Get to grips with inflation risks
Member of the AAE Risk Management Committee
Inflation at 6.8% in Germany… 9% in Estonia… 19.9% in Hungary… 6.4% for the EU as a whole*. These unfamiliar conditions in the macroeconomic environment have been in the headlines for some time, but what do the changes signal? What can be done to mitigate negative impacts? What inflation scenarios should we keep in mind?
With inflation rates in some European countries hitting levels not seen for 40 years, entire generations of practicing actuaries have no experience of a high-inflation environment. Given that inflation is a factor which can be expected to affect every part of the economy, this represents a critical gap in knowledge. With this in mind, and to support the actuarial community in effectively understanding the specific uncertainties that arise from inflation risks, the AAE has published A Primer on Inflation Risk Management. This is a discussion paper which serves as a comprehensive introductory explainer on this key topic.
Those attending the General Assembly heard him speak warmly on the subject, contemplating the fact that the work of actuaries is to endow value upon something that previously had an unknown value. He described this as equivalent an artist’s creative process, making something new by bringing hidden aspects to light.
It opens with a rundown of what can drive and mitigate inflation, using examples from history to illustrate specific situations and explain the special cases of deflation, hyperinflation and stagflation. Elaborating on the understanding that inflation erodes the real value of “fixed claim” assets including cash, the paper summarises why governments try to control inflation by raising interest rates; this leads into an overview of the current situation around the world.
A significant portion of the paper is dedicated to strategies that actuaries can offer for managing risk, such as product design and hedging measures. In this chapter, the information provided about scenario testing is made even more useful with the inclusion of specific example suggestions as well as an appendix of resources to help with building and understanding high-level macro scenarios for inflation.
Subsequent chapters examine how the direct impact of high inflation affects uncertainty management, and the broader impacts that may arise as a result of high inflation. As a whole this discussion paper is an invaluable asset for actuaries, and will ensure they are equipped with the necessary tools for understanding the inflationary picture which is still developing, and to offer meaningful risk management in a volatile environment.
*As at June 2023, Statista.com
This blog is written on a personal title, with the assistance of Yestrans.
07 December 2023
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