Inflation's impact on reinsurance should not be overlooked
Higher claims costs driven by inflation coupled with more frequent claims driven by climate change have had a toll on reinsurers.
Continuously rising inflation, paired with the subsequent rising interest rates used to combat that inflation, stands to have a strong impact on most lines of property and casualty insurance in the near- to medium-term.
The easy, short answer to how inflation will impact P&C insurers is that inflation increases the value of each loss, which leads to bigger payouts. Those payouts have to be recouped through higher premiums, leading to higher insurance costs across the board.
The questions of interest rates and their impacts on reinsurers shouldn’t be overlooked, though.
Auto
When it comes to automobile prices, they hold a significant weighting of the Consumer Price Index, used to calculate inflation. Auto prices have gone up significantly since the beginning of the pandemic, driven by well-reported supply chain kinks and microprocessor shortages, followed by a dearth of available used cars for sale, meaning the story of inflation is largely the story of auto prices.
That’s bad news for insurers because as the cost to repair and replace autos increases, premiums will inevitably have to follow just to recoup the higher losses. Add in the more costly labor at repair shops driven by the Great Recession, and the cost to repair or replace a vehicle after a crash is much higher than it was just three years ago.
Looking at early rate filings in states throughout the country, insurers seem to be asking for increases, ranging from a relatively modest 3% to 15% or more, depending on the state and insurer.
Many state regulators are pushing back on those rate filings, but with the higher underlying costs, it is going to be hard to make the case that premiums need to stay put, much less go down, in the near future.
Home
Similar to automotive, home values have seen historic increases; up nearly 60% nationally over the past five years according to Federal Reserve data.
Couple higher base housing prices with higher labor costs and higher prices for construction materials and commodities thanks to economy-wide inflation, and the cost to repair or replace a home following a claim is also much higher than it was in the past.
Some potential good news on the home front is higher interest rates being used to combat inflation are also translating to higher mortgage rates — higher than 6% in October, compared to less than 3% just a year ago. Higher mortgage rates are pushing down on housing prices, and even leading to price pullbacks in some markets in the past month.
Still, higher valuations are already baked in from the perspective of an insurer, meaning higher premiums are almost certain in the short-term.
Then there is Florida. The state’s homeowners market was already on shaky ground thanks to roofing scams, and now the state has to deal with the aftermath of Hurricane Ian. If major waves hit the Florida homeowner’s market, ripples are sure to be felt throughout the rest of the nation’s markets. The major question many people are watching is how Florida’s state insurance backstops are going to come into play, and how they weather this storm.
Reinsurance
Higher claims costs driven by inflation coupled with more frequent claims driven by climate change have had a toll on reinsurers. But a less-discussed area affecting the reinsurance market is the cost of capital.
With interest rates rising throughout the world to combat inflation, the costs of capital for the reinsurance market also stand to go up.
Since reinsurance rates sit below the surface of nearly every P&C policy, as reinsurers struggle with flagging profitability, their struggles promise to play an even bigger role in the cost of nearly every policy in the near- to medium-term.
The real story will be told in the fourth quarter and into 2023 as the new reinsurance contracts are written. If the anticipated higher costs are felt in these contracts, expect those costs to reverberate through nearly every P&C policy in the market.
Conclusion
Nobody likes inflation, and few people enjoy the high interest rates that are used to combat inflation. Still, that one-two punch stands to have an outsized impact on nearly every property and casualty insurance line over the next 18 months or so.
As interest and inflation battle it out, the insurance industry stands to be in for a bumpy ride.
Michael Giusti, MBA, is a senior writer and analyst for InsuranceQuotes.com.