Enduring high inflation could lay ambush for liability reserves: Guy Carpenter

Enduring high inflation could deliver a “delayed and amplified” hit to reserves on longer-tail insurance lines - where reserve redundancy has not been as prevalent - given how insurers have a history of falling behind the inflation curve, officials at  Guy Carpenter and Marsh have warned.

Insurers tend to treat inflation “in a vacuum,” not as part of a comprehensive forward-looking view, Guy Carpenter’s global head of business intelligence Jayan Dhru said during a recent webinar. One upshot: the treatment of inflation by re/insurers “is lagging” on the way up and will lag on the eventual way down.

“Inflation will drive up costs and Covid increases backlogs,” Dhru said. “There’s a risk that inflation will have a delayed and amplified impact on loss reserves.”

While short-tail lines move quickly to price ahead of a more immediate loss trend, longer-tail lines have to be more forward-looking.

To-date, medical costs and other casualty-sensitive price measures have avoided the type of punishing inflation readings seen by property, but analysts at Guy Carpenter sister firm Marsh don’t expect that will hold.

“I certainly do expect inflation to spread to medical costs for sure,” a qualified solutions team leader at Marsh, Jack Sallada, told the webinar. Sallada expects inflation to spread across categories “and I don’t see that going to premiums like we do in other lines as of yet.”

To date, the industry has been more self-congratulatory for its decades-long run of prior period reserve releases. But the reserve redundancy that has driven favourable prior period adjustments has been focused in short-tail and workers’ comp, Dhru noted.  Some of the liability and other lines “already showed some [reserve] deficiency.”

That sets up liability lines for an eventual shock adjustment. “The view is that [insurers] may go from reserve redundancy to adequacy,” Dhru said. “What we see often is that they skip adequacy and go right to deficiency.”

Given the delayed recognition of long-tail inflation and the Covid-driven bottlenecks to claim development, the problem could fester “several years” before manifesting itself in full, Dhru warned.

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