Towers Perrin warns that 3% inflation means a $1m claim could leap to $1.113m

Future inflation may damage reinsurers’ profitability on all lines of business, with casualty lines of business likely to be hardest hit, according to global professional services firm Towers Perrin, the world’s fourth largest reinsurance intermediary.

“When it comes to reinsurance contracts, where several years often elapse between rates being set and claims being paid out, inflation is a potential threat and can become a real problem. Historically, inflation has caused larger future claims, and, in the current climate, the industry is not likely to be able to factor this into pricing,” said Ross Howard, COO Europe for Towers Perrin’s reinsurance brokerage business.

Towers Perrin has estimated that the impact of an inflation rate of 3% would be that claims that cost $1 million today would cost a reinsurer $1.113 million on average, 111% of today’s claim size. Five percent inflation could result in a claim of $1.195 million, 119% of the original claim size.

Inflation doesn’t just impact claim severity. It can also have a knock-on effect on frequency. Periods of high inflation generally correspond with greater numbers of claims. Looking at historical loss ratios for casualty lines, the impact of inflation can be clearly seen with a two-year lag. An inflation high point of 3.4% in 2000 was followed by a loss ratio of 99% on casualty lines in 2002. Conversely, a 2002 low point of 1.6% saw loss ratios fall to 73% in 2004.

“Reinsurers are already looking hard at their casualty books, and the impact of inflation on profitability may lead to reinsurers reducing their casualty writings next year,” added William Eyre, Jr., managing director of Towers Perrin’s reinsurance brokerage business. “We are closely monitoring inflation as we advise our clients on their optimal reinsurance structure.