ESKA Watch: Sky-High Inflation Tests Global Insurers

By: Ahmad Sweiss

Economists speculate whether soaring consumer prices could still provide insurers with a silver lining as policymakers rush to counter record inflation and safeguard price stability over economic growth.

These are challenging times for the insurance and other growth-driving industries, heavily weighed by the pandemic aftermath, the war in Ukraine, and the surge in commodity prices amid growing fears of supply disruptions. Meanwhile, insurers are closely monitoring the related inflationary pressures, with headline inflation, the Consumer price index (CPI), hovering around its highest level in four decades. Simultaneously, markets are eyeing world central banks, expected to wave their magic wands against the inflation crisis before it takes an immense toll on the global economy. Still, we doubt that casting more counter-inflation spells will be as enchanting as in the old days. Only time will tell if it does!

In this article, we explore the correlation between inflation and insurance, the effect of inflationary pressures on claims and premiums, and how monetary policy decisions could influence the outlook of this resilient industry.

But first, let us start by defining inflation!

Inflation is the terminology economists use to describe how prices change over time—a general increase in prices and a fall in purchasing power of money.

How Does Inflation Affect Insurance Rates?

While the basket of goods and services gets more expensive worldwide, so does the cost of avoiding risks and finding collateral or a haven for miscellaneous losses companies and their insurers could financially endure.

Inflation can increase the cost of insurance, like most other goods and services, as insurance rates are rising in line with general inflation trends. However, we have seen consistent inflation of claims with the headline inflation, even though insurance could exceed or lag the headline inflation rate in some years.

Even before the war in Ukraine and escalating fears of a shutdown of Russian gas and oil, some alarming inflationary trends were driven by higher commodity prices, supply-chain interruptions, and high energy prices. Therefore, insurers are laser-focused on how price benchmarks for energy, raw materials, and construction costs are developing since these impact businesses and potential claims instantaneously.

Premiums, Claims Inflation on Watch

Suppose the cost of house building materials has increased, and the cost of automobiles has increased due to a chip scarcity and a labour shortage. In that case, these expenses will most definitely trigger higher house and automobile repair costs in the case of an insurance claim.

Naturally, insurers carefully consider claims inflation when determining insurance premiums. Therefore, premiums are positively correlated to changes in the number and prices of claims.

Insurers use several variables, including market trends, the volume and value of claims and other variable costs, when setting insurance prices, which means that costs are not fixed! And so, the cost of insurance premiums will increase if those prices do as well.

How Can Interest Rates Influence Demand, Inflation?

Generally, central banks are responsible for maintaining currency stability, low inflation, steady GDP growth and robust employment, mainly through setting monetary policy. The primary tool they use is changing the base rate, which influences all the interest rates that commercial banks set. Another critical tool affecting interest rates is participating in open market operations and quantitative easing.

When central banks are alarmed about inflation exceeding their target threshold, they can increase interest rates. Higher interest rates slow down economic activity, reducing inflationary pressures and vice versa.

When rates are low, more people and businesses will borrow to invest in goods and services. Higher demand for goods and services and lower rates compel employers to open more positions to meet market demands and raise wages to appeal to potential employees. Consumers, then, turn around and spend these wages on goods and services, which would lead to more jobs and higher prices.

Conversely, higher rates mean lower spending, weaker people and business borrowing, nominal job growth, and decreased spending. Furthermore, Higher interest rates make it more appealing to save. Accordingly, inflation slows as supply and demand balance out.

While interest rates can effectively bring inflation down, a rate hike could take time to ripple through the markets. Nonetheless, the impact of higher interest rates on borrowing will instantly hit consumers and businesses.

Policymakers Eye Interest-Rate Hikes to Tame Inflation

Unlike the stubborn clouds of weak growth and sky-high inflation, the pandemic nebula might be receding, or so we have been told. But with the risks of a recession looming toward year-end, the economic outlook remains bearish— a perfect setting for policymakers to tighten monetary policy.

An aggressive interest-rate hike to beat the inflation outbreak might be around the corner, but most probably at the cost of the lax pandemic recovery and potential global recession. Henceforth, insurers must keep a close eye on prices and central bank movements in the short-to-medium term.

In such heightened uncertainty conditions, consider digitalisation using ESKADENIA Software’s comprehensive insurance systems. We offer efficient insurance systems to manage your premiums through policy administration systems, claims through the claims management module, and much more.

Learn more about our inclusive suite of insurance software products, ESKA® Insures, then opt for the system that matches your profitability goals and let your business blossom!