Analysts at UBS have highlighted that the risk of insurers and reinsurers being exposed to higher claims inflation is on the rise, with companies focused on longer-tail business and those with lower reserve buffers being the most at risk.
UBS explains that in an increasingly reflationary environment it could be that the cost of goods sold rises while the potential to realise greater profits on business already written diminishes for re/insurers, adding that the U.S. election has seen the range of potential outcomes for claims inflation broaden as uncertainty has increased.
With the global insurance and reinsurance sector being reliant on reserve releases for earnings, a trend that has intensified in the soft market cycle, UBS analysts describe the potential for higher claims inflation as a “big risk” to the industry.
“Claims inflation is pivotal in pricing long tail lines of business in particular. It is also a key assumption in setting reserves and the level of capital,” says UBS.
For insurers and reinsurers inflation as a result of tort/social change has the greatest impact, and some industry observers actually feel that the tort environment could improve/tighten under President Donald Trump, says UBS.
Although, adds UBS, expected deterioration under President Obama failed to materialise, so widespread uncertainty remains and it’s most likely that only time will tell what impact the U.S. election will have on the tort landscape, and what this might mean for claims inflation.
Medical cost inflation can also have a strong impact on re/insurers as the cost of care embedded in claims increases, while commodity/food inflation has little impact on the re/insurance industry, explains UBS.
The firm states, in its European Reinsurance – Global Research report, that it can be challenging to ascertain company exposures to higher, or stable claims inflation from the outside, but discusses a number of factors that can help to build a picture.
Most at risk “are longer tail carriers with slim reserve margins and elevated levels of reserve releases vs. company guidance backed into numbers,” says UBS.
By their very nature, longer tail lines of business take longer for claims to settle, which in turn results in annual changes in claims inflation compound. So by the time the claim settlement date comes costs can differ greatly when compared to initial expectations when the policy was priced and reserved for.
Insurance and reinsurance analysts and observers have been citing a decline in reserves for some time now, as companies look to bolster weaker underwriting returns in a highly competitive operating landscape.
“When inflation rises reserve buffers fall,” warns UBS, suggesting that those companies with limited reserving buffers in the current market environment could feel the greatest impact as they are less equipped to absorb any claims inflation.
The third and final factor that increase the exposure for insurers and reinsurers again relates to reserving practices, and those companies that have an elevated level of reserve releases when compared to company guidance of ongoing reserve releases that are embedded in market expectations, explains UBS.
The outlook for claims inflation in a potentially more reflationary environment remains unclear, but UBS’ commentary provides some useful insight into trends that can increase the exposure to inflation for re/insurers.
Owing to its current bias towards longer-tail business, no reserve buffer above best estimate and heightened levels of releases above the company’s 0% guidance, global reinsurer Swiss Re stands out as the most at risk, according to UBS analysis.