Impact of Inflation on Insurance Industry

The immediate impact of inflation on non-life (property & casualty and health) insurers’ earnings is negative, primarily through rising future claims costs on current insurance policies, the need to bolster loss reserves and, in case of stag-flation, reduced demand.

Acording to The Geneva Association Report, the effect on life insurers’ earnings is more neutral. As opposed to non-life insurance, most life insurance products, e.g. mortality, wealth accumulation and longevity protection, offer benefits that are nominally fixed. Having said this, inflation tends to erode the value proposi-tion of life insurance with fixed benefit payouts, weighing on new business and leading to higher lapses.

The affecting insurers’ balance sheets through mark-to-market valuation losses

Lower equity markets, rising interest rates and widening credit spreads adversely affect insurers’ balance sheets through mark-to-market valuation losses. On the other hand, higher interest rates, i.e. discount rates, have a favourable effect on the net present value of future liabilities.

There is a wide range of management actions insurers can take to respond to the new macroeconomic environment. In terms of product design, with customers typically suffering a reduction in real income, insurers could offer more affordable, low-cost products with an increased focus on risk and loss prevention (see How Artificial Intelligence Can Help Insurers Reduce the Inflation Impact?).

Digitalisation is one obvious route to achieve this objective in areas such as distribution (the biggest non-claims cost block), marketing and customer service.

The main underwriting response is to reprice insurance risks that exhibit elevated claims costs. The need and scope for doing so depend on the competitive environment in the relevant insurance markets, insurers’ assumptions concerning central banks’ ability to tame inflation within a reasonable period of time and the degree of public policy and regulatory constraints and interventions (see How P&C Insurers in the US Can Increase Inflation Resilience?).

To counter rising claims costs, insurers may further accel-erate claims automation and straight-through processing as well as expand (or build) partner and supplier networks in order to negotiate fixed prices for a longer period of time.

In investment management, there is some scope for inflation protection on the back of tactical asset allocation, for example by tilting the investment portfolio away from bonds towards commodities, equities and real estate. For insurers, however, such benefits remain elusive in light of very high solvency capital requirements for those asset classes.

Going forward, demand for insurance could benefit from the shock experience of resurging inflation. Such shocks — similar to what we witnessed as a result of COVID-19 — typically affect risk perception and sharpen risk awareness.

Demand for non-life insurance could also benefit from portfolio shifts from financial to real assets. Furthermore, increasing prices of real assets such as cars and property translate into higher demand for insurance as asset owners seek to expand policy limits.

Inflation effects on Non-life insurance

The immediate impact of inflation on non-life (property & casualty and health) insurers’ earnings is clearly negative. It occurs through two main channels: first via rising future claims costs on current insurance policies and the need to bolster loss reserves,38 and second via inflation-induced changes to interest rates which lead to higher realised capital losses.

According to P&C Insurance Pricing Trends Outlook, longer-tailed P&C lines of business, where claims may need years to settle, are most exposed to unanticipated surges in inflation that are not accounted for in the pricing of insurance contracts and may accumulate over time. Among those lines of business are medical malpractice and general liability.

With claims payouts based on indemnity, health insurance is as vulnerable to inflation as P&C insurance, both due to higher claims and the risk of reserve deficiencies. On top, as mentioned before, health cost inflation typically exceeds consumer-price inflation.

As insurance investment portfolios are dominated by fixed-income securities held to maturity, these interest-rate-induced valuation losses do not impair earnings but reduce the insurer’s net asset value (shareholders’ equity) in Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS) accounting.

Similar to non-life insurance, slower economic growth, eroding inflation-adjusted incomes and price increases are set to curb demand for life insurance products (both protec-tion and savings), especially as life insurance has been found to be more price elastic than non-life insurance, potentially reflecting the fact that their investment components have close substitutes in the form of investment products provided by banks or funds. For protection products, however, this negative impact on demand is somewhat offset by customers’ desire to insure higher benefit limits.

Effects of inflation on insurance penetration

Insurance penetration is defined as the ratio of premium volume to GDP. It measures the importance of insurance relative to the size of the economy. As it is based on the product of quantity and price, penetration is, however, not a perfect measure of consumption.

Also, a lack of competition may increase the price of insurance without implying a higher level of insurance consumption. Despite these shortcomings, we use insurance penetration as a proxy for the insurance industry’s relevance in economy and society.

Given the ambiguities around the effects of inflation on insurance demand and supply, there are no unequivocal conclu-sions as to the impacts of inflation on insurance penetration.

Based on the logic outlined above, relevant factors (with contradictory effects) to examine include:

• Sums insured
• Prices (premium rates)
• Changes to the product mix (savings versus protection, long tail versus shorter tail)
• Competition
• Customer behaviours in the face of affordability issues and changing risk perception.

For those policyholders who are financially able to avoid underinsurance, sums insured and prices will rise in tandem with inflation for most non-life insurance and protection-ori-ented life insurance policies, pushing up (nominal) premium volumes.

………….

FULL Report — https://beinsure.com/inflation-rates-impact-to-insurance/