Friday, February 18, 2011

Inflation and Insurance

Is the return of “cash flow underwriting” a possibility?
Inflation—or the prospect of inflation in the U.S. in the near future—dominates the news today. To gain some perspective on inflation and any impact on the fortunes of property-casualty insurers, this week IN&V will look at insurer investment income and profits and compare that with historical changes in consumer prices (inflation). While the historical data are interesting and provide some insights, making predictions is very difficult—especially about the future.
China’s inflation rate was reported on Feb. 15, 2011, as nearing 5%, up significantly from a year earlier with food prices rising annually there at near 10%. Much of the Mideast turmoil is being attributed to unrest from high inflation in food prices. Then, to bring matters home to the U.S., many feel the Federal Reserve’s approach of quantitative easing will drive inflation via devaluation of the dollar, and there are concerns over oil and food prices here as well.
To gain perspective on a potential increase in inflation and the possible impact on insurance, consider data beginning from 1969 from A.M. Best Aggregates and Averages for insurance and the Bureau of Labor Statistics for inflation. This time period is of interest as it includes the 1970s and early 1980s when the U.S. saw two dramatic spikes in consumer prices. Using insurer profits and investment income as a percentage of industry premiums, the graph below shows inflation as measured by the change in consumer prices for urban areas.Source: A.M. Best Aggregates & Averages and the Bureau of Labor Statistics (CPI: All urban consumers).
As you can see, there is no obvious correlation between insurer investments or profits and inflation. There are two spikes in inflation in 1974 and 1980, and after that the p-c industry benefited from a general increase in investment income. Beyond that though, any conclusions seem at best speculative. If anything, what seems most obvious is insurance profits are quite volatile in spite of more stable inflation rates and investment income.
Some industry concerns surround possible increases in inflation, focused on the hyper-inflation of the 1970s and early 1980s and the prospect of a return of “cash flow underwriting.” Readers who were in the business at the time may recall that following a period of underwriters pursuing soft insurance premiums at seemingly any risk for dollars to invest at high interest rates, the industry saw investment income fall and loss costs rise, ending in the epic hard insurance market of the mid-1980s (see the infamous “Time” magazine cover story, “Sorry America, Your Insurance Has Been Cancelled,” from 1986).” No one seems to have a strong opinion whether this could or would

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