A nine-letter word begins with ‘I’ and affects everyone. Of course, it is not insurance, but inflation.
Far from being a charade, when inflation combines with the prospect of minimal growth or even recession, it is as serious an environment to operate in as we have had for decades. It is not local, but global, and there is a very thin line to be walked between stimulating growth and fuelling inflation or conversely suppressing growth to control inflation.
How does this potentially play out for insurance customers from homeowners to commercial construction?
For homeowners setting the sum insured on their house, they can use the online calculators that are readily available which are updated based on the most recent building inflation. That though generally looks back to what inflation was, say, three months ago.
But, if building inflation runs away in double digits over the following 12 months, as it has done over the past year, homeowners could be under-insured toward the end of that period if they had a total loss. Not only that, if supply chain issues persist, then the time it will take to re-build or repair may see further inflationary costs accrue.
Fortunately, there are policies available that, subject to certain conditions, provide some uplift in the sum insured. Even so, it is important for customers to think carefully about setting their sum insured.
It will also be important to think about the excess that is chosen. Risk retention by the insured is often used as a means of lowering insurance costs. On the other hand, for the insurer, the impact of inflation means the excess layer will be exhausted quicker.
Fortunately for homeowners the averages clause does not apply to residential cover, but it does apply to commercial cover. This clause means that if you are underinsured, you do not receive a full pay-out because you have been paying only part of the premium you should have been paying. So, inflationary impacts can be more pernicious for those with commercial covers if it is not well anticipated.
Inflation, supply chain delays and a slow-down in growth can often catch some businesses out. Some may be faced with contractual commitments they cannot meet. Others may face cost escalations they cannot absorb, or they may not have been realistic about their forward cash flows.
Those locked into fixed price contracts which lead to business failure can have a knock-on effect to other businesses they supply or are supplied by. Tougher business conditions have historically led some to cut corners and led to the use of lower quality materials and quality of work. This may create future liability risks.
Tougher times will lead to the need for a greater focus on customers’ financial vulnerability. General insurers responded well to that challenge in their swift response during the early days of the pandemic.
There is uncertainty around how consumers will respond to premium adjustments due to a combination of changes to the EQC cap, increased sums insured due to increased rebuild costs, a hard reinsurance market due to rising climate-related claims, and inflation at the same time as mortgage interest rates are rising adding to the wider squeeze on household budgets. If we tip into recession and unemployment rises from current historic lows, that too will add to affordability pressures. Sadly, financial difficulties can also lead to an increase in crime including thefts and fraudulent claims.
Inflation’s impact on insurers shows up in other ways too. It can have an adverse impact on underwriting loss ratios, due to the difficulty in estimating future losses, and it has a direct impact on all expenses. It can also add costs in provisioning to meet prudential capital requirements.
So, the sector faces strong headwinds and rough seas ahead. Navigating through this will not be easy as there is no off-the-shelf playbook for a set of economic conditions that have not been around in the working lives of most people.
