Cat losses & inflation drive rate hikes

Recent cat losses and a lack of capacity will increase pressure on pricing in the next renewal season, according to Robert Mazzuoli (pictured), director, Insurance Ratings for Fitch Ratings.

Speaking on October 20 in a Fitch Ratings online discussion on the impact of rising interest rates and inflation on European insurers, he addressed whether a hard market was likely to be maintained to offset claims costs, and how price increases are likely to compare with inflation.

While economic inflation has driven claims inflation, Mazzuoli emphasised that natural catastrophes are an important contributory factor.

“If you have rising claims inflation caused by the economy and then on top inflation caused by climate change on the nat cat side, that certainly creates a lot of upward pressure on pricing,” he said.

At the same time, he noted a potential negative impact on available capital and that, in property-catastrophe business in particular, capacity is shrinking and demand is growing—a scenario Fitch expects to be evident the next renewal season.

“We expect, for the first time in many years, a deficit of capacity available to cover all demand for property-cat covers, so pressure on prices will be immense,” he said. “Let’s see how it goes. For now, we would expect that underwriting margins remain stable, and that means that the price increases more or less equal claims inflation.”

He addressed what impact the strong dollar could have on rate on reinsurance and the London Market.

“The global reinsurance business and London Market are normally done in US dollars, but the reporting of the companies is in local currencies—that can be the euro or the pound,” he said.

“Everything that is then translated from US dollars gets more when you translate it back into your local accounting—so that’s an accounting impact, and we should be aware that normally, currency matching is in place, so insurance exposures in US dollar are normally masked with assets and investments in the same currency, so we do not expect any margin impact from a rise in the US dollar.

“There is another aspect that might be more interesting, and that is imported inflation through very weak currencies. A strong dollar means in principle that other currencies weaken and that imports inflation and increases pressure on inflation in the eurozone, in the UK, and in emerging markets as well.”

A strong dollar

This is probably the more significant transmission mechanism for the reinsurance business and the London Market, because in those regions, there might be additional inflationary problems, Mazzuoli explained.

“The opposite is true in the US, so US business then might get some benefit, although we know that the US market or economy as a whole depends less on imports. I would say, taking everything together for global business such as reinsurance or the London Market, a strong dollar means probably higher inflation, imported inflation on a net basis, and therefore, additional problems for margins,” he said.

Willem Loots, senior director, insurance ratings, addressed the issue of inflation and the strong US dollar, discussing what these factors, and rising rates, imply for insurance asset allocation and investment strategy.

“This is a particularly important question for life insurers which are more balance sheet-intensive,” he said. “The key thing is the distinction between rewarded and unrewarded risk. and we expect insurers to keep focused on mitigating unrewarded risk where they can.”

Fitch’s report, “ Impact of Rising Interest Rates and Inflation on European Insurers”, released September 5, warned that several European insurance sector outlooks could move to “deteriorating” if high inflation persists and interest rate rises become more significant.

Fitch analysed the potential impact of an economic scenario with mid- to high-single-digit inflation throughout 2023 and 10-year interest rates increasing by a combined 300bp in 2022 and 2023.

“Non-life insurance sectors would typically be worst affected, particularly those with a high proportion of long-tail business where higher-than-anticipated claims inflation could lead to reserve deficiencies,” Fitch said.

“High inflation could also lead to margin pressure for short-tail business in markets where strong competition or societal pressure limit insurers’ ability to increase prices. Non-life insurance companies that already have weak reserving levels or lack pricing power are most at risk of negative rating action due to the adverse impact of claims inflation on margins and capital.”

Fitch said the European non-life sectors most under pressure would be in Italy, the UK and France.

“Italy has a high proportion of long-tail motor third-party liability insurance, the UK market is particularly competitive, and French non-life insurers already face government demands to give rebates to customers struggling with inflation,” it said.

“Life sectors with large books of traditional life policies backed by assets of shorter duration than liabilities would be net beneficiaries from rising interest rates. The French and German life sectors are the most notable examples, and we would expect the positive effects on capital and medium-term earnings to offset the negative short-term effects of increased investment volatility, higher lapse rates and lower new business volumes.

“However, financial market volatility and lower asset values would be detrimental to margins in life sectors with a high proportion of unit-linked business.”