Line by Line Analysis of Inflation’s $30 Billion Impact on Insurers
According to McKinsey & Company, inflation increased loss costs for property/casualty insurers by around $30 billion last year, with personal lines accounting for nearly three-quarters of that amount.
McKinsey partners Kia Javanmardian, Sebastian Kohls, and Fritz Nauck, along with senior expert Gavin McPhail, emphasize the role of insurance executives in directing a coordinated response to inflation’s potential jolts to profitability, with leaders orchestrating actions across pricing, underwriting, claims, and other functions—basically following a “resilience playbook” that will resiliency.
The authors calculated that growing prices will drive a nearly $22 billion rise in personal lines loss costs in 2021, above and beyond historical loss patterns, by focusing on the amount an insurer must pay to cover claims, or its loss costs. They anticipated that the impact of cost inflation in 2021 would be almost $8 billion for three commercial lines: workers compensation, commercial multiple hazard, and commercial auto. While the monetary implications for longer-tail business lines are lower than for personal lines, a graphic illustrating the percentage impact on each line indicates a 16 percent impact for workers compensation.
Neither the dollar nor the percentage impacts on loss costs forecast the full impact of inflation in 2022. The authors stated that they utilized the most recent full-year data available for their research, and that the effects will be considerably greater once 2022 is in the books.
They cite price increases in motor vehicle components and equipment between June 2021 and June 2022, as well as supply chain interruptions, to explain the substantial impact of inflation on personal auto for both years.
“Under these conditions, insurers’ short- and long-term strategies focus upon clever pricing, expenditure management discipline, and claims operational excellence,” the authors write. While the authors advised insurers to keep a watch on general inflation, wage inflation, and interest rates, they emphasized that claims cost inflation should receive the greatest attention in the coming months and years.
“To successfully control such expenses, insurers must focus on boosting claims efficiency and automation, as well as improving or mending managed-care network usage and negotiated pricing, while also balancing cycle time gains with claims accuracy,” they write.
The article also presents nine alternative future-state scenarios, which combine projected degrees of cost inflation in global energy, food, and commodity markets with prospective reactions from the United States Federal Reserve and other government agencies and corporations worldwide. They identify three possibilities as particularly significant for insurers in the months and years ahead: price stability with the Fed remaining on its current course; further price disruption in global markets with the Fed obliged to raise policy rates above 4%; and persistently rising inflation (and U.S. stagflation).
According to the McKinsey experts, the intermediate option—continued price disruption—is worse for P/C insurers than the less likely scenario of chronically high inflation. Underwriting earnings would be disrupted in the short term in both the most optimistic (stabilization) and pessimistic (stagflation) scenarios. However, they warn that a medium scenario in which energy, food, and commodity prices continue to rise—and then adjust—could result in a catastrophic hard market.
In the second scenario, disruptions in global commodities markets would raise claim costs, while modest general inflation may keep insurers from raising consumer rates. In a highly difficult market, insurers may restrict underwriting capacity and impose tight underwriting rules in response to profit problems.
The authors suggest that insurers that maintain expense discipline, superior underwriting, pricing discipline, and focus on pockets of the market will profit in this scenario, and they urge executives to put together a “resilience playbook,” mapping out responses to any of the scenarios that ultimately play out.
The article includes recommendations for chief underwriting and product executives, chief claims officers, and chief financial officers. For example, in the section on underwriting leadership, the McKinsey team discusses the need for price granularity and suggests lowering policy calendar exposure from 12 months to six months or less.
In the part devoted to chief claims officer answers, they say, “Now may be a good moment to accelerate novel loss prevention capabilities through in-home Internet of Things apps, car telematics (such as vehicle tracking), and workplace surveillance.”