their smaller peers. However, sound regulatory capitalization levels will help insurers cope with economic woes.

High Investment Yields Should Strengthen Brazilian Insurers' Profitability

After sharp growth in property and casualty (P/C) premiums in 2022 amid rising auto prices, we expect the pace to return to historical levels in 2023. Moreover, similar to last year, agribusiness insurance should continue fueling the P/C sector's growth. We also believe that profitability will improve across the P/C, life, and health segments in 2023. This reflects our expectation of lower claims for P/C, especially after a year of high claims in the agribusiness and auto insurance segments, and higher interest rates in Brazil, which should lift profits. The policy interest rate is currently at 13.75% and should remain in double digits until the end of this year. Nevertheless, we expect economic uncertainties to generate profit fluctuations. We forecast GDP growth of only 0.5% in real terms this year due to restrictive financing conditions, which could curb the insurance industry's expansion and profits.

Colombian Insurers' Profits Will Remain Resilient Thanks To Investment Income

Thanks to high energy commodity prices and strong domestic demand, Colombia's GDP expanded about 7.7% in 2022. However, we expect growth to lose steam and slump to about 1.1% in 2023, given that domestic demand will cool as sluggish global growth saps investor confidence. After Colombia's inflation reached nearly 12% in 2022, among the highest in the region, we expect it to recede in 2023. However, domestic interest rates will remain relatively high, given that inflation expectations remain well above the central bank's 3% target.

We project gross premium growth (GPW) of about 10% nominally (3% in real terms) in 2023 amid challenging economic conditions. Stable auto sales, along with the increase of policy prices in response to higher claim costs, will continue fueling premiums growth of auto insurance at double digits in nominal terms, which makes up almost 20% of the industry's premiums. Additionally, government-sponsored agricultural and construction insurance offerings may offer significant growth opportunities in the P/C sector in the next couple of years. In addition, insufficient public healthcare infrastructure, along with increasing awareness in the population with respect to insurance protection (life and health products) due to the pandemic, will continue boosting growth of the life and health sector. We project the insurance industry's return on equity (ROE) to remain in double digits in 2023 thanks to GPW's continued growth, and high inflation and interest rates bolstering investment returns. We also expect claims to remain stable in the life segment thanks to lower mortality rates, while auto insurers would be able to adjust prices in order to partly compensate for the increasing the cost of claims due to high inflation.

High Inflation And Weak Currency Dampen The Argentine Industry's Profitability

Argentina's very high country risk reflects the stressed economy and business conditions, along with fragile economic fundamentals, including tightening controls on the foreign exchange market and very high inflation and unemployment. Significant macroeconomic distortions and inconsistencies in the past two decades have led to economic volatility and a secular decline in living standards. We expect real GDP to expand 4.6% in 2022 and subpar growth afterwards amid the ongoing economic imbalances and strains.

As of June 2022 (fiscal year-end), high inflation has hit the industry's profitability. The sector posted negative real ROE of 11% and combined ratio of 97% from a positive ROE of 4% and combined ratio of almost 90% in June 2021. On the other hand, GPW soared 66% year-on-year in nominal terms, generally in line with inflation as of the same date. The sector faces considerable product risk from high inflation, a volatile exchange-rate policy, and foreign-exchange controls. These factors cause uncertainties in both pricing and reserve adequacy.

For the next 12-24 months, we expect negative real ROE of 5%-8% and a combined ratio of 100. Also, we estimate premiums will contract in real terms by 5%-10%, expanding below inflation growth rate as insurers focus on retaining customers and collecting premiums, given Argentina's economic malaise.

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Related Research

• Global Credit Conditions Downside Scenario: Inflation, Geopolitics Are Twin Threats To Our Base Case, Dec. 8, 2022
• Global Credit Outlook 2023: No Easy Way Out, Dec. 1, 2022
• Insurance Industry And Country Risk Assessment Update: October 2022, Oct. 31, 2022
• Credit Conditions Emerging Markets Q1 2023: Downturn Exacerbates Risks, Dec. 1, 2022
• Global Insurance Markets: Inflation Bites, Nov. 30, 2022
• Economic Outlook Latin America Q1 2023: A Shift To Lower Growth, Nov. 28, 2022