Reinsurance Tutorials #5 - Season 3
Hi everybody 👋
Today, and for the fifth Reinsurance Tutorials video of the season, we will talk about "Impact of inflation on insurance"
This subject will be addressed by CCR Re experts Emmanuel Jacquemin and José Luis Campos.
Let’s start! ⏬
[José Luis Campos] : Hello I am José Luis Campos, Vice President Life & Health Latin America.
[Emmanuel Jacquemin] : Hello I am Emmanuel Jacquemin, Head of Underwriting - Non Life - Southern Europe and Latin America.
[José Luis] : Today, we will talk about the impact of inflation on Insurance. Emmanuel, it’s your turn!
[Emmanuel] : After decades of monetary stability in most economies, inflation came back in 2022. Inflation is defined by a loss of value of the currency. Insurance being a financial activity relying on currencies, inflation has of course a strong impact on its functioning.
[José Luis] : The first impact of inflation is the increase of claim amounts. For example, we are currently observing a strong increase in the Motor spare parts and this translates into higher reparation costs paid by the insurance companies. Companies must closely monitor the evolution of the average loss cost in order to adjust tariffs rapidly if required. Companies also often try to stagger the impact of the inflation, for example signing annual agreement for fixed tariffs with garages or construction companies. The 2 main risks for the companies are to charge insufficient premium if they do not adjust the tariffs or to lose clients if the adjustment is too harsh.
[Emmanuel] : The second impact is on the amounts insured. As the currency is losing value, the amount insured of a defined good in the currency should increase, otherwise it could create a situation of under insurance potentially dangerous for the insured. Companies usually automatically update the TSI applying an index. It is very important to have this update done as regularly as possible and to make sure that the index used for the revaluation is correlated to the actual inflation impacting the line of business. For example, indexes specific to construction are better correlated than CPI for the CAR branch. Companies must also make sure that premiums automatically follow the evolution of the amounts insured, which is usually the case if the insurance’s price is expressed in rates.
[José Luis] : On the Reinsurance side, the same problematic affects the non-proportional treaty layering. On long tail business, a stability clause is requested in order to make sure that the layering is adjusted on a defined index. Otherwise, there is a risk for the reinsurer to see the priority being reduced in relative terms, in other words to pay losses which were initially expected to fall below the priority. For the reinsured, the risk is to see the limit decreasing in relative terms and to be under protected. As for the insurance automatic adjustment of TSI, it is adamant to have an index narrowly correlated to the actual inflation in order to eliminate these risks. The indexation clause can be found also on short tail businesses in countries with high inflation. It is worth mentioning that the stability clause contributes to reduce the price of the treaty.
[Emmanuel] : Inflation also impacts the assets of the company. It is therefore important to have a wide variety of assets and to protect them against inflation to make sure that the company’s solvency will not be eroded.
[José Luis] : Lastly, inflation has an effect on reserves. The company needs to reevaluate the outstanding reserves on a regular basis in order to make sure that they constantly reflect the amount that it expects to pay. Otherwise, there is a risk of being under reserved and exposed to adverse liquidation of losses. While measuring the effect of past inflation and applying it on reserves is relatively easy, projecting the impact of future inflation is much more challenging. For example, large MTPL claims are often indexed on the labor cost because medical assistance often constitutes the largest part of the indemnity and projecting the future evolution of labor cost is very difficult.
[Emmanuel] : While inflation impacts insurance and reinsurance, reinsurers are somehow protected by the monetary evolution when they deal with foreign currencies. Effectively, the devaluation of the currency is expected to somehow absorb the inflation effect – partly or fully- , considering of course that the contract includes a proper Currency Conversion Clause and a Stability Clause. However, if this is true in the ultimate, there may be years when the devaluation does not follow the inflation, which may amplify the inflation effect for reinsurers.
[José Luis] : To conclude, inflation is a disease and as such nothing positive should be expected from it as far as insurance is concerned. However, there are tools and practices that allow insurance companies and reinsurers to protect themselves from it.
[Emmanuel] : Even if it does not bring all good news, we hope that this video has been useful to you.
[José Luis] : Thanks a lot for watching it.
[Emmanuel] : Thanks, and goodbye.
Bye for now 👋
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