The impact on insurers will crystallise in different ways, varying by business lines and by region, but property and construction are expected to be among the first segments to come under pressure, with concerns that systemic underpricing may materialise if insured values are not accurately assessed.
Other lines generally considered to be more affected in the near term include motor (particularly in the US), workers’ comp and general liability business.
Specialty and general liability are exposed to social inflation, while in casualty, there are concerns around underpricing from prior years but also a recent downward spiral in D&O prices.
Pricing movements in these exposed classes will come against a backdrop of elevated loss costs.
A McKinsey report estimates that rising prices contributed to an approximate $30bn rise in global P&C loss costs in 2021, year-on-year, over and above historical loss trends.
In terms of an outlook for industry-wide top-line prospects, Swiss Re estimates that persistent inflation and accelerated monetary policy tightening will soften global non-life insurance premium growth over the next 12-18 months, although some segments such as property will grow.
The focus areas expected to determine board-level decisions in the year ahead include managing reinsurance rate hikes through increased transparency; an emphasis on safeguard clauses that mitigate the risk of under-valuations; casualty back-year reserve evolution and the need to manage rising operational costs.
More transparency for reinsurance renewals
A commonly held view among sources this publication spoke to is that more transparency will be required of reinsurance cedants over how loadings and assumptions have been made, how pricing is outpacing inflation, and how exposures have increased after updated valuations.
As this publication has explored, inflation will be a focal point of tussles at upcoming reinsurance renewals, and as one London market source pointed out, the topic will fuel “a combustible mix of issues” at 1 January, where a capacity crunch is likely to ensue.
“People who renewed at 1.4 this year will probably have got away lightly,” the source said, adding that insurers will get “hammered on outwards purchases at 1.1 – which will be a bit of a bloodbath, frankly”.
Many reinsurance underwriters have not worked in conditions where inflation levels have reached 40-year peaks in the US and the UK. The macro picture could render it more challenging to ensure rate growth outpaces loss costs, given the unprecedented circumstances.
Signs so far suggest that further rate hardening is required in reinsurance, as demonstrated by a recent Gallagher Re report.
The intermediary found that a subset of global reinsurers produced an ex-cat accident year ratio of 60.2% in H1, a 0.4-point deterioration on the prior-year period, demonstrating how rate increases failed to keep pace with the impact of inflation on loss costs.
Property and the risk of systemic underpricing
For primary carriers, property values and construction costs are key focus areas and in the US, coverage-limiting endorsements have come into play, such as margin clauses and co-insurance. Motor is another key area, particularly in the US, where concerns are mounting about social inflation.
In another outlook on what will be required on pricing for next year, a recent Swiss Re Sigma report estimated that for 2023, in an environment of high inflation, low growth and higher interest rates, underwriting margins will need to rise by four points to meet return-on-equity expectations.
Another central issue is the focus on establishing valuation gaps in property and construction.
In its recent study on inflation, Allianz Global Corporate and Specialty (AGCS) stated that the global insurance market has already seen a number of claims where there has been a significant gap between the declared value and actual replacement value.
AGCS gave one example of a claim for a commercial property destroyed in the 2021 Colorado wildfires, for which the rebuild value was almost twice the declared value, due to a combination of inflation, demand surge and underinsurance.
“On average, construction inflation is around 11% to 25% in the US, UK and Germany. Even before the Ukraine war, property and construction claims in North America had already seen an inflation-driven claim cost increase in the upper single digits as of end 2021,” AGCS stated.
In a general perspective on the London market, Chris Sharp, active underwriter at Verto Syndicate 2689, warned earlier this summer that “systemic underpricing” may unfold if sold limits fail to keep up with inflation.
“Having an accurate statement of values incorporating inflationary impact is more critical than ever,” he said, adding there will likely be inconsistent methods for risk-adjusted rate change in the market.
As Lloyd’s scrutinises business plans, it’s expected that the inflation, rate and increased exposure components of growth will be inspected in granular detail, particularly how exposure is growing net of inflation. CEO John Neal recently said that Lloyd’s was “relaxed” about the quality of business plans seen so far from syndicates.
Volatility and adjustable clauses in focus, but not a failsafe
Another focus area is on the use of adjustable features in policies as an inflationary guard. These enable the premium to be adjusted based on the actual or audited value. A source said these features often appear in workers’ comp and general liability policies in the US, though less so in auto, where they may be more needed.
Another guard, typically used in downstream energy to recognise commodity price swings, is the use of volatility clauses. These impose a cap on a percentage increase on the declared value in the policy, which establishes the maximum recovery a client can make on the policy.
If asset values are not updated sufficiently, these clauses are expected to be brought back into wordings to address the under-valuation risk.
Wage inflation, professional service and legal fees
As well as pure valuation and pricing concerns, another aspect that may drive up expense ratios is mounting wage growth, the cost of consultancy fees for insurers and legal expenses when claims are subject to litigation.
[US] partners’ fees can be as high as $1,800 per hour, compared with $1,000 just five years ago. With the US inflation rate now at over 8%, legal costs are likely to rise further
Angela Sivilli, co-head of global practice group for commercial D&O and FI claims, AGCS
One source highlighted the related issue of loss adjustment expenses, due to rising costs of outsourcing to third parties and the fact PwC announced pay rises of at least 7% due to living costs.
“Other (professional services firms) are likely to follow. The costs and services that we all need and rely on as businesses is only going to rise,” the source added.
AGCS’s report also drew attention to US legal services inflation. Angela Sivilli, co-head of global practice group for commercial D&O and FI at AGCS, said: “Partners’ fees can be as high as $1,800 per hour, compared with $1,000 just five years ago. With the US inflation rate now at over 8%, legal costs are likely to rise further.”
US auto at epicentre of social inflation
Amid the backdrop of rising legal fees, social inflation is a paramount concern for US auto insurers.
Signs are already emerging of inflation’s impact on the financial performance of some US motor underwriters, particularly Berkshire Hathaway subsidiary Geico, and a general negative market sentiment, due to loss costs that were already rising last year.
McKinsey estimates that supply chain disruptions and other causes of inflation in the global automotive industry led to an estimated $9bn in loss costs for auto physical damage in 2021.
On a recent Marsh webinar on inflation, where speakers stressed the need for US motor insurers to pursue rate growth, Jack Sallada, managing director, global placement, at the broker said: “US auto insurers collected a lot of premium during a period of low severity [during the pandemic]. We expect new US auto premiums to trend upwards about 2% year-on-year. Claims severity will now be under particular focus, especially large legal awards.”
Casualty underpricing and reserve movements
Sources also mentioned potential issues in casualty lines as a pressure point. One source said that 2016, 2017 and 2018, are “regarded as some of the worst global casualty years in the market,” and that rates have risen 30%-40% since then.
It was highlighted that the quantum of casualty losses from these underwriting years may deteriorate.
Despite the potential impact on reserving, and putting Lloyd’s aside, there were notably few major disclosures on inflation-driven reserve movements at H1 results.
Lloyd’s has proactively put aside an additional £1bn to account for inflation – after 65% of syndicates adjusted their reserves. The average syndicate uplift in reserves for inflation was 2.3%, but there were no similar announcements from continental or US insurers.
Fuel for the legacy market?
Another characteristic of inflation’s influence is its potential to act as one of the drivers of legacy transactions.
A source said that legacy transactions can remove some of the inflation-driven uncertainty on balance sheets, while acquirers should be able to price in inflation during negotiations over deals. Acquirers will also be looking at pricing adequacy themselves on books they’ve taken on.
In its recent launch into the legacy market, Inver Re highlighted the opportunity to assist carriers in the disposal of liabilities and to deal with inflation-related claims and reserving issues.
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