How Rising Energy Prices Affect P/C Insurance

April 11, 2011

The leveling off of the world’s oil supply and the resulting rising gasoline prices and their economic impact carry implications for property/casualty insurance rates.

Oil spikes have been known to precede recessions, which affect auto, home and workers’ compensation claims as well as the investment income insurers can earn. At the same time, energy costs can increase demand for new “green” insurance coverages, according to Gail Tverberg of Tverberg Actuarial Services Inc., a panelist at the Casualty Actuarial Society’s annual Ratemaking and Product Management Seminar in New Orleans.

“In terms of how these issues are already affecting insurers, remember the Deepwater-Horizon oil drilling platform blowout that happened in the Gulf of Mexico last year, the nuclear meltdowns in Japan this year, and the recession of 2008-2009,” said Tverberg, whose firm is based in Atlanta.

“We knew there was a correlation between oil price spikes and recessions,” she said. “Since World War II, there have been 12 oil price spikes and 12 recessions. Eleven of the oil price spikes immediately preceded recessions, so we only have one of each that didn’t get explained by the other.”

She said recessions affect insurers by reducing auto claims, high unemployment affects workers compensation insurance, falling home values and unoccupied homes affect homeowner insurers, and insurers can’t earn as much investment income. On the other hand, rising energy prices can boost demand for new insurance coverages for risks such as solar panels and electric cars.

According to Tverberg, population growth corresponds very closely to growth in fuel use and food prices also correlate closely with oil prices.

“We are reaching limits in many areas,” she said. “Fresh water is limited, oil and natural gas are becoming more expensive to extract, soil is suffering depletion and erosion, and capital for solutions is limited.”

The leveling of oil production is not entirely unexpected, she said, and oil production in many countries has reached a peak and started declining. “We’re reaching limits in many areas in a finite world,” she warned. “Everyone assumed technology would take care of things, but it hasn’t.”

Tverberg said that while everyone expects very high prices and inadequate supply, the real problem is that the economy cannot afford even moderately high oil prices.

“In terms of implications for ratemaking, we should expect more recessions, or a shift from slow growth to recession and back again, but I think the general direction is going to be in terms of more recessions,” she said. “We should also expect that governments are going to be in worse financial shape, so they may not repair roads as well, they may default on their bonds, and they may not be able to fix damage after catastrophes.”

Tverberg listed some of the possibilities for new insurance coverages as a result of a shift away from oil and petroleum-based products, including homes with expensive solar panels that may present the risk of theft if they’re installed on or near the ground, and homes with wind turbines that tend to cause vibration and damage if they are on top of buildings. Electric cars are also being added. They are likely to be second or third vehicles with very low mileage, because of their limited range.

“Among the implications for homeowners insurance ratemaking are that home prices are likely to continue to decline and more problems with defaulting on home loans mean that some are not keeping up their homes because they don’t have the money to do necessary maintenance, resulting in more claims due to causes like leaky roofs,” she said.

Also, a shift in mix is likely to be toward older homes that could raise the average loss amount for claims, with struggling homeowners “shopping” rates more, raising the loss ratio.

“Higher oil prices also are likely to reduce the number of miles driven, which could have a favorable impact on claim frequency, but there may be more theft claims due to fraud, a rising crime rate and fewer police as well as more costly accidents as auto repair costs rise with the price of oil and roads deteriorate due to the high cost of asphalt and poor government finances.

The potential impacts on catastrophe pricing are that following natural disasters, governments are likely to be slower to fix roads and provide basic services, so business interruption claims may go on longer than they would otherwise. Government intervention in settlements may occur, as in the Deepwater Horizon oil spill,” she noted.

“With rising oil prices having the potential to push up long term inflation rates and defaulting bonds possibly causing investment returns to be far below what was anticipated, the long term outlook for long-tail insurance lines is dim, resulting in insurers returning to short-term, quick payout lines,” said Tverberg.

“The basic issue is that exponential growth cannot continue in a finite world with oil being a major variable, along with population, water supplies and the financial system. A clear solution does not exist,” she said.

Many of the members of the Casualty Actuarial Society are experts in property/casualty insurance, reinsurance, finance, risk management, and enterprise risk management.

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