PHIL’S CORNER: The Impact of Inflation on Insurance
I’m not an economist, but I could play one on TV. Plus, which economist do you believe since they all have slightly different opinions. So, let’s stick to the things most people in the insurance industry agree: the impacts from inflation we are almost certain will occur.
We know many actuaries are nervous in issuing their opinions because inflation has changed the environment in their financial forecasting and the impact on loss reserves, pricing and the overall rating of products. That pretty much sums up every aspect of insurance.
Historical Patterns and Actuarial Modeling
You can build in models for some moderate inflation. However, the soaring inflation we are seeing is especially damaging because it exacerbates loss trends that have already been rising significantly in the industry, including those for professional liability. Actuaries are tremendously dependent on loss trends built on historical loss results. In a suddenly inflationary environment, past results are much less credible, and therefore less helpful in predicting future losses. It is impossible to accurately factor in the impact of unprecedented supply chain issues, labor shortages and the obviously slowing economic growth. It is a little like chasing the wind during an Oklahoma spring.
One thing I can say with certainty is that pricing an insurance product like lawyers professional liability insurance in a single state like Oklahoma is difficult in normal times. The relatively low number of claims (although growing slightly), coupled with potentially high severity, creates a moving target. Many of you have heard me say that it is a product in which the price of goods sold is not completely known until years later. I don’t know of another product where that is the case.
Inflation can distort or alter otherwise seemingly reliable loss development patterns. The other difficulty is attempting to ascertain whether the inflation is temporary or if it will exist for an extended period. It is difficult to find quick solutions for any of the things impacting the financial picture, such as increasing demand and supply chain issues.
We know our insureds don’t deal in percentages, but rather in real dollars. When we consult with our actuaries and visit with reinsurers, we are careful to convert proposed rate changes from percentages to dollar amounts to better see the actual impact any rate changes may have on our insureds. Unfortunately, we have been in challenging times with respect to achieving rate adequacy. There is always a need to increase our number of policyholders and maintain retention of existing insureds. Inflation like we are seeing at present intensifies these issues.
Investments to Level the Needs
Quite a few years ago, a very good investment guy who ran the California lawyers liability program taught me to be very careful about getting the company investment portfolio too heavy in equity holdings. He said you can starve the “monster” (insurance company) on unrealized capital gains. An insurer needs periodic monthly income from the fixed income portfolio to meet the ongoing claims needs, as well as the operational expenses. In recent years, it has been challenging to fund these needs out of fixed income earnings. Treasury yields and bond returns were artificially suppressed and the $5.7 trillion in relief and stimulus kicks an inflationary environment into high gear.
The impact of a considerable shift in inflation can take a few years to be seen in loss development patterns. The industry has never seen the circumstances it faces today. I am thankful to be meeting these challenges with a very well capitalized mutual insurance company. We don’t answer to shareholders who are only interested in maximizing earnings per share. Plus, if claim results are better than forecast, we have the policy dividend mechanism to share profits with our insureds.
Hang in there with us as we navigate through these somewhat unchartered waters. We have been here with the Oklahoma legal community for 42 years. Others may jump in and out of this market and this line of coverage, but we will be here for the long-term. As always, contact us if you ever have questions.