As American inflation soars, property and casualty (P&C) insurance companies can’t help but squirm. Nearly all lines of insurance are affected by rising costs and expenses of claims. With no quick relief in sight, insurers will need to modify their pricing strategies and bolster their operational resilience to weather whatever scenario unfolds. 1 1. “Something’s Coming: How Businesses Can Build Resilience, Survive a Downturn and Thrive in the Next Cycle”, July 28, 2022. Close engagement from senior management will be essential to ensure the best response. 2 2. Asutosh Padhi, Sven Smit, Ezra Greenberg, and Roman Belotserkovskiy, “Navigating Inflation: A New Playbook for CEOs,” Mckinsey Quarterly, April 14, 2022.
the insurance industry faced profitability challenges even before the pandemic, 3 3. “creating value, finding focus: global insurance report 2022”, February 15, 2022. and the sudden and unexpected increase in inflation was only joined them. our estimates show that rising prices contributed to an increase of approximately $30 billion in loss costs (the amount an insurer must pay to cover claims) in 2021, above historical loss trends.
Price increases have been exceptionally high for goods and services that generate personal insurance claims. for example, motor vehicle parts and equipment prices rose 22.8 percent between June 2021 and June 2022, while the cost of used cars and trucks rose 14 percent. 4 4. “creating value, finding focus: global insurance report 2022”, February 15, 2022. supply chain disruptions and other causes of inflation in the auto industry led to an estimated $9 billion cost of loss per auto physical damage in 2021. costs for lines with long settlement periods, such as workers’ compensation, rose $4 billion, and high commodity prices increased loss costs on multi-peril insurance lines, both personal and commercial, $8 billion and $2 billion. , respectively (Annex 1).
Under these circumstances, both short-term and long-term strategies for insurers revolve around smart pricing, 5 5. Gregor Becker, Udo Klotzki, Doug Mcelhaney, and Ashish Srivastava, “The Post-Pricing Imperative.” al covid-19 para p&c insurers”, mckinsey, july 14, 2020. expense management discipline and operational excellence of claims. We can’t predict the exact path of inflation and interest rates, but we do see several key variables to watch and three possible scenarios that traders should consider preparing for.
key indicators as claims costs continue to rise
As insurers plan their response to inflationary pressures, they must monitor four important measures: headline inflation, claims cost inflation, wage inflation, and interest rates.
the interest rate policy of the us federal reserve. uu. it will depend on the agency’s expectations of how inflation will play out. Any sign that long-term expectations become “unanchored” and trend above 2 percent could cause concern and lead to aggressive policy intervention, as noted during the March meeting of the federal open market committee 6 6. Federal Open Market Committee Minutes, Federal Reserve, March 15-16, 2022. (See sidebar, “Where Is Inflation Headed?”).
For insurers, high general inflation creates an environment that favors assertive pricing and premium strategies. this requires discipline in account pricing management: smart insurers incorporate favorable premium trends, improve responsiveness and agility in pricing and reporting, and reduce calendar period exposure through product improvement and innovation.
inflation of claims costs
The most important factor for P&C insurers to monitor is the inflation of claims costs above general inflation. The factors driving claims cost inflation differ between lines of business. supply chain disruptions have had strong effects on specific goods, such as vehicles and vehicle parts; Global market turmoil has been particularly pronounced in the commodities and energy sectors.
To manage such costs effectively, insurers will need to focus on increasing productivity and claims automation and improving or repairing managed care network utilization and negotiated pricing, while balancing improvements in the cycle time with the accuracy of the claims.
During the early days of the pandemic, the labor market participation rate dipped to a low of 60.2% in April 2020. Two years later, participation was 62.2%, 7 7 labor force participation rate, us bureau of labor statistics. uu. , July 14, 2022. Still well below the pre-pandemic level of 63.4% in February 2020. As the labor market continues to tighten, insurers must remain vigilant of mounting pay pressure on insurance rates. general expenses. this will mean maintaining discipline and transparency in managing expenses, as well as investing in greater productivity and digital self-service.
As the Federal Reserve adjusts its targets for the fed funds rate, Treasury rates and other yields on the insurer’s portfolio will increase. this can offset some of the pressure on margins from rising claims and wage inflation, and will allow leading insurers with advanced pricing capabilities to invest to gain market share.
three main scenarios will present opportunities and threats
Based on global market conditions and responses from governments, businesses and consumers, we identified nine possible scenarios and identified three that appear to be the most relevant for insurers in the months and years ahead (Exhibit 2) . Under these scenarios, insurers’ profitability will follow one of three patterns (Chart 3).
- Scenario A: Stabilization. In the most optimistic outlook, energy, food, and commodity markets would stabilize, and in response, the Fed would most likely remain on hold. its current path, raising policy rates to 3 or 4 percent. Inflation expectations would remain stable and actual inflation would recede towards 2023. For insurers, this is likely to represent a short-term erosion in combined ratios (losses and expenses relative to total premiums collected) and overall profitability. , but with a final return to long-term standards. this scenario favors operators with large, diversified portfolios, healthy surpluses, and operational excellence, particularly in expense and claims management.
- scenario b: continued disruption. if conflicts in eastern europe are intensifying and covid-19 continues to affect the global economy, there is a real risk that global markets will continue to be affected, with energy and commodity prices continuing to experience volatility and general inflation. In response, the Fed could be forced to raise policy rates substantially above 4 percent to keep long-term inflation expectations anchored. this could have adverse effects on the economy in general, particularly on real estate construction. For insurers, this scenario would translate into more persistent profitability challenges, a worse scenario than one with consistently higher inflation. claims costs would continue to rise due to disruptions in global commodity markets, but subdued headline inflation could prevent insurers from raising premiums for clients. the result could be a severe contraction in underwriting capacity and a tough market with stricter underwriting standards. the insurers that will come out ahead will be those with superior underwriting and pricing discipline and a focus on profitable pockets of the market.
- scenario c: persistently high inflation. Finally, though less likely, major global market shocks could push global energy and commodity prices to high inflation in the longer term. In such a situation, the Federal Reserve might see the need to raise interest rates even higher, but may not be able to control inflation. If expectations become unanchored and the economy continues to struggle under global market turmoil and tight policy, the United States could enter a new period of stagflation—that is, high inflation despite high interest rates and slow growth. economic growth. For insurers, this scenario would cause a significant short-term disruption to combined ratios and underwriting earnings. however, as is sometimes the case in foreign markets with persistently high inflation, the long-term view could allow premiums and investment returns to rise in tandem with expenses and loss costs. this market will favor P&C carriers that can deliver operational excellence throughout the value chain, especially those with better pricing strategies and underwriting discipline.
senior management can collaborate to improve resilience
Insurers can handle any scenario if senior executives drive a well-coordinated approach to countering inflation across all functions of the value chain. 8 8. “The CEO Risk Agenda: An Insurance Perspective,” Mckinsey, April 25, 2022. Leaders may want to consider preparing a “resilience playbook” that enables them to implement tactics as warranted by circumstances. conditions. this means creating visibility into the value at risk, implementation time, and investment required for each lever being considered. it also means setting measurable thresholds for taking such actions and having the organizational alignment and resources ready to manage risk. the playbook can be written addressing issues such as where customers will see value in the new environment, how to look for price review, and how to prioritize and organize activities.
Individual tactics will differ by role, but collectively, the chief product officer, chief claims officer, and chief financial officer can build enterprise-wide resiliency by taking the following recommended steps.
product and subscription directors
The company’s underwriting and product managers should focus on building as much insight into product profitability, developing rate indications frequently and as granularly as possible to enable quick action. Major carriers must maintain visibility into data indicators that provide early warning. high inflation worsens existing operational weaknesses of carriers, such as vulnerability to runaway verdicts, excessive damage awards aka social inflation verdicts, premium leakage issues due to undisciplined underwriting practices and/or management tools slow and inefficient rates. the solution is to catalog all available pricing and fee levers to take advantage of opportunities and identify and classify existing sources of leakage. Successful underwriting officers will push rate targets to the lowest responsible staff in the product or underwriting organization, closely monitor rate actions taken, and emphasize accountability and urgency to ensure value capture.
In an environment of rapidly rising prices, speed to market is critical. delays of just a few months can cost millions of dollars in lost revenue. achieving such speed may vary across lines of business. carriers must present and/or increase product class factors that follow expected inflation, generating an automatic channeling rate. For inoculation against extended periods of profit and uncertainty, this may be the time to consider reducing policy calendar exposures from 12 months to six months or less, further innovation in usage-based exposures, or expanding methods retrospective rating pricing (premiums that adjust for losses occurring during the pricing period). this may also be a good time to review the portfolio’s exposure to long-tail lines and consider rebalancing portfolio mix and growth appetite in favor of short-tail exposures that can be liquidated quickly.
The inflationary environment and the need to act quickly further reinforce the compelling need for insurers to transform their underwriting capabilities. Major carriers are developing digital workflows, merging underwriting “judgment” with science by leveraging data and analytics. Many companies face stiff competition for top subscription talent; By transforming the way underwriters work, insurers can not only reap the benefits of better risk selection, but also improve their employment value proposition for underwriters, who can focus on making decisions about administrative and highly transactional tasks.
Furthermore, high inflation effectively reduces an insurer’s actual portfolio and leaves policyholders increasingly underinsured as rising replacement costs outpace coverage limits. this is a time to offer higher limits and proactively review coverage needs with customers and agents to ensure adequate coverage is provided and therefore support the best customer experience.
Insurance companies that achieve claims management excellence will be more resilient in responding to loss pricing pressures. Claims managers play a critical role in managing the claims process from start to finish, including customer satisfaction goals and cycle times. in times of inflation, these executives should increase focus on the types of claims with the greatest exposure to price inflation and those with the longest cycle times. By highlighting cycle time variability and creating a sense of urgency among frontline staff, claims managers can help drive efficiencies through operational excellence. Investing in automation and straight-through processing without manual entry can also help reduce costs and give organizations breathing space to absorb sudden price changes.
Direct claims processing can give customers more choice about whether to receive direct settlement or redress, balancing loss accuracy accordingly. In addition, property repair and managed care networks represent an opportunity to negotiate longer-term fixed prices and greater use in claims operations, particularly if analytical insights have identified exposure to rising labor and raw material costs. under the influence of networks.
Now may be a good time to accelerate innovative loss prevention capabilities through home Internet of Things applications, automotive telematics (such as vehicle tracking), and workplace monitoring. data and analytics can help ensure targeted hazard engineering inspection for large commercial properties at risk of accidents, while satellite imagery can be used to look at adjacent brush and debris cheaply and effectively across the portfolio of personal lines properties, avoiding the risk of fire. Automated telematics applications, already used effectively for pricing, can also provide advice, disable phone use, and manage driver drowsiness.
The CFO’s key task is to emphasize discipline in managing expenses, ensuring visibility into productivity, and allocating direct investment where the greatest improvements can be achieved. the only role the CFO can play is to guide the company in balancing growth and profitability as the inflation and mitigation levers take hold across the portfolio.
Across the value chain, insurers can better manage expenses and exposure to salary inflation by reevaluating service levels and expanding self-service adoption, especially as customers increasingly show a preference by digital tools. In parallel, the CFO, in partnership with the chief actuary, must continually reassess reinsurance appetite and capital allocation as the portfolio and market evolve. under sustained severe conditions, offshoring certain labor-intensive operations to stable markets may be on the table for consideration. Market volatility will favor CFOs who are agile, responsive and well prepared.
inflation may well recede in the coming months, with prices beginning to stabilize later in 2022. however, regardless of the future path of inflation, insurers investing in their operational and financial resilience today will almost certainly they will become stronger and better able to withstand future shocks.