Canada’s annualized inflation rate hit a 31-year high of 6.8% in April, largely driven by higher prices for energy and food, and the Bank of Canada has since reported that inflation “will likely move even higher in the near term before beginning to ease”.
On June 01, the central bank increased its policy interest rate by 50 basis points, following a steady stream of hikes intended to return inflation to target and keep inflation expectations well anchored.
There are several factors driving inflation in Canada (and worldwide), including Russia’s invasion of Ukraine, which has put upward pressure on prices for energy and agricultural commodities; and the COVID-19 pandemic, which continues to disrupt global supply chains.
Now, insurance brokerage and risk management giant Aon has released an ‘Inflationary Trends’ report for Canada, to help insurers understand the current economic climate and their exposures to inflationary pressures.
According to Aon, the COVID-19 pandemic has caused high levels of inflation by shifting demand away from services and towards goods, while also disrupting global supply chains. There’s been a “supply and demand mismatch” across many industries, said Jason K. Machtinger, SVP – Analytics & ERM, Reinsurance Solutions Aon, based in Toronto.
He gave the example of the global semiconductor industry, where the confluence of soaring demand for consumer products that contain semiconductor chips (such as cars, personal electronics like laptops and phones, and medical devices) alongside COVID-19 pandemic-related disruptions in production has led to a major imbalance in supply and demand.
“We also had car rental companies with inventories of cars that were just sitting on their lots during the pandemic, and, to shore up some of their income, they had to sell their inventories. Then as demand picked back up, they just didn’t have any cars. That’s another example of the supply-demand mismatch that’s driving a lot of constraints right now,” Machtinger added.
According to John Jacobi, managing director, reinsurance solutions, Aon, based in Minneapolis, supply and demand challenges were exacerbated by monetary policy, with “stimulus measures and low interest rates at the beginning [of the pandemic] fuelling some of the demand”. However, those trends have now cooled off as inflationary pressures have forced the Bank of Canada (and other central banks) to take measures to control inflation.
It takes some time for (re)insurers to measure the impact of inflation on claim severity. The most obvious impact so far has been in the auto insurance industry, according to Jacobi.
“Used-car prices have exploded … and when they go up, it makes it more expensive to total a car if you’re in a wreck, so that automatically adds to the severity of the event,” he explained. “It’s harder to find a new car, it’s harder to get a rental car if your car is in the shop, car parts and services are more expensive – and so this rise in costs has immediately impacted the severity of auto insurance claims.”
What is certain is that inflation will impact every carrier across Canada in some way, shape or form – and through its monthly ‘Inflationary Trends’ report (until further notice), Aon is trying to help insurers understand their exposures and advise them on appropriate inflation guard mechanisms.
Regarding insured values, for example, personal lines values are often automatically indexed to CPI at renewal, but other lines might require a more bespoke approach. Jacobi cautioned that insurers should be careful about which inflation metric is used for inflation indexing.
“Throughout the report, we’ve shown that building materials and construction prices tend to be a little higher than overall CPI, so if insurers are using CPI for their inflation guard, they’re likely falling behind,” he explained. “Insurers need to be particular about what metric they’re using to inflate their values, because it’s really business and line dependent.”
Other strategies that insurers can use to help with inflation include: using percentage deductibles, especially if they can be applied based on value at the time of a loss; and using rate increases to make up the differences between actual values and adjusted values. However, Aon warned that pricing and reserving models must account for recent inflationary trends, but not double count.
“We’re recommending that clients make decisions that make them robust against whatever happens going forward,” Jacobi told Insurance Business. “We know what the banks are saying about inflation going forward, but this changes every day and something new can come up, so we’re just trying to help our clients be ready for all potential outcomes and make decisions that make them robust.”
Machtinger added: “Every insurer needs to keep a close eye on what economic conditions are doing, and they need to stay on top of their portfolio to make sure that they really understand how exposed they are to inflationary pressure.”
