Flexibility Is Key for Insurers Managing Inflationary Challenges

Inflation likely won’t subside anytime soon, and insurers will need to be proactive and flexible if they want to stay on top of the challenges, said Keith Buckley, managing director of Fitch Ratings’ global insurance rating group. He was speaking on the most recent episode of Carrier Management’s Strategy Sessions webinar series.

“I think the biggest thing is companies just need to be very proactive in thinking about it and making sure that they’re thinking about it from all angles and all the different levers they can pull, so if their vision isn’t able to be executed as they’re hoping, they can maybe change course and find another way that can narrow that gap between inflation and pricing,” he said.
Buckley said part of the challenge is that inflationary pressure is coming at a time when the economy is already challenged due to the ongoing COVID-19 pandemic, supply chain shortages and even the war in Ukraine.

“We haven’t seen this type of inflation in many years in the U.S., so it’s going to take some time to manifest,” he said. “We’re in a very unique economic situation coming out of a pandemic lockdown and the recovery from that, which created some additional challenges and problems.”

With this in mind, insurers need to prepare for inflation to endure for a number of years at even higher rates than are currently being seen, he added.

“Being ready is a very important part of a good strategy,” he said.
Pulling Different Levers

In terms of pulling various levers in their playbooks, Buckley said one of the biggest levers insurers can pull is pricing.

“The challenge insurers always face, and this is just part of their core business model, is that it’s an industry where you don’t know your cost of goods sold at the time the product is sold, and that’s why you employ a bunch of actuaries who can do their predictive work and try to figure out what those cost of goods might be so that they can price the product accordingly,” he said.

One difficulty, however, is that not all lines of insurance can raise their prices, as regulatory pressures could limit some consumer-oriented lines of business.

“Regulators in various states are very interested in why you need to raise these lines and if you can demonstrate that to them and can get the rate approved,” he said.

In addition, companies that are more pessimistic about inflation and overshoot their competitors risk losing market share if their pricing is higher than others, he said. On the other hand, companies that underprice against inflation could lag the competition, widening their gap between inflation and pricing.
Fitch Ratings: Keith Buckley. Photo by Andrew Collings.

“There are a number of external pressures, there are challenges in predicting what assumptions you want to use, and there are just going to be differences in execution across companies,” Buckley said. “Managing all of those elements well is going to lead to not all companies performing the same way in dealing with this issue.”

That said, Buckley said that overall, he is seeing more insurers being proactive when thinking about current inflation.

“I would say insurers are definitely thinking about this issue,” he said. “It’s probably one for us, as credit analysts, where we get more questions on this topic than almost any when talking to investors. I think for insurance companies too as we talk to them, it’s a big part of the strategy discussion.”

He said this is something Fitch is taking into consideration in its ratings analysis.

“What are they doing in some of the key lines of business that are being affected? Are they recognizing or are they putting in new rate increases? Are they able to get those through regulators?” he said. “So a big part of our analysis now is just trying to understand strategically what are companies doing and trying to get a sense of how well they might be executing. It’s still somewhat early days in certain lines and for certain companies, but that’s sort of the angle we’re taking. We recognize it’s a risk a lot of companies haven’t really faced before, at least in the lifetimes of the employees that work there.”

Indeed, Buckley said one of the big challenges with the current inflationary environment is that data and history exists from previous inflationary periods, but there are few who lived through it, especially those in a decision-making situation.

“I think that’s a real challenge, because it means that people are learning it for the first time,” he said.
A Unique Environment

That said, what’s unique about this current inflationary period is that there are many other factors putting pressure on the economy as well, Buckley said. In additional to the pandemic and subsequent supply chain challenges, changing weather patterns are further complicating things.

“I think the one challenge with climate change is that it is sort of a long, slow phenomenon, so insurers tend not to think about or price out to 30 years from now; they think over the life of policy, a lot of which are much shorter,” he said.

With this in mind, insurers will need to consider what strategies can be adopted now to make sure they’re prepared as the climate situation evolves, Buckley said, while remaining flexible to changes in weather patterns.

“When I think of climate change relative to the general inflationary pressures we’ve been talking about, I would say if I think over the next three to five years … probably the general inflationary pressures are going to be most pronounced and the one companies are focusing on the hardest,” Buckley said. “But certainly the climate change issues and how those evolve … that’s going to be a further complication [insurers] have to deal with and further factor in as they try to deal with this one very challenging issue.”

He said this all means a lot of uncertainty exists right now.

“There’s still a lot of uncertainty as to how will this play out in people’s crystal balls, because there are so many moving parts,” he said. “So I think that’s one of the most unique challenges we’re facing now is just trying to come up with what is your assumption for inflation, how many years will it last, how will it play out, what type of stress situations do you see and how much do you factor them into pricing and things like that. I think that’s definitely a unique challenge companies are facing today because of the other things that are happening that are either driving or ancillary to inflation.”

As he looks into his own crystal ball, Buckley said he sees inflation likely creeping into most lines of business.

“Right now, companies are dealing with inflation hitting into things like auto and property lines where inflation very much affects a product whose costs will drive up claim costs,” he said. “General inflation, if it endures for a number of years, will start creeping into all products … So, this will ultimately creep into every line of business, but it’s going to come at different stages and different paces and that’s going to be an additional challenge for actuaries if they get to that situation and trying to figure out how do I price it now.”

Beyond thinking about pricing as well as remaining proactive and flexible for what’s ahead, Buckley said the biggest thing companies need to be doing is simply recognizing that inflation is a real risk that is not going away anytime soon.

“If you think back about six, seven, eight months ago, there was definitely a school of economists who thought inflation would be transitory and go away and not something to worry about as much,” he said. “I think very few are in that camp now, but given that it was not that long ago that there was a large school thinking that, that does create a challenge and make us think about execution. The first step in execution in this type of environment is saying, ‘Okay, we’re going to buckle down, assume it’s happening, have some assumptions that make sense, and have contingency plans in place as we think about repricing.’”