Conning Report Warns Of Effects Of Inflation

NU Online News Service, Jan. 5, 3:33 p.m. EST

Inflation should be a "significant concern" for insurers, a new Conning Research report says.

The firm said inflation and inflation volatility could have both positive and negative effects on property and casualty insurer operating results and economic value.

Stephan Christiansen, director of research at Hartford-based Conning, said that while the insurance industry has dealt with inflation and associated volatility in the past, there has been little inflationary impact in the past 15 years.

The report, "Inflation in Property-Casualty Insurance: How Bad Can It Be?" said surveys of economists and forecasters actually suggest that prospects for inflation "remain fairly benign, though the dispersion around those projections is widening."

Potential inflation drivers exist, such as an increase in the money supply, complexity around monetary and fiscal policies entered into by the Federal Reserve, increasing federal debt and the short-term duration of that debt, and the pressure on the U.S. dollar in foreign currency exchange rates, Conning noted.

But the report states each of those factors "has corresponding solutions and tools to address them, and the consensus views of economists and forecasters suggest a belief that these solutions and tools will be successfully deployed."

Still, Conning warned that "the factors also present a complex picture, interacting with behavioral responses in the economy and financial markets that can produce a range of unintended consequences and self-fulfilling downside-case scenarios."

The study models the impact of inflation on the workers' compensation and personal auto lines of business and finds that, in some early stage inflation scenarios, there is actually some improvement in operating results. However, "longer term we see dramatic value destruction from hyper-competitive pricing and loss reserve development," Conning said.

For insurers, the report said that an enterprise risk management (ERM) approach "must consider contingencies and inflation scenarios in its risk tolerance analysis or risk being caught unprepared."

Insurers should take into account both investment considerations and underwriting and operational strategies to mitigate or control the cost of inflation, the report said.

Investments in shorter-term Treasuries and bonds could act as a hedge against inflation risk over the medium term, the report advised.

On the underwriting and operational side, the report said, "an initial consideration may be the development of an explicit risk charge applied to reflect inflation risk across a continuum of inflation probabilities. Mitigating factors to consider in inflation scenario analysis would include behavioral responses in the competitive, regulatory and political environments."