Impact of inflation on non-life insurers

Non-life insurers are negatively impacted by higher inflation due to impacts on claims costs. Actuarial models which assume the past is a good predicter of the future need adjusting. This requires assumptions about the duration and severity of excess inflation, and its effects on lines of business.

As inflationary pressure intensifies, the challenge of how insurers need to deal with it also grows. Over the past year, prices have risen sharply as a result of post-pandemic supply chain disruptions and rocketing energy prices due to the war in Ukraine. Claims costs are directly linked to inflation and hence heavily impacted.

The majority of traditional actuarial models assume the past is a good place to start when predicting the future. They therefore don’t capture the significant change in inflation that we are now experiencing, and need to be adjusted. It is not an easy task – any model that will allow for excess inflation must be sufficiently granular to capture the different effects of inflation on individual geographies and lines of business.

So far the inflation spike we have seen has mostly been on prices. This directly impacts mainly short-tailed lines of business such as property and engineering. Early indications suggest, however, that price inflation is now also driving wage inflation in some countries, which then also affects the cost of claims for long-tailed lines of business such as liability. 

We know that excess inflation is with us, but for how long? At KPMG’s recent Actuarial Smart Soiree event of more than 100 insurance industry representatives in late November, more than half of attendees believe excess inflation will last well into 2024. This is important, as the compounding nature of inflation means that its duration materially affects the impact on insurers’ reserves.

We observe most European (re)insurers now adding explicit inflation loads to their reserves. The most common approach is via a simple cashflow projection-type methodology, with shocks applied to future cashflows based on appropriate index projections. 

The devil is always in the detail, however. For a suitable inflation model the following also needs to be considered:

• How does my organization define excess inflation? In other words, what is the baseline inflation that is subtracted from the projected inflation to obtain this?
  
• To what extent are my case reserves already adjusted by claims adjustors/cedants
• What is the effect of gearing for non-proportional reinsurance or direct insurance with material deductibles?
• How is economic inflation interacting with other types of inflation, e.g. social inflation?
• What might be the impact of inflation on court awards?
• What changes are required to my future models, such as stripping out inflation from the loss development triangle, or adjusted APLRs?
• Which possible mitigating factors need to be considered, such as premiums linked to sums insured?

The impact of inflation on insurers’ capital models are needs to be considered, for example: 

• The capital impact of a reduction in the market value of bonds if there is an asset/liability mismatch
• A rise in insurance risk due to higher premiums and reserves
• Whether macroeconomic and inflation models remain appropriate.

We are still at the start of what could be a lengthy period of excess inflation, which will undoubtedly throw up fresh challenges as the months pass by. We strongly encourage Swiss (re)insurers to take a close look at their actuarial models to ensure inflation is appropriately reflected.

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Download our publication on this topic: Inflation impact on insurers − How actuarial models need to change.