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Scenario Planning in a Low Growth Environment

This paper explores the factors causing low growth and its impact on the insurance and pension sectors. It provides insights on drivers of growth, the role of demographics, and economic forecasts.

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Scenario Planning in a Low Growth Environment

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  1. Scenario Planning in a Low Growth Environment Nebraska Actuaries Club January 30, 2019 Max J. Rudolph, FSA CFA CERA MAAA

  2. Outlier Scenario? • SOA Research Projects • A Low Growth World: Implications for the Insurance Industry and Pension Plans • Mark Alberts and Max Rudolph • Expected publication: Spring 2019 • Resources • www.rudolph-financial.com • SOA annual meeting presentation • https://www.soa.org/prof-dev/events/2018-annual-meeting/ session 168 • ERM Symposium May 2/3 Orlando session 2

  3. Key Takeaways • This paper focuses on factors causing low growth • High growth needs technological solutions, peace, renewable energy, or a group to enter work force • “Expected” growth is lower than historical • Fiscal/monetary responses ineffective – choices with ramifications • Asset returns, premiums, mortality, morbidity, some property, product design will evolve

  4. Global GDP Growth Scenarios

  5. GDP Growth

  6. Disciplined Thought Process • Know your risk profile • Learn/understand conventional solutions • Identify gaps • Seek out wisdom, knowledge, opinions of others (especially contrarians) • Critically evaluate that wisdom • Apply the best of old/new solutions • Own your decision

  7. Sections of the Paper • III Survey of existing literature • IV Scenarios • V Impact of low growth on insurance/pension sectors • VI Enterprise risk management implications • VIII Ideas for future research

  8. Drivers of Growth • Productivity • Markets (invisible hand) and technological innovation • Recent inventions take a generation to increase productivity • Population • Ecosystem • Biodiversity, clean environment, stable temperatures • Not plague, influenza, spillover diseases, pollution, CO2 • Advice: the economy is a complex adaptive system – look for interactions between productivity, population growth, conflict, climate, energy… 8

  9. Max Roser (2019) - "Economic Growth". Published online at OurWorldInData.org. Retrieved from: 'https://ourworldindata.org/economic-growth' [Online Resource]

  10. Role of Growth • Perpetual economic growth • Implicit in economic theory • Dominates our planning/forecasting • Theory of interest relies on it • Some believe capitalism and debt markets require growth

  11. GDP Growth • P, population (labor force) growth • TFP, total factor productivity (capital, technology, government policy) • GDP = P x TFP • Increase the labor force or productivity

  12. GDP per capita and TFP Comparison

  13. Demographics is Destiny • Fewer people lowers GDP • Role of immigration, fertility rate • Interacts with emerging risks (e.g., conflicts, climate change) • Older population lowers relative GDP • Buy services • Spending down their nest egg • Advice • Watch and learn from Japan and Europe 14

  14. Things have changed since 1900 • Reliance on horses • Manure piled up in the streets, mixed with urine/rain • 25% of agricultural land used to feed horses • Humans were paid to feed and clean up after them • Cholera and other contagious diseases • Since 1900 • Antibiotics/germ theory of disease • Pivot to automobile/public sanitation • Expected lifespan – reduced infant mortality, lower risk of childbirth, reduced deaths due to smoking • Going forward – opioids, deaths of despair in US • Developing world – improving (Gates Foundation)

  15. Malthus 1798 • Believed crop yields grew linearly and population exponentially – and would self correct • Population grows when wages are above subsistence • Builds off work by Benjamin Franklin • Why he has been wrong so far • Agricultural pivots – fertilizer • Why he may be right (hammers) • Biodiversity loss (fish, insects, large mammals) • Poor stewardship – the Garden of Eden is now full of climate refugees

  16. The Rise and Fall of American Growth - Robert Gordon • Return to pre-1700 growth rates (0.2%) • Third Industrial Revolution (computers) breakthroughs have been incremental rather than transformative – is he right? • Where are cars, electricity, lighting, refrigeration • One time circumstances in 1930s/1940s • Why growth will stall • Females already in workforce • Outsourcing/gig economy • Education – single parents, student debt • Sustainability/climate – historical, future • Income inequality • Government actions – debt, stimulus • http://www.cepr.org/sites/default/files/policy_insights/PolicyInsight63.pdf 17

  17. Economic Forecasts • Reviewed 20 existing GDP scenarios • Global results, split US and China • Median is half historical growth since 1960 • Highest are low compared to historical • University of Denver Pardee Center’s International Futures (IFs) model (open access modeling platform)

  18. What GDP Forecasts are (and aren’t) • Are • Expected path • Smooth • Aren’t • Tail risk • Reflect tipping points or cliffs

  19. Government Policy • Fiscal policy • John Maynard Keynes • Net spending stimulates the economy • Monetary policy • Interest rates stimulate borrowers

  20. This Time is DifferentCarmen Reinhart and Kenneth Rogoff • Inflation spikes (into hyperinflation) when • Debt becomes large - $22 trillion (over $60,000 per capita) • Central bank monetizes the fiscal debt – quantitative easing (QE) • Debt is owed to foreign sources • Sound familiar? • Timing not predictable • Needs trigger • Monetary policy works best with balanced budget (above 90% debt/GDP reduces growth) – 104% currently 21

  21. Velocity of MoneyPushing on a String • Expectations Theory • Trust in system • Low • Focus on me • High • worried about systemic risk • GDP = MV = PY • Money supply M • Velocity V (constant?) • Prices P • Output Y

  22. Modern Monetary Theory (MMT) • No spending limits since US can print money • Impossible to default • Relies on Congress to tax and keep spending balanced • High/hyper inflation could result • Associated with progressive Democrats but consistent with every Republican administration since Reagan • Alexandria Ocasio-Cortez, Stephanie Kelton • Fiscal policy is the signal, monetary policy is the noise – monetary policy is ineffective if debt is high

  23. Hillebrand-Closson 4 • 2x2x2=8 qualitative scenarios • Economic growth (low/high) • Energy prices (low/high) • Geopolitical relationships (low/high political harmony) • HC4 is low growth, low energy prices, low political harmony • Regional mercantilism • Regional trading blocks, US loses role as economic leader and reserve currency, populism and state capitalism grow

  24. HC4 vs. base scenario

  25. Internal vs. Regulatory Scenarios • Actuarial/investment software doesn’t model GDP • Convert to narrative of interest rates, inflation and equity returns • Align variables – if you have an inverted yield curve, include a recession with higher defaults • Focus on deterministic stress tests • Analytical tool, not meant to be predictive • Improved decision making is the goal

  26. Contrarian • Time horizon – go longer than comfortable • What could go wrong? • What rules of thumb are no longer appropriate? • Don’t forget about stagflation • Risk interactions • Advice: qualitative analysis drives quantitative analysis, resilience 27

  27. Products in a Low Growth Environment • Unknown knowns • Historical data is not predictive • De-emphasis on investment risk • Shift to pass through • Guarantees based on real rates • Shift to shorter term coverage • Risk pooling instead of systemic risk • Previous feedback loops • Loan guarantees • Credited rate guarantees • Variable guarantees • Loose contract language

  28. Impact on Investments • Depends on drivers of low growth • Environmental drivers • Avoid coasts (esp. Miami), ski resorts • Buy fresh water locations • Financial drivers • Be wary of leverage • LBO, CLO, loose covenants, BBB downgrade risk

  29. Global Levels of DevelopmentFactfulness (Hans Rosling)

  30. GDP vs. Well-Being • GDP is a number • Well-being is qualitative • Recognize that economic output does not define society’s well-being • Economic means to well-being

  31. ERM Focus • Effective resiliency building • Avoid black boxes – false aura of precision • Qualitative analysis • Monitor/contingency planning • Unanticipated/unintended consequences

  32. Clustering • Risk pooling allows insurer to manage a 4% frequency risk smoothly if it happens every 25 years • If it happens 2 consecutive years the risk of insolvency becomes much larger • Applies to individual risk or independent risk combinations – influenza pandemic and San Andreas earthquake could happen simultaneously • How many risk events can you survive? Does your risk appetite reflect this, or do correlations mask it? • One sensitivity should always look at what happens with no diversification benefit (100% correlation)

  33. Worst Case Scenario? Climate Change • Canada becomes warmer, but equator is uninhabitable • Immigration crises incite regional conflicts • Reduced biodiversity leads to food becoming scarce • Global war is fought with fossil fuels, accelerating the problem (potentially masked by volcano) • Deadly virus have no coordinated response • Financial systems and trade collapse • Did you survive to this point? • The scenario gets worse • Actex webinar March 6 Emerging Risks and Climate Change

  34. Future Research • Alternatives to GDP metric • Treat depletion/use of natural resources as cost • Costs/benefits of activities accruing to others (e.g., pollution) • Develop measures of happiness • Is all growth due to fossil fuels? When it is repaid do we end up back in 1700 or some version of The Gilded Age? • Complex adaptive system model of the global economy (perhaps built off Rosling’s Global Levels of Development • Immigration management system based on demographics and expected growth • What hammers are imminent? What pivots will save us? • Crops • Carbon • Rate of change drives resilience breakdown

  35. What could go right? (Gordon) • Inequality • Minimum wage/Earned Income Tax Credit/prison reform/drug legalization • Free preschool/student debt income-contingent (delays marriage/kids/home) • Regulation • Seek out ways to reduce • Recognize some regulation is good (safety) • Immigration (encourage) • Tax policy (carbon tax, progressive, incent)

  36. Thank you! • Recognize past NAC Presidents • Recognize Jeanne Daharsh and Craig Schommer

  37. Thank you! Max J. Rudolph, FSA CFA CERA MAAA max.rudolph@rudolph-financial.com Twitter @maxrudolph Omaha, Nebraska, USA (402) 895-0829 • Rudolph Financial Consulting, LLC • ERM/ALM/ORSA strategist • Private investor/writer/researcher • adjunct, Creighton University • CRO, gapwallet •  Professionalism • Nebraska Actuaries Club President • SOA Board of Governors • SOA President’s Award • Investment Section Chair • ERM Symposium Chair • ASB ERM Committee

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