Moody’s: P/C Insurers More Mindful of Inflation Risks

October 11, 2011

Until recently, the risk of inflation shocks has not ranked high on the agenda for U.S. property/casualty insurers, Moody’s Investors Service says in a new report, but aggressive monetary policy over the past few years has rekindled concerns about escalating inflation over the medium to long term.

“P/C insurers are sensitive to unexpected changes in inflation rates,” said Pano Karambelas, vice president and co-author of the report. “As seen during the 1970s and 1980s, volatile inflation can squeeze insurers’ balance sheets by increasing claims liabilities across multiple business lines and lowering the valuations of fixed-income investments.”

Insurers have responded to the current environment by investing in economic scenario generators to gauge the impact of a potentially volatile macro-economy, including inflation stress scenarios, on capital and earnings, according to Moody’s. Moody’s has also conducted its own analysis of insurer underwriting and investment results in a number of inflation volatility scenarios.

“On the investment side, our analysis indicates significant exposure to market value declines in the P/C sector’s holdings of fixed-income securities,” Karambelas said, noting however that barring a significant catastrophe, the ultimate impact would be manageable for most firms, which would be able to hold these investments to maturity.

In the area of underwriting, however, the challenges would be less tractable if unexpected claims inflation were to emerge. Moody’s said its baseline stress scenario reflects the fact that claims cost inflation continues to outpace general inflation as insurance-specific trends, such as healthcare utilization, remain dominant drivers of claim severities. “Our baseline stress scenario indicates a surplus reduction of between 7 percent and 24 percent for Moody’s-rated casualty insurers,” Karambelas said, “with writers focused on long-tail liability business most affected.”

The report is titled “Inflation Risk of U.S. P/C Insurers” and is available on moodys.com.

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