The impacts of inflation on the cost of insurance and coverage

“If inflation is increasing, our loss costs (what it takes for us to pay for claims) are increasing. That, traditionally, and put very simply, will increase rates,” said Marsh. “However, pricing itself isn’t the sole answer. A reason for that is we’ve been in a price increased market for the past number of years – and the market will only bear so much.”

In the first half of 2022, commercial insurance direct written premium (DWP) in Canada increased by 7% compared to the prior-year period. All things considered, that was “a good result,” according to Marsh, but it pales in comparison to the 22% increase in DWP in the first six months of 2021.

“We’re definitely seeing a significant trend downwards,” he pointed out. “That 22% was largely aided last year by rate increases. That double-digit rate increase trend will taper, and we’ve already seen that as conditions continue to change.”

Listen: Meet Rob Marsh: Liberty Mutual Canada’s President

To address inflation, insurers need to be “very proactive in accelerating [their] understanding of inflationary trends” and the impact of those trends on insurance pricing and reserves, said Marsh. To manage the impacts on pricing and the overall portfolio, most insurers are focusing on underwriting excellence and risk selection.

“It isn’t just a pricing play,” Marsh emphasized. “It’s about: What does your portfolio look like? What’s the diversification? How long-tail are you looking at between first- and third-party lines? How does that come together to generate the appropriate return on equity?”

The Liberty Mutual leader also pointed out that often the government numbers are lagging slightly behind what’s actually happening, and he said that’s evident in day-to-day claim discussions.

As for how Liberty Mutual is addressing inflationary pressures with its broker partners and clients, Marsh said: “It’s really about being proactive in monitoring and tracking a lot of these trends, and making sure that we’re being very transparent and open with our clients.

“We make it a big priority to leverage the resources, not only in Canada but around the world, to have those conversations because this is a global issue. There’s a number of pieces that are particularly predominant in Canada, but, ultimately, a lot of these trends are indeed global, and our ability to navigate is going to depend on a lot of other factors.”

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Marsh went on to explain how inflation impacts insurers’ balance sheets. He said that when interest rates rise, insurers typically take a hit on their investment portfolio. This is contrary to the common assumption that rising interest rates lead to better returns on insurance investment portfolios.

“Ultimately, our two levers that we have to make return on capital are underwriting profitability or investment return,” said Marsh. “When we’re seeing such an increase in inflation, particularly at the speed that it’s operating, we’re actually taking quite a hit on our investment portfolio – on anything that we already owned – because we’re typically invested in much more conservative instruments (bonds, fixed income, etc.) because of the nature of our business and the need to have capital … when claims are coming, but also as a result of a regulatory environment where we’re required to do that.”

It has been almost 15 years since the financial crisis, during which the industry has experienced “a very good period of stability,” according to Marsh. When the financial crisis hit in 2008, interest rates were at around 4%, but, since then, rates have fallen to below 1% and have not increased past 2% in the last 15 years.

“We were able to manage that. We were able to understand where we were going, especially in long-tail lines of business,” said Marsh. “But the amount of volatility we’ve had, and base point increases that we’ve subsequently had in the past few months and quarters – the pace of that, due to high inflation, has really put [the industry’s] balance sheet under stress. This, in turn, has a tremendous impact on the available capital in the market.

“Generally speaking, as an industry, we came into 2022 in a pretty stable place. Luckily, it’s not something that I have concern about in the aggregate, but as you look at the hundreds of millions of dollars that have been lost as a result of these interest rate changes relative to the portfolio, it really does [create] strain and we can no longer invest in the same way that we had planned to perhaps at this time last year, when we were planning for 2022.”

Moving forwards, insurers are going to be focused on portfolio diversity, risk selection, and excellent underwriting, Marsh reiterated. He added: “It’s important for clients to understand the underwriting process [and how to] differentiate one risk from another risk. No risk is one and the same. Sometimes, there’s a lot of rigor relative to that differentiation.”