Inflation is a manageable risk for the insurance sector, says JP Morgan in a new note.
The note, called Love Actuary, says that increased inflation is not only manageable but is not a major risk to business models or capital. This, says the authors, is being made possible by better disclosure done under Solvency II.
The arguments that JP Morgan puts forward for this are that life insurers carry mostly nominal guarantees and are least impacted by inflation, while non-life insurers face a more-direct but still manageable risk.
The authors wrote on life insurers: “Guaranteed investment returns or mortality benefits in life policies are usually nominal in nature. Therefore, for such policies, payouts to policyholders are immune to inflationary pressures. Exceptions include annuity and bulk annuity contracts, where pension payments during retirement may ultimately be linked to CPI or RPI. Such liabilities are common in countries with an established defined benefit pension product or buy-out market, most predominantly in the UK and Netherlands. However, pension payment increases are usually capped (e.g. at 3% or 5% depending on the rules of the particular policy or scheme). In addition, it is very common for life insurers exposed to such risks (e.g. Legal & General, Aviva, Phoenix, Just and M&G) to hedge against inflation.”
Around non-life, JP Morgan wrote: “The insurance of physical goods is clearly prone to inflation given its potential to impact the cost of rebuilding properties, spare parts and labour to repair damaged assets. Wage inflation costs are an important driver too in casualty business. Social inflation, the phenomenon of rising claim awards in litigation cases that may be covered by insurers, has also resulted in significant loss cost inflation in commercial casualty and liability lines of business. However, these are factors that are monitored closely by non-life insurers and factored into both claims reserves and pricing. For example, after a natural catastrophe event, it is normal for there to be an inflation spike in a local area as individuals and corporates seek to rebuild or repair damage, resulting in a shortage of labour, raw materials or parts.”
They added: “We would argue that insurers have been factoring in higher inflation rates than normal retail inflation indicators for some years now and loss cost inflation trends have been higher than general retail or consumer price indices. Finally, in longer-tail and more risky commercial P&C lines, we have seen a multi-year hard market in pricing that seeks to address issues such as climate change and social inflation. The annual nature of most P&C insurance policies means insurers can quickly pass on higher claims costs to their customers if they need to.”
