Inflation Could Impact Reinsurance Sector, Consultant Cautions

NU Online News Service, Oct. 23, 2:19 p.m. EDT

Reinsurers' profit line could be hit hard by future inflation leading them to cut back on the business they write next year, a large consulting firm is warning.

Stamford, Conn.-based Towers Perrin, said the impact from future inflation would hit all reinsurance lines with casualty lines likely to suffer the most.

Ross Howard, chief operating officer Europe for Towers Perrin's reinsurance brokerage business, said in a statement that, "When it comes to reinsurance contracts, where several years often elapse between rates being set and claims being paid out, inflation is a potential threat and can become a real problem."

He noted that, "Historically, inflation has caused larger future claims, and, in the current climate, the industry is not likely to be able to factor this into pricing."

Towers Perrin said it estimates an inflation rate of 3 percent would mean claims that cost $1 million today would cost a reinsurer $1.113 million on average, 111 percent of today's claim size. Five percent inflation could result in a claim of $1.195 million, 119 percent of the original claim size.

And the firm advised that inflation doesn't just impact claim severity. It can also have a knock-on effect on frequency. Periods of high inflation, said Towers Perrin, generally correspond with greater numbers of claims.

Looking at historical loss ratios for casualty lines, the company said that the impact of inflation can be clearly seen with a two-year lag. An inflation high point of 3.4 percent in 2000 was followed by a loss ratio of 99 percent on casualty lines in 2002. Conversely, a 2002 low point of 1.6 percent saw loss ratios fall to 73 percent in 2004.

"Reinsurers are already looking hard at their casualty books, and the impact of inflation on profitability may lead to reinsurers reducing their casualty writings next year," said William Eyre, Jr., managing director of Towers Perrin's reinsurance brokerage business.

Mr. Eyre said the firm is "closely monitoring inflation as we advise our clients on their optimal reinsurance structure."

The company said its inflation figures were calculated using the payment patterns of U.S. Nursing Homes' Professional Liability/General Liability claims and inflation data was sourced from the U.S. Bureau of Labor Statistics at http://www.bls.gov/.