Nearly two years ago Americans took their first steps into a pandemic-changed world. With it came a jarring reality not seen for decades: unusually high inflation. Part one of this series examined whether inflation would be a temporary visitor, or instead settle in for a an extended stay. Part two surmised that inflation had established residency, explained how “shock events” such as COVID‑19 played an outsized role in the upward spiral, and suggested that the action by the Federal Reserve (Fed) would either slowly defuse those inflationary pressures or introduce a new generation to 1970‑style stagflation.

While it remains to be seen whether inflation ultimately will spike upward, remain stable, or unexpectedly recede, insurers now find themselves operating in an inflationary environment not seen in many years. This piece will discuss how insurers can navigate the terrain, and how a “return to fundamentals” might be the best course.

The Current Environment

Recently released data suggest a continuing of the slow and steady moderation first seen in early spring, with Federal Reserve officials now deliberating the number and extent of future rate increases, given that inflation appears to be still running above the their two percent target.¹ Other hopeful signs point in that direction, with suggestion that supply chain pressures have receded and that conditions have normalized after temporary setbacks at the beginning of the year.¹

12‑month percentage change – Consumer Price Index³
Major categories, July 2023 (not seasonally adjusted)

PPI for Final Demand, 1‑month percent change (seasonally adjusted)⁴

Taking these signs into account, inflation, as measured by the Consumer Price Index (CPI), currently stands at 3.2%, up slightly from 3.0% in June.⁵ Multiple observers express surprise at the ongoing resilience of the American economy, as evidenced by robust global travel and continuing high demand for goods and services, driven largely by pent‑up pandemic desire.⁶ For these reasons, the long-anticipated recession triggered by the string of Fed rate increases hasn’t yet materialized, with increased sentiment suggesting that it may be side-stepped entirely.⁷

Determining the timing, extent, and duration of any economic recession has been the subject of speculation for months. By most objective accounts, the economy remains strong, with employment remaining solid overall, though shortages continue to plague “high touch” sectors certain sectors such as leisure and hospitality.⁸

Civilian Unemployment Rate (seasonally adjusted)⁹

This strong labor market is thought to be a key inflation driver, particularly in services that directly impact the insurance industry, such as medical care, car repairs, and transportation services (“core services ex‑housing”).¹⁰ Further, the Fed is thought to be watching whether the economy will slow enough to bring down these service-related costs.¹¹

Insurance Industry Impact

Factors beyond economic inflation have buffeted the insurance industry for several years, including high numbers of traffic fatalities not seen in 16 years and unprecedented weather-related Cat activity punctuated by the 2022 Hurricane Ian’s $112 billion sting, as well increasingly quantifiable loss costs caused by social inflation and propelled by Third-Party Litigation Financing (TPLF), “shock” verdicts, and the billions of dollars spent in attorney advertising.

These factors alone would strongly support the need for rate increases; inflation adds to that need. However, there’s a suggestion at this point that insurer rate increases are lagging inflation.¹²

Personal Auto & Homeowners Premium Rates vs. U.S. Inflation & Replacements Costs*

Insurance Industry Response – “Return to Fundamentals”

Being subject to state-specific regulation, insurers are limited as to how quickly and steeply they may raise rates. With limited relief available via rate increases, insurers can dip into policyholder surplus, but they do so at the risk of dropping below regulatory thresholds and in turn limiting their ability to write coverage and possibly jeopardizing their future.¹³

Given the above, insurers will need to be both operationally efficient and technically sound in underwriting risks and handling claims. Critical to this success should be a “return to fundamentals” in the following areas:

• Policy Considerations – This area entails ensuring that policy language and commitments reflect the current inflationary environment. Items like “inflation guard” endorsements should be regularly updated without using a “one size fits all” approach. Carriers should be looking closely at providing scheduled versus blanket limits, as these are heavily dependent on market conditions and require an accurate breakout of each.
• Underwriting Considerations – Data accuracy, relevancy, and recency will be of paramount importance now more than ever. With respect to Personal lines, are insured values being updated to reflect current realities? Have all home additions and renovations been reported? As to Commercial lines, does the insured have specialized equipment or materials that cause long lead times, such as that potentially associated with internationally sourced equipment?
• Claims Department Performance – Timely and accurate loss adjustment will now take on increased importance. On the first-party side, are Claims staff using pricing tools and estimating software that accurately reflect material costs, labor wages, overhead and burden? As to Casualty claims, are large cases being evaluated early on, with a focus on obtaining accurate medical records and bills, while concurrently developing damage models that address a continuing care and accurately reflect ongoing costs?
• Loss Mitigation and Prevention – The best loss outcome is the loss that never occurs. To that end, insurers would be well-served by implementing incentives that promote loss-preventing policyholder behavior. With respect to Auto, it may mean making greater use of safe-driving discounts, enabled and/or fortified by telematics. With Homeowners and Commercial properties such a strategy could include insistence on use of “smart” products that detect water leaks and/or infiltration.

Conclusion

Baseball great Yogi Berra reportedly once said that “It’s tough to make predictions, especially about the future.” Predicting inflation’s path in 2023 and beyond is one such example. Nevertheless, the insurance industry finds itself once again amidst persistent inflation.

While these periods have periodically plagued the industry previously – and at levels much greater than this – it has endured them while maintaining commitments to policyholders and the public at large. So too will it persevere through this current storm, but not without remembering how it got through prior ones.