In our earnings preview published this week, we noted that the tariff question would be one of the focal points for this earnings season. Additionally, in our tariff note published last week, we argued that when factoring in the puts and takes, the impact of the tariffs should be manageable for now.
Yesterday, Travelers reported its first-quarter earnings, and on the analyst call, several questions were focused on the impact of tariffs on the company’s operations and the broader insurance market.
Travelers noted that, based on its current view, the tariffs' direct impact would be on personal auto and property losses. The most significant impact would be a one-time step-up in physical damage repair loss costs – that would likely be mid-single-digits – and beyond that, the effect would diminish significantly.
The announcement of tariffs has negatively affected expectations for Q1 2025 GDP growth, which the Atlanta Federal Reserve now predicts to be –2.2%. Other economists and market participants have predicted more optimistic figures, particularly since President Donald Trump postponed many of the tariffs announced on April 2, but the consensus remains that GDP growth will be weaker than it was last quarter.
Over the following analysis, we review the industry’s and Travelers' correlation to GDP and the relationship between prior-period development and CPI inflation.
We find that both the data and Travelers’ messaging on the earnings call supports our prior view that the industry, based on our current position, will be able to manage the direct and indirect impact of tariffs as well as negative shifts in the economy’s direction.
The P&C industry’s growth, although correlated with GDP, has outpaced GDP growth trends
As with most earnings seasons, Travelers' results and comments on its earnings calls are viewed as a bellwether for industry trends.
The chart below shows industry commercial line growth versus GDP growth over time. The graph's peaks and troughs clearly show a longer-term directional correlation.
However, not only have commercial lines growth rates outpaced GDP trends, but a divergence can also be seen post-pandemic. This is due to the “hard market” in recent years, which was a function of shifts in catastrophe losses, social inflation, reserve adjustments, as well as pricing inadequacy after years of rate cuts.
This “hard market” is different from those that often follow a capital shock or significant loss event, which have lasted for shorter periods before dissipating.
The chart below shows Travelers business insurance segment – which is a proxy for commercial lines – and GDP over time. Yet again, we can see that even though there is a strong long-term correlation, the company has outpaced shifts in GDP materially over several time periods.
However, recent weeks have shown that tariff impacts are already beginning to influence future decision-making for businesses. The chart below shows the National Federation of Independent Businesses' hiring expectations.
We can see that the net percentage of planning to hire has dipped this quarter, reflecting uncertainty. On the other hand, overall employment seems strong since permanent job losers' (i.e. those who lose their jobs but do not expect to be re-hired) change over time has remained fairly steady, as evidenced by the BLS data in purple.
For the sector, this implies that if GDP declines meaningfully, commercial lines insurers will also feel directional pressures on their top lines. However, the industry and leading commercial lines players have outpaced the economy’s growth over time.
Though rates and inflationary effects during the time period helped drive this growth, we still would not anticipate a precipitous decline in new and renewal business in a downturn.
Loss costs and social inflation pressures remain, but it's early days to factor in the impact from tariffs
Over the past few years, the industry has continued to reflect reserving volatility from a combination of soft market years' additions, recent uncertainty surrounding so-called hard market reserves. For some companies any negative movement has been more than offset by releases from segments such as workers' compensation.
Industry participants often look at Travelers' results as an indicator for the rest of the commercial-predominant carriers. Although the quarter did not reflect any apparent reserve volatility, the company, in response to a question on its earnings conference call, noted the continued presence of social inflation and the consequent loss-cost inflation.
The chart below shows the industry’s and Travelers' commercial lines reserve development over time. Note the decline in reserve releases for Travelers and the industry’s adverse development, as inflation has become more challenging to predict, as shown by the uptick and then downtick in CPI inflation.
Which direction the Fed will take with interest rates in the short term complicates the issue. Chairman Jerome Powell noted yesterday that the central bank could struggle to deliver on its dual mandate goals of controlling inflation and supporting growth.
The US dollar has also weakened recently, raising the cost of imports even further, and yields on 2- and 10-year Treasury bonds were rising recently until beginning to trend downwards this week. With some indicators showing slowing economic growth while others point to rising prices, it’s hard to know what the Fed’s best move is regarding interest rates at this point. Powell noted on Wednesday that the Fed is “well positioned to wait for greater clarity”, meaning that maybe the best move is simply not to play.
In summary, Travelers' results and commentary strengthen our conviction that the direct and indirect impact of tariffs are mostly manageable based on what we know today. We anticipate other commercial-predominant insurers will adopt similar messaging this earnings season.