Claims analysis, inflation and discounting (part 2)

This is part 2 of a 3 part series. Part 1 is here.

Non-life claims reserves are regularly not discounted, for bad reasons and good. This part of the series looks at the related issue of inflation in claims reserving. (You’ll have to wait for part 3 for me to talk about the analysis that prompted this lengthy series.)

In many markets, inflation is low and stable. Until a decade ago, talk of inflation wouldn’t have raised much in the way of deflation either. That’s still sufficiently unusual to put to one side.

Low, stable inflation means that past claims development patterns are mostly about, in approximate descending order of importance (naturally depending on class and peril) Continue reading “Claims analysis, inflation and discounting (part 2)”

Claims analysis, inflation and discounting (part 1)

I’ve had the privilege to straddle life insurance and non-life insurance (P&C, general, short term insurance, take your pick of terms) in my career.  On balance, I think having significant exposure to both has increased my knowledge in each rather than lessened the depth of my knowledge in either.  I’ve been able to transport concepts and take learnings from one side to the other.

A recent example relates to the common non-life practice of not discounting claims reserves.  Solvency II, SAM and IFRS17 moves to require discounting aside, it is still more a common GAAP approach to not discount than to discount claims reserves.

Discounting or fiddling with inflation has some obvious implications for analysing actual vs expected analysis, reserve run offs, and reserve adequacy analysis. That some non-life reserving actuaries trip over because it’s more natural in the life space.

But, first, why are non-life reserves so often not discounted? There are several reasons typically given: Continue reading “Claims analysis, inflation and discounting (part 1)”

Economic growth during and after Apartheid and the real problem with 1%

I read a letter from Pali Lehohla on news24 this weekend. Lehohla, the head of StatsSA, disagreed with a report by DaMina Advisors on economic growth in South Africa during and post the apartheid era.

To paraphrase Lehohla, he disagreed with their methodology, their data and their values and ethics:

First, I need to engage the author on methods. Second, I address the facts. Third, I focus on the morality of political systems and, finally, I question the integrity of the luminaries of DaMina and ask them to come clean.

This wasn’t data I had looked at before, but some of Lehohla’s criticisms seemed valid. Using nominal GDP growth data is close to meaningless over periods of different inflation.

Second, the methodology of interpreting economic growth should use real growth instead of nominal growth because this carries with it differing inflation rates. This is to standardise the rates across high and low inflation periods.

I haven’t confirmed the DaMina calculations, but the labels in their table do say “current USD prices” which suggests they have used nominal data. It’s little wonder any period including the 1970s looks great from a nominal growth perspective with nominal USD GDP growth in 1973 and 1974 being 34% and 23%, compared to real growth of 2.2% and 3.8%. The high inflation of the 1970s arising from oil shocks and breakdown of the gold standard distorts this analysis completely.

Lehohla’s other complaint is also important, but less straightforward to my mind –

The methods that underpin any comparison for a given country cannot be based on a currency other than that of the country concerned. The reason is that exchange-rate fluctuations exaggerate the changes beyond what they actually are.

Two problems here – one is that purchasing power adjusted GDP indices are not typically available going far back in history. The other is that if one is using real GDP, the worst of the problems of currency fluctuations are already ironed out. (The worst, certainly not all and it would still be a factor that should be analysed rather than completely overlooked.)

I was disappointed that neither piece mentioned anything at all about real GDP per capita. Does it really matter how much more we produce as a country if the income per person is declining? Income inequality aside, important as it is, more GDP per capita means more earning power per person, more income per person, more things per person. It is a far more useful measure of prosperity for a country, and particularly for comparing economic growth across countries with different population growth rates.

My own analysis, based on World Bank data (available from 1960 to 2013)

real GDP growth (annual %) real GDP per capita growth (annual %)
1961-1969 6.1% 3.5%
1970-1979 3.2% 1.0%
1980-1989 2.2% -0.3%
1990-1999 1.4% -0.8%
2000-2009 3.6% 2.0%
2010-2013 2.7% 1.1%
1961-1990 3.6% 1.2%
1971-1990 2.4% 0.1%
1991-2010 2.6% 1.3%
1991-2013 2.6% 0.8%


I’ve put these numbers out without much analysis. However, it’s pretty clear that on the most sensible measure (real GDP per capita) over the periods the DaMina study considered, post-apartheid growth has been better than during the 1971-1990 period of Apartheid.

The conclusion is reversed if one includes the 1960s Apartheid economy and the latest data to 2013, the picture is reversed on both measures.

This, above all else, should talk to the dangers of selecting data to suit the outcome.

This analysis doesn’t talk to the impact of the gold standard, the low cost of gold mining closer to the surface than it is now, the technological catch-up South Africa should have benefited from more in the past, the impact of international sanctions and expenditure on the old SADF and who knows what else. There are much big monsters lurking there that I am not equipped to begin to analyse.

My overall conclusion? The Apartheid days were not “economically better” even without ignoring the millions of lives damaged. Unfortunately, our economic growth has for decades been too low to progress our economy to provide a better life for all.

Here is the problem:

1961-2013 1961-2013
Real GDP growth Real per capita GDP growth
South Africa 3.2% 1.0%
Kenya 4.6% 1.3%
Brazil 4.3% 2.3%
USA 3.1% 2.0%

Despite the theory of “Convergence“, the US has had double South Africa’s per capita GDP growth for over five decades.  Real GDP per capita increased by 72% in South Africa over the entire period from 1960 to 2013, which sounds impressive until you realise that the US managed 189%. That is more than 2.5x our growth Brazil has done even better at 237%. “Even Kenya” outperformed us over this period.

1% per annum real per capita GDP growth is just not good enough.

European deflation risks not deflating

The UK Telegraph (and other sources) are highlighting the rising panic about Euro area deflation. For those Austrian / hard money / gold standard / bitcoin / generally poorly informed amongst you, it’s not that deflation is itself a problem, but that it creates scenarios of debt spirals increasing the real value of debt obligations and decreases demand and economic growth through increasing the real cost of labour through downwards sticky prices (most especially wages).

European five year inflation expectations

European five year inflation expectations

It really does seem that UK / US policies are, more slowly than necessary, coming right and the economies are slowly shrugging off the GFC and are moving forwards.  The rest of Europe is not.

Is credit extension in SA out of control?

Unsecured credit explosion? Sure. Concerns about abuses and sustainability in this sector? Absolutely.

But is overall domestic credit extension out of control? Are real interest rates negative? Is the global economy strong and steaming ahead?

The answer to all these questions is “no”. Here is a graph produced from public reservebank data.

Credit extension is recovering after a precipitous decline after 2007, but is still below long run averages
Total credit extension is hardly out of control.

Eskom, inflation and early onset dementia

Everyone has totally lost the plot.

The proportion of people who speak sense has declined to the lowest level recorded since ever.

“If Eskom puts up its prices too high we’ll have higher inflation. Inflation is bad therefore Eskom shouldn’t put up electricity prices so much.”

Oh really? What happens to the cost of producing electricity when Eskom puts up its prices by 16% rather than 8%? Nothing. Well actually the cost goes down, but then I’m being sneaky – raising the price will reduce consumption, which in turn will decrease the total amount of electricity produced, thus reducing the aggregate cost of electricity production. Yes, it’s sneaky because we all knew I meant the “cost per unit” of electricity.

But wait, if we consume less electricity, Eskom presumably would have to use less gas-turbine powered emergency and oh-so-very-expensive sources of electricity to fill in at peak times. So just maybe the cost per unit of electricity would go down if Eskom were allowed to raise it’s prices by 16% and not 8%.

Another good way to lower inflation would be for government to add a 1% subsidy on everything this year. Everything will be 1% cheaper because you mail (fax?) your receipts to Pravin and Government will mail you a postal order for 1% of the value back in.  Instantly effective prices are 1% lower and inflation is more under control.

Hell, why stop at 1%? Let’s have a 2% reduction.  And a further 2% next year and so on.