In a recent thematic review conducted by UK regulator the Prudential Regulation Authority (PRA), part of the Bank of England, across the general insurance sector, concerns have been raised regarding the impact of claims inflation on general insurance claims.
The review focused on how insurance firms have responded to a previous letter to chief actuaries published by the PRA in October 2022.
Claims inflation refers to the increasing cost over time to settle general insurance claims, which can have varying effects on different firms based on their business models and risk profiles.
The PRA has emphasised that persistently elevated claims inflation could potentially lead to a significant deterioration in solvency coverage for some firms if appropriate mitigating actions are not taken.
During discussions with various firms in the London market, as well as retail and commercial insurers, the PRA sought to understand how these organisations have incorporated the content of the PRA’s letter into their calculations for technical provisions and Solvency Capital Requirement (SCR).
Of particular interest was the firms’ identification of drivers of claims inflation, their approaches to assessing claims inflation present in the claims data, and their expectations for future claims inflation.
It is crucial for technical provisions to be calculated based on up-to-date and credible information, considering realistic assumptions that robustly account for claims inflation.
Firms using internal models or the standard formula for SCR calculations need to ensure that the risk of further claims inflation is appropriately factored in.
The PRA’s findings from the review are grouped into three specific areas: the adequacy of reserve strengthening, observations on mitigating benefits to firms’ reserves and capital, and financial resilience and governance challenges in responding to claims inflation.
The review highlighted that the average increases in reserves applied by firms may not be sufficient to support future claims in relation to the total economic inflation forecasted for the economy.
Firms acknowledged that there could be a lagging effect as the heightened economic inflation passes through to claim settlement costs, such as higher court settlement costs and increased compensatory claim settlements.
Some firms may still be experiencing a delay in claims inflation reflecting in their data for longer-tailed lines of business. The PRA encouraged all firms to carefully assess whether such a lag might apply to their business and be prepared to justify their considerations.
Firms with better monitoring of the impact of changing economic conditions are expected to respond more effectively to emerging claims inflation trends.
The PRA emphasised the importance of regular communication and discussion of monitoring results across all functions within firms.
As firms prepare for their mid-year reserving exercises and plan for 2024, it is essential for them to take into account the key findings and observations highlighted by the PRA.
The authority may request explanations on how these findings have been considered during the 2023 year-end reserve adequacy supervisory work.
The PRA’s thematic review sheds light on the challenges posed by claims inflation in the general insurance sector, emphasising the need for proactive measures and realistic assessments to ensure financial resilience and adequate coverage for future claims.
