Several factors have contributed to the recent uptick in inflation including government spending, supply chain challenges and post-pandemic restlessness.
These trends, in turn, have resulted in a reduction of the U.S. dollar’s purchasing power, and this pressure is further exacerbated by material and labor shortages. The result has been unpredictable increases to both claim costs and settlement times.
Changes in claim costs and settlement time make pricing, reserving, and maintaining a book of business more difficult for surplus lines carriers. While admitted carriers will bear many of these same complications, surplus lines carriers are positioned to respond more effectively to fiscal pressures due to the absence of heavy regulation that admitted insurers must negotiate.
And then there’s social inflation.
Social inflation is a phenomenon in which carriers’ liability claims rise above general inflation due to unfavorable results in liability court proceedings. Legal proceedings that take longer than expected, increasing statutory limits on non-economic damages, and a rising number of outside jury awards all contribute to social inflation.
With reductions to non-economic loss limits, claimants can receive more for subjective losses such as pain, suffering, stress and inconvenience. These changes are increasing the number of “nuclear verdicts,” or verdicts that reach into the billions, which leads to excessive losses not accounted for in the standard ratemaking process. The graphic pictured to the right from the Institutes compares annualized loss rates for various liability lines of insurance between the periods of 2009 and between 2014 and 2018. It illustrates how social inflation contributed to the significantly higher incurred losses in recent years.
Shortages pinch economy
Labor force participation reached its lowest point in well over twenty years due to the COVID-19 pandemic, according to FRED. Because claims can only be settled as quickly as they are valued, worker shortages could result in slower processing times for claims.
For an auto collision claim, an understaffed vehicle repair shop will take more time to get the carrier a quote. Delays in the reporting process introduced by worker shortage will likely create unexpected increases in claim settlement time and loss because the longer a claim is open, the more likely it is to develop complications or become litigated. It also seems plausible that shortages in ‘dangerous’ job fields could result in workers being overworked, stressed, and more prone to injury, thereby increasing the likelihood of claims.
Americans who remain in the workforce have been shifting roles. More than half of Americans who quit their jobs in 2021 did so for a career change, according to the Pew Research Center. Short-tenured employees have significantly higher rates of injury than longer-tenured employees, driving up coverage costs across numerous lines of insurance.
The presence of labor shortages, in conjunction with aging infrastructure and geopolitical factors, contributes to supply chain issues, which ultimately make it more difficult to transport materials. One industry experiencing significant labor shortages is trucking. According to the American Trucking Association, the United States is short around 78,000 truckers. As a vital component of the supply chain, trucker shortages mean that material deliveries are being delayed. While the trucker shortage is just one of many components that are causing material shortages, it demonstrates how labor shortages and material shortages are linked.
Inflation has had adverse effects on the entire U.S. economy. Prospective insureds, both new and renewing, who are facing their own difficulties associated with inflation, may be unwilling or unable to accept substantial rate increases. Faced with high rates, insureds may choose to shop around, even though rate increases are likely to be industrywide. It follows that insurance carriers must provide agents and brokers with tools and information that helps them justify higher rates to clients.
The mounting pressure of inflation, further compounded by labor and material shortages, makes future increases in claim value and settlement time seem inevitable. If surplus lines carriers fail to adapt their pricing and reserving procedures to accommodate high inflation, they risk inadequate premiums.
The coming wave of premium increases will put pressure on agents and brokers to maintain wholesale insurers’ books of business. Despite all the inflation-induced difficulties facing surplus lines carriers, with its low levels of regulation, the WSI industry is in an advantageous position over the admitted market. A carrier in the admitted market must have all rate increases approved, meaning it is limited in its ability to set adequate rates. Without such limitations, surplus lines carriers can adapt their rating practices to incorporate inflation data from relevant indices in a way that aligns with their unique book composition.
A surplus lines carrier who can innovate its rating process and capitalize on a potential influx of business from the admitted market could turn this period of high inflation into a tremendous business opportunity.
This article is an abridged version of “Inflation: A Silver Lining,” an award-winning, insurance-industry white paper prepared by Arizona State University RMI student Connor Lindgren. Visit https://www.wsia.org/wcm/Foundation/Contests to read this work in its entirety.