The Impact of Inflation on the P&C Insurance Market

Russ Banham


August 1, 2022

Inflation's Impact on Insurance

During the winter 2021 policy renewal season, pricing was finally beginning to moderate for many property and casualty insurance lines after several years of market volatility. Midway into 2022, however, rates are expected to turn upwards again as inflation begins to take a toll on the insurance market. For many policyholders, this could mean higher property and casualty premiums at renewal this winter. “We expect a harder market, but what will come out in prices depends on each insured’s loss experience and mitigation factors,” said Brian Suozzo, director at S&P Global Ratings. 

Rising inflation has produced an uptick in insurer loss costs, demonstrated most clearly by the price tag for commercial building materials and commercial automobile and truck parts. These costs have been further exacerbated by continuing supply chain challenges that make it more difficult and time-consuming to source necessary materials and parts to repair or replace damaged buildings and auto and truck fleets. 

Although most experts do not predict a knee-jerk reaction by insurance markets to the higher loss costs in commercial pricing, they maintain that the opportunity to negotiate a lower premium is limited, given fast-rising inflation and growing alarm over a possible recession. 

“Expand your insurance limits and budget—that’s a priority,” said economist Michel Léonard, vice president and head of the economics and analytics department at the Insurance Information Institute. “Existing limits and budgets are not enough. Fortunately, CFOs are aware of the impact of inflation on insurer loss costs and are very likely to be responsive.”

Soaring Inflation

As measured by the Consumer Price Index, the inflation rate in the United States in June was 9.1%—the highest level recorded since 1981. The current economic environment is the result of a “perfect storm” combination of supply chain disruptions; worker shortages; rising wages; difficult-to-source materials and parts; and strong consumer demand, which was encouraged by government financial support early in the pandemic. To contain rampant inflation, the Federal Reserve raised interest rates by 75 basis points in mid-June—the highest increase since 1994—and signaled that other hikes of 50 to 75 basis points could be in store if inflation is not curbed. 

Despite skyrocketing inflation, the U.S. economy is surprisingly robust. The Department of Labor’s July 8 hiring report found that employers added 372,000 jobs in June, in line with similar gains in the prior two months. Unemployment also remained at 3.6% for the fourth month in a row. 

“There’s no question that the economy is growing,” said economist Robert Hartwig, clinical associate professor of finance and insurance at the University of South Carolina, where he leads the school’s Risk and Uncertainty Management Center. He is hopeful that inflation will peak in the second half of the year, but noted it may not happen until late in the year, “too late for risk managers renewing policies in the winter.”

Property Policy Challenges

The most significant premium increases are likely to occur in commercial property lines. “There are a lot of variables in play that are impacting property valuations, such as the cost of materials to rebuild in the event of a loss,” said Mike Pesch, Americas president and U.S. CEO of Gallagher’s property and casualty division. “The message our folks are carrying to our clients and risk managers is to revise their property valuations, bringing up their limits by 10% to 30% to address rising insurer loss costs brought about by inflation.”

Rating agencies agreed with this rough estimate. “A building insured for $1 million might need to be at $1.2 million this year, due to large increases in the cost of construction materials,” said Jasper Cooper, vice president and senior credit officer at Moody’s. 

According to Suozzo, “The cost of contractors and construction services is higher, along with materials, due in part to supply chain issues. Wage inflation also factors into higher building replacement and repair costs.” He added, “There is a big focus by insurers and policyholders to make sure the limits they are buying are adequate to address these costs if something happens.”

Unfortunately for buyers, higher limits typically result in higher premiums. However, the alternative is to retain current limits and potentially suffer a property loss that exceeds the top limit. “Because of inflation, we’re in a place where replacement costs have made it a fiduciary duty, from a governance standpoint, for risk managers to insure a company’s property risks at higher limits,” Léonard said.  “My advice is to work with brokers to revisit your limits and optimize them.”

Experts expect similar pricing upheaval with commercial auto insurance. The long-embattled line of insurance appeared to be calming during the first quarter of 2022, when rates increased by 12%, compared to the 14% in the prior quarter, according to a report by Marsh. The increases are driven by inflation, supply chain disruption, and pricier repairs and replacements as advanced features like rear-view cameras, lane-changing signal systems and navigation technology become more common. 

“You have all these embedded sensors in cars and trucks and a pronounced shortage in semiconductor chips,” Suozzo said. “Supply chain disruptions mean longer wait times to source and get parts. There is also a labor shortage of repair people.”

Motor vehicle accidents and fatalities are also on the rise in the United States, with vehicle deaths increasing 17.5% from summer 2019 to summer 2021, according to a New York Times analysis of federal data. 

All of these factors are driving rising aggregate repair and replacement costs, which in turn pressure insurers to compensate with higher premiums. “When motor vehicle repairs cost 8% to 10% more, insurance premiums generally follow suit,” Hartwig said.

Casualty Insurance Trends 

While casualty insurance lines are not as directly impacted by inflation as property lines, rising medical care expenses and indemnity costs still create cause for concern. “Medical inflation was relatively moderate during the first two years of COVID-19, but it has ticked up over the last couple of months due to general inflation trends,” Cooper said. “On the indemnity side, there’s been an uptick in social inflation over the last few years.”

“Social inflation” is a term insurers increasingly use to describe so-called runaway verdicts. These are characterized by extreme punitive damage awards that are levied when a jury sides with a plaintiff in a liability action against a company. In recent years, these verdicts have grown in size and frequency, and have been exacerbated by the hard times brought on by the pandemic. “Behavioral economics indicates that, in times of economic duress, the social inflation component increases,” Léonard explained.

Social inflation ultimately results in large casualty claims, which then impact liability insurance premiums. “When people on a jury feel harmed by the economy, they seek significantly higher dollar amounts—it’s just human nature,” Pesch said. “Insurers have to price for the larger verdicts.” 

Preparation and Due Diligence

As the winter renewal season nears, risk managers should look to expand their company’s current limits of financial protection under the affected property and casualty lines of insurance.

In order to do so, risk managers must be ready to explain the need for a larger budget to address rising insurance costs. Getting buy-in from the C-suite is seldom easy, but it will be particularly challenging this year as no executive looks forward to spending more when inflation is rising. 

Risk managers need to go into meetings with the CFO “having done the due diligence,” Léonard advised. “Explain what is going on in the industry and provide examples of what peer risk managers are doing. Point out that you have analyzed the limits from a realistic standpoint and explored all possible risk mitigations and retentions to keep premiums lower. And do this sooner than later—no one likes a surprise.” 

Russ Banham is a veteran business journalist and author based in Los Angeles.