How Is the Insurance Industry Navigating Increasing Inflation Rates?

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Rising Inflation Rates

As the cost-of-living crisis worsens, UK inflation rates have risen to 9.4% in June 2022, its highest rate in over 40 years. Due to the Covid-19 pandemic, and strict lockdown measures, inflation rates became extremely low, with people unable to physically spend their money. However, once society began to open up again, and businesses returned in-person, there was a surge in demand for goods and services.

According to Derek S. Taddei, Relationship Manager and 401k Specialist at Hoyle Cohen, “The strained supply lines due to Covid-19, paired with an increase in demand […] would be one of the main reasons for inflation at the moment”, “a combination of Demand-Pull and Cost-Push inflationary pressures”. Perpetuated by the Russia-Ukraine war, and the inaccessibility of crude oil, this has resulted in the combined effect of increased fuel and food prices, as well as a spike in energy bills and housing costs.

Risks Facing the Insurance Industry

Rimini Street’s Q3 2021 earning calls state that the three main challenges facing insurers currently are climate change, supply chain disruptions, and – as discussed here – inflation. According to S&P Global, Covid-19’s impact on global insurance markets is most evident in asset risks, specifically the volatility of capital markets, and weaker premium growth prospects. Tending to favour a more conservative investment strategy, increasing inflation rates may affect the value of the insurer’s balance sheets.

Currently, the UK is in a ‘hard market’. As such, capacity for risks and returns in equity decrease, underwriting becomes more stringent, and interest in new business declines, all of which force premiums upward. Notably, rising inflation rates create underinsurance risk and widen the gap between accounting valuations, with replacement costs becoming greater than anticipated following a claim.

For example, for those working in commercial property, costs to rebuild and repair structures have increased considerably. Storing or shipping materials like metals, gas, and agricultural goods, alongside higher labour costs driven by worker shortages, further exposes companies to the risk of underinsurance. In relation to motor insurance, the increasing demand for car parts, compounded by supply chain issues, has led to inflated car part costs. Like the commercial property sector, auto repair shops have been experiencing staffing issues and rising labour costs, thus increasing the price of repairs.

Mitigating the Impact of Inflationary Pressures

When navigating increasing inflation rates, insurance companies can adjust their investment strategies. This may include data-driven analysis, such as statistical forecasting or process mining. By enabling insurers to evaluate the performance of their vendors and suppliers, they may then more accurately assess risk, thereby controlling and optimising costs. Importantly, insurance companies should utilise current, technological advancements to expand their digital strategies, working more efficiently when managing such risks.

Dr Kurt Karl, Chief Economist at The Swiss Re Group, proposes three top mitigation strategies; contract design, reinsurance, and other investment strategies. As Karl suggests, contract design may enable insurance companies to mitigate their exposure to inflation in long-tail business, ultimately lessening the duration of liabilities. This could also involve indexing limits to provide protection against instances of severe inflation. Reinsurance absolves risks of claims escalation. Other strategies include hedging assets or putting in place structured solutions for future scenarios.

For insurers, the main impact of inflation will arise in increasing claims costs, with motor and liability lines seeing the most immediate effects. Yet, The Bank of England predicts that inflation rates will begin to lower in the next two years, with a target level of 2%.