NU Online News Service, Oct. 11, 1:43 p.m.EDT

Sudden inflation could reduce property and casualty insurer'ssurplus by as much as 24 percent over a prolonged period, accordingto a Moody's Investor Service report.

In the report, “Inflation Risk of U.S. P&C Insurers,”Moody's says that a baseline stress scenario of 3 percent inunexpected claims inflation over a three-year period wouldtranslate into surplus reduction between 7 percent and 24percent.

The numbers cover the firm's rated universe of U.S. casualtyinsurers with writers focused on long-tail liability business mostaffected.

“P&C insurers are sensitive to unexpected changes ininflation rates,” says Pano Karambelas, Moody's vice president andco-author of the report. “As seen during the 1970s and 1980s,volatile inflation can squeeze insurers' balance sheets byincreasing claims liabilities across multiple business lines andlowering the valuation of fixed-income investments.”

Because of this growing concern kindled by “aggressive monetarypolicy,” Moody's says insurers are investing in economic modelingto gauge the potential impact on capital and earnings.

According to Moody's, insurers are subject to “significantexposure to market value declines” in their holdings of fixedincome securities. However, barring the impact of a verysignificant industry catastrophe that would place demands onliquidity, the situation is viewed as manageable. The reason isbecause insurers tend to hold onto these securities until theymature.

The real challenge comes in underwriting, especially whereclaims inflation emerges, Moody's explains. The problem is thatclaims inflation is expected to outpace general inflation “asinsurance-specific trends such as healthcare utilization and tortlitigation remain dominate drivers of claim severity.”

Offsetting inflation claims cost would be “attendant increasesin investment income on fixed income assets,” Moody's says.