ECONOMIC CONDITIONS
A stable but shifting economic environment
How long can the global economy remain resilient?
The question is becoming more urgent as the threats to that resilience continue to grow.
The resumption of the Middle East conflict in the second quarter has sent energy prices soaring and has contributed to renewed inflationary pressure across the economy.
The Federal Reserve raised interest rates in September as it sought to bring inflation back to its 2% target. Another increase appears possiblebefore year-end.
Higher rates can benefit insurers' investment yields, but they also raise borrowing costs for businesses and consumers. For example, interest rates for a 30-year home mortgage crossed the 7% threshold in September for the first time in more than a year, according to Freddie Mac.
Long-term bond yields have also risen across major markets, reflecting concerns about inflation, government borrowing, and the outlook for interest rates. Heavy investment in AI infrastructure is adding additional pressure.
Still, the economy continues to expand, at least for now.
Corporate earnings remained strong in the second quarter. Revenue growth for S&P 500 companies reached 15%, the highest rate since the fourth quarter of 2021, with every sector reporting growth. Energy led, supported by higher oil prices.
Equity markets, while not necessarily a direct measure of economic performance, remain an important gauge of investor sentiment. Major indexes reached record highs in August before encountering a more volatile trading environment in September.
The labor market has also remained steady, giving the Fed an opportunity to focus on inflation.
Developments that could disrupt the economic landscape:
- Prolonged disruption to Middle East oil shipments could drive inflation higher.
- Renewed U.S.-Canada trade tensions could increase costs, disrupt supply chains, and weigh on growth across North America.
- Further interest rate increases could put more pressure on borrowing, investment, and consumer spending.
- Investors could become less willing to finance government borrowing or AI infrastructure spending at current valuations.
- Key central banks, including the Fed, raised interest rates in September to try to tame inflation and may increase rates further before the end of the year.
- Long-term bond yields are near levels not seen since the outset of the Great Financial Crisis, reflecting concerns about inflation, government borrowing, and the outlook for monetary policy.
- Investors are questioning how quickly heavy investment in AI infrastructure will produce adequate returns.
For insurance buyers, slower exposure growth means insurers are competing for a premium base that is growing less quickly. That supports favorable pricing and broader options today, but conditions could change quickly if a shock alters carrier appetite or increases volatility or the cost of capital. Buyers should use the current market to strengthen program structure, reassess limits and retentions, and build greater resilience against an increasingly unpredictable macro environment.
Global headwinds
U.S. GDP growth in the second quarter, lower than 2.5% in the first quarter.
Growth remains positive across most major economies, but many countries are relying on a relatively narrow set of supports. That makes economies across the globe susceptible to any unforeseen calamity or the worsening of existing crises.
U.S. real gross domestic product increased at an annual rate of 2.2% in the second quarter, a slight deceleration from 2.5% in the first quarter, according to the U.S. Bureau of Economic Analysis (BEA). Consumer spending, investment, and exports supported growth, while higher imports were offsets. The economy is still expanding, but at a pace that leaves it vulnerable to persistent inflation and higher energy prices.
China grew 4.3% in the second quarter, below its full-year target of 4.5% to 5%. The country continues to contend with an overbuilt real estate sector, weak consumer demand, and higher energy costs. Slower Chinese growth matters beyond its borders, particularly for economies and industries dependent on its manufacturing, commodities, demand, or consumers.
The U.K. economy grew 0.5% in the second quarter. Services and business investment remained supportive, but production declined slightly, and construction activity remained below year-earlier levels. The mix suggests an economy that remains sensitive to financing costs, consumer confidence, and external demand.
The European Union's (EU) GDP grew by 0.7%, according to Eurostat, but performance remained uneven. Ireland, Slovenia, and Lithuania performed relatively well, while Germany, Italy, and France grew modestly or not at all. The broader concern is not simply that Europe is growing slowly but that its largest economies have limited momentum at a time when the region remains highly exposed to energy disruption.
Europe produces relatively little crude oil and depends heavily on imports, including supplies from the Middle East, while sanctions restrict access to Russian energy. The collapse of the U.S.-Iran ceasefire, therefore, heightened concern across the region.
While the initial outbreak of the conflict in February closed the Strait of Hormuz, through which 20% of the world’s oil supply flows, the latest wave of hostilities has resulted in Houthi forces advancing upon the Bab el-Mandeb Strait, effectively cutting off an alternate route for shipping oil supplies. Saudi Arabia shut down its East-West pipeline after militia strikes damaged the critical pipeline, marking the latest event that has transformed what started as a regional security concern into a global supply chain and inflation concern.
The conflict has consumers paying nearly $4.50 per gallon of gasoline once again and more than $6.50 per gallon of diesel as of Sept. 30, according to AAA. Higher gasoline and diesel prices affect far more than household transportation costs. They raise expenses across manufacturing, agriculture, construction, and logistics, eventually impacting replacement costs, business interruption exposures, and claims severity.
While oil-producing nations have increased production and countries have tapped into strategic oil reserves, these tactics cannot fully replace normal trade flows indefinitely. Top oil officials are warning that reserve levels are precariously low with fewer buffers remaining to offset higher energy prices. The key issue is how long alternative supply, production increases, and reserve releases can offset a sustained disruption. If the conflict continues, higher energy costs could worsen the current slowdown, keep inflation elevated, and eliminate any near potential for interest rate relief.
Inflation challenges
Consumer Price Index for August.
Energy prices and the continued rise in the cost of services helped keep the Consumer Price Index (CPI), a measure of annual inflation, at 3.4% in August, above the Fed's 2% target. The Fed’s preferred personal consumption expenditures (PCE) measure ran at an annualized 3.4% in August (3.0% when excluding food and energy).
Fed Chair Kevin Warsh pointed to persistent inflation, alongside resilient spending and solid economic growth, as the Federal Open Market Committee (FOMC) unanimously voted in September to raise interest rates for the first time since 2023, bringing the Fed's target range to 3.75% to 4%.
At the same time, Treasury yields continue to rise. Yields for 10-year Treasury notes surpassed 5% in September, the highest level since 2007. The Treasury Department announced in September it would buy back $6 billion of long-dated government debt in an effort to tamp down bond yields. But the Treasury’s intervention did little to stem the increase in yields as demand for Treasury notes dampened during the month.
Interest rate traders have assigned a 58.5% probability through Sept. 30 of another quarter-percent rate increase by the end of the year, according to the CME Group's FedWatch. That would bring the target range to 4% to 4.25%.
Fed governor Michael Barr said the central bank took the appropriate action by raising interest rates in September, and indicated that further action may be necessary.
"In my base case, further policy adjustments are likely to be needed to ensure inflation comes down to target in a timely fashion," Barr said at a Fed event in Chicago on Sept. 23. "We want to support sustainable, durable growth in support of maximum employment, and price stability is crucial to that."
Investors are demanding higher yields to absorb growing Treasury issuance. That raises the government's borrowing costs, adding to deficits and the amount it must borrow.
The Fed faces a difficult choice. Higher energy and service costs are renewing pressure at a time when financial conditions have already tightened. Further rate hikes could help contain inflation, but would also raise borrowing costs for consumers and businesses. Holding rates steady could give inflation more room to build.
The path forward is narrowing, and either choice carries a cost.
Other central banks face similar tradeoffs. The Bank of England held its policy rate at 3.75% in September, although two committee members said they may reconsider their position and vote for a rate hike, given higher inflation. The European Central Bank increased rates to 2.5% for its 21 member countries for the second time since the onset of the Middle East conflict. The Bank of Japan also raised interest rates in September, bringing its policy rate to 1.25%, the highest range in more than 30 years, in an effort to beat back rising prices.
For insurance buyers, the immediate issue is not simply what central banks do at their next meetings; it is how long borrowing costs remain elevated while economic growth slows, and what this means for exposures, retained losses, and premiums.
Consumer pressure
The University of Michigan Consumer Sentiment Index, down nearly 13% compared to a year ago
Consumers are still spending, but the foundation beneath that spending is beginning to crack.
Personal consumption expenditures rose 0.3% in August. BEA data show that consumers are increasing their spending on nondurable goods, gasoline/energy, food services, and motor vehicles and parts, while cutting back on recreation.
Confidence is moving in the opposite direction. The University of Michigan Index of Consumer Sentiment fell to 48.1 in September, down from 51.7 in August and 12.7% lower than a year earlier. Uncertainty about the Middle East conflict and inflation — including gasoline prices — continues to weigh on American consumers.
Spending and sentiment can diverge when employment and household balance sheets remain supportive. Eventually, however, households expecting their purchasing power to decline are likely to postpone discretionary spending and reduce larger purchases, such as automobiles.
The August jobs report showed the U.S. economy added 162,000 jobs, easily surpassing expectations and reversing the trend of earlier jobs reports that pointed to a slowing labor market. The report revised July’s jobs figures, initially a net loss, upward to a slight gain for the month.
The August numbers were a cause for optimism on the labor market front, allowing the Fed to concentrate its focus on fighting higher inflation.
Stock market remains bullish
Despite economic and geopolitical risks, equity investors remain broadly optimistic. The S&P 500 advanced 11.8% through the first nine months of 2026, with nearly every sector posting gains.
The rally has broadened as capital moved from AI-related companies, including hyperscalers and semiconductor and memory-chip manufacturers, into more defensive sectors. Developed markets outside the United States have also outperformed U.S. equities so far in 2026.
Trading in September has been more volatile due to concerns about inflation, energy prices, the Middle East conflict, and rising bond yields. Whether this trend will continue remains to be seen.
Implications for insurers
For insurers, the implications of the current environment are nuanced.
Higher interest rates boost investment income as maturing assets are reinvested at more attractive yields than were available during much of the last decade.
At the same time, higher returns available elsewhere can raise the return investors expect from insurer capital. Insurers, therefore, have reason to remain disciplined in deploying capacity, with a continued focus on risk-adjusted returns, portfolio quality, and underwriting performance.
Higher rates also constrain premium growth. Slower construction activity, fewer transactions, reduced investment, and softer real estate markets can limit the new business available to insurers and ultimately weigh on exposure growth. Insurers may benefit from stronger investment returns, but economic activity that generates insurable exposures can also decelerate.
Rising energy prices add another challenge, with potential loss-cost inflation across transportation, logistics, manufacturing, labor, construction materials, and replacement costs for property.
This dynamic is important because inflation affects insurers differently than interest rates do. Higher yields support investment income, while inflation pressures underwriting margins. Stronger investment returns may help insurers absorb some increase in claims costs and support competition., but they do not eliminate the need for pricing to keep pace with loss trends over time.
Thoughts for buyers
For buyers, capacity should remain available, though pricing and terms will depend on each insurer's view of the risk and its expected losses.
Conditions remain broadly favorable for buyers, but the economy is becoming less supportive of continued broad-based softening. Capacity remains abundant across many lines, and competition is still healthy.
As exposure growth slows and loss costs remain elevated, carriers will focus on underwriting profitability and the returns they earn on deployed capital. In practical terms, they will compete for well-performing risks while becoming more selective where returns do not adequately compensate for volatility, inflation exposure, or capital consumption.
Buyers with strong risk management practices, accurate valuations, demonstrated loss control, and sound fundamentals should continue to benefit in this market. Still, they should expect more scrutiny around property valuations, catastrophic exposures, supply chain dependencies, fleet performance, and overall loss trends as insurers look to protect their margins.
Many organizations are managing new risks, insurance costs, higher financing expenses, wage pressure, and slowing economic activity all at the same time. This creates a greater need to balance risk transfer decisions with broader business objectives, including the need to preserve profitability and financial flexibility.
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