Risk Management for P&C Insurance Companies in the Face of Inflation

Risk Management for P&C Insurance Companies in the Face of Inflation

Media attention has focused on the seven-percent inflation rate forecast for 2021, which the market has widely anticipated. Various institutions, including the U.S. Federal Reserve, address the Reagan-mentioned inflation threat. Property and casualty (P&C) insurance companies must understand the magnitude of inflation they are dealing with and the potential impact on their balance sheets to build strategies to counter this concern, a complex task that Conning believes can be aided significantly through risk modeling. In the meantime

Inflation can harm insurance companies in a variety of ways. A rise in inflation affects the value of the portfolio, income, and returns in real terms. Insurance companies with longer tail risks are more affected by the impact on obligations, which might be more complex.

The analysis is difficult because inflation is not a static phenomenon, and the effect on individual insurers will depend on circumstances specific to each company. Conning argues that insurers can better design methods to control inflationary risk by simulating the many possible outcomes at the investment portfolio and enterprise levels.

With Regards to Insurance Operations, Inflation

Separating the effects on current and future losses from those on historical losses and reserves may help better understand inflation's impact on liabilities.

An increase in inflationary pressures means insurance costs and claims that lower present profits. Some of this can be minimized as insurers adjust premiums to account for rising costs and claims. Insurance firms have reserves to cover known and unforeseen losses, but these reserves may be insufficient if prices grow. As a result, redundant reserves may be reduced, or new reserves may be needed to compensate for past period losses.

For simplicity's sake, we divide P&C insurers into two buckets: short-tail lines, such as personal lines, and longer-tail policies, such as workers' compensation, medical professional liability, and other liability coverage.

Regarding personal lines like auto insurance, claims are easy to track down and may be estimated quite quickly. These claims also tend to have shorter payout durations, which reduces the risk of underestimating reserves for losses. As a result, liability lines may not be identified or settled for many years after they have occurred. In an inflationary climate, the danger of underestimating current claims is magnified because of the longer payouts and uncertainty about future claims.

Inflation will have varying effects on different businesses. In the case of short-tail insurance for a personal automobile, the firm will be sensitive to future inflation in the cost of automobiles and to medical costs associated with accidents. Long-tail business insurance, such as workers' compensation, is less affected by changes in automotive prices. Still, it is more affected by changes in wages, medical costs, and other cost factors.

As a result of the potential risks on both the asset and liability sides, insurance companies may see significant declines in key financial indicators like net income, surplus, or value.