NU Online News Service, Oct. 11, 1:43 p.m. EDT

Sudden inflation could reduce property and casualty insurer's surplus by as much as 24 percent over a prolonged period, according to a Moody's Investor Service report.

In the report, “Inflation Risk of U.S. P&C Insurers,” Moody's says that a baseline stress scenario of 3 percent in unexpected claims inflation over a three-year period would translate into surplus reduction between 7 percent and 24 percent.

The numbers cover the firm's rated universe of U.S. casualty insurers with writers focused on long-tail liability business most affected.

“P&C insurers are sensitive to unexpected changes in inflation rates,” says Pano Karambelas, Moody's vice president and co-author of the report. “As seen during the 1970s and 1980s, volatile inflation can squeeze insurers' balance sheets by increasing claims liabilities across multiple business lines and lowering the valuation of fixed-income investments.”

Because of this growing concern kindled by “aggressive monetary policy,” Moody's says insurers are investing in economic modeling to gauge the potential impact on capital and earnings. 

According to Moody's, insurers are subject to “significant exposure to market value declines” in their holdings of fixed income securities. However, barring the impact of a very significant industry catastrophe that would place demands on liquidity, the situation is viewed as manageable. The reason is because insurers tend to hold onto these securities until they mature.

The real challenge comes in underwriting, especially where claims inflation emerges, Moody's explains. The problem is that claims inflation is expected to outpace general inflation “as insurance-specific trends such as healthcare utilization and tort litigation remain dominate drivers of claim severity.”

Offsetting inflation claims cost would be “attendant increases in investment income on fixed income assets,” Moody's says.