Although economists generally do not expect sharp increases in inflation, insurers should develop plans to consider how they will respond if inflation surges amid record government spending and aggressive monetary policies, a new Swiss Re study states.

A Swiss Re sigma study, "The Impact of Inflation on Insurers," notes in 2009, financial institution risk managers surveyed by the Professional Risk Managers' International Association and Capital Market Risk Advisors cited inflation as their second biggest concern for the latter part of that year, behind only "Government changing rules."

Inflation, listed as the top concern for 28 percent of the risk managers, ranked ahead of credit losses and counterparty risk.

Swiss Re said insurers "are more worried than other institutional investors about inflation, particularly in the U.S."

For non-life insurers, Swiss Re said inflation leads to higher claims costs, which erodes profitability. "It has the greatest effect on long-tail lines: the longer the tail, the greater the impact.

The study notes, "While aggressive monetary policies and record government spending have triggered concerns that inflation could sharply increase, many economists do not expect inflation to rise."

But the study adds, "Nevertheless, insurers can and should consider how they might respond if it does."

If inflation rises only in the short term, the study notes that insurers can adjust premium rates to compensate. "But this is not always possible if regulations or the competitive environment do not allow it."

For longer-term inflation risks, Swiss Re said insurers can invest in inflation-indexed bonds as well as "real assets" such as commodities and real estate, "which are the best inflation hedges."

Swiss Re also said contract design can be used to shorten the tail of risk. "For example," according to the study, "the introduction of 'claims made' policies or sunset clauses addresses the issue of latent claims. Insurers can also add index clauses linking premiums, limits and deductibles/retention to an inflation-related index."

Insurers can protect themselves by purchasing reinsurance, Swiss Re said. "Reinsurance should be particularly helpful in emerging markets due to the larger risk of high inflation phases."