Navigating claims inflation in volatile times

This article first appeared in Claims Media, which reports on and analyses the claims sector through online and physical channels.

Without adequate allowance for the impact of claims inflation, insurers will potentially be exposed to inaccurate reserves and additional challenges when adjusting claims.

Not a day goes by without another news story detailing how rising inflation is affecting our day-to-day lives. Similarly, for those working in claims and insurance, the issue is requiring urgent consideration to ensure business resilience and adequate claims management.

Claims inflation is not a new phenomenon. Insurers, brokers and lawyers take ordinary economic inflation into account every time they consider the future value of a claim and set an appropriate reserve. It is understood as the change in the expected cost of claims from one year to the next.

‘Ordinary’ economic inflation is calculated by use of standard economic indices, such as the Retail Price Index (RPI), the Consumer Price Index (CPI) and the Annual Survey of Hours and Earnings (ASHE), all of which are provided by the UK government’s Office of National Statistics.

Excess claims inflation, however, is the increase in the cost of a claim beyond that of ordinary economic inflation. It is driven by many different inflationary factors, including increased costs and risks associated with the use of new materials, medicines and technologies.

Examples of such inflationary factors include:

  • Advances in medical science and technology.
  • New categories of claims responding to shifts in working environments and the use of evolving technologies.
  • Professional services spend, including increased costs of instructing experts and lawyers.
  • Costs of energy, transportation, construction materials and labour pushed higher by supply issues.
  • Demand surges, for example, after an extreme weather event.

Social inflation

Social inflation is a subset of excess claims inflation and refers to increased costs largely attributable to social trends or movements. The rise of these social trends and movements has resulted in an increase in the volume and costs of claims, meaning that social inflation is also causing understandable concern for insurers and their customers.

Societal changes that are increasing the volume and costs of claims include unanticipated emerging risks such as a greater willingness to challenge corporate behaviours and old hierarchies, shifts in the legal and regulatory environment, evolving societal attitudes, and demographic and political developments.

Examples of recent social movements that have resulted in an increase in both the volume and value of claims include the activities and actions associated with Black Lives Matter, #MeToo, climate change activism (including Extinction Rebellion/Just Stop Oil), COVID-19 and associated business interruption losses, the expansion of the gig economy and, currently, the ongoing cost of living crisis.

Along with social trends, procedural changes are facilitating claims inflation in the UK market through the increase in appetite of third-party funders prepared to finance collective or group actions, and the growth of claims management companies (CMCs) that see this as a lucrative growth area.

Although litigation funding can be seen as a particular driver of increased claims activity in both the UK and the US, in the latter, the jury award system, coupled with shifting societal attitudes in respect of certain classes of claim, including environmental litigation and discrimination-based actions, means that the impact is perhaps even greater there.

Mentioned briefly below are recent drivers of excess inflation.

#MeToo

The #MeToo movement continues to have a global impact on claims, as do similar social media driven groups, such as Everyone’s Invited, which gives people the opportunity to share their experiences of abuse and provides a means of support for victims.

Cost of living crisis

Many countries are currently facing a cost-of-living crisis as a result of increased financial turbulence. The COVID-19 pandemic has left economic scars on the global jobs market, despite a jump in wages and a fall in unemployment. The key drivers of the increase in consumer price inflation include petrol, food, durables, consumer goods and, crucially, energy prices which have been affected hugely by the war in Ukraine.

Fraud

Instances of fraud tend to increase in times of recession, meaning that the combined impacts of COVID-19 and the current cost-of-living crisis have the potential to cause a spike in fraud related claims.

An example of that is Action Fraud recently urging the public to be aware of scam emails claiming to be from Ofgem (the energy regulator). The Financial Conduct Authority is also warning firms about rising fraud rates across all lines of business.

New types of claims

As well as an increase in general and special damages (including as a result of new heads of loss), we are witnessing new types of claims, such as those relating to complex post-traumatic stress disorder (PTSD) and functional neurological disorder. Indeed, we anticipate that claimants of the future may be more vulnerable to adverse psychological consequences as a result of the impact of the pandemic on their long-term mental health.

The development of these types of claims, coupled with increased awareness of the ability to claim for such disorders, may well increase the volume of such claims, thereby increasing their cost to insurers.

During previous spells of high inflation, the insurance industry has experienced inadequate reserve levels, unpredictable claims trends and an impact on underwriting performance that had the potential to fuel an increase in coverage challenges.

Today, the insurance industry is better placed to deal with inflationary based losses due to changes in operational structure, investment and financial reporting requirements. These measures should assist insurers in identifying and responding to changes in loss trends. However, the current uncertainty surrounding the global markets does still have the potential to threaten underwriting profitability in the long term.

Most, if not all, sectors are feeling the ongoing impacts of the pandemic, together with supply chain disruption and the Russia-Ukraine conflict. Climate associated risks are also increasingly becoming front of mind for businesses. The addition of 40-year record highs in inflation simply brings another layer of uncertainty to an already unpredictable landscape, which may give rise to increased caution when applying underwriting criteria, potentially resulting in reduced capacity and fewer choices available to policyholders.

Forward thinking insurers will place a heightened emphasis on educating their customers and adopt an advisory role regarding risk-mitigation, as is already being seen in the broker community around climate (and other ESG-related) risks. They will seek out innovative, data-led solutions to assist in setting and maintaining accurate reserves, while meeting the demands of the customers of the future who will demand instant responses alongside the highest levels of customer experience in the post-pandemic environment.

Businesses rely on insurers to assist them in mitigating and managing their risk exposures—an area in which the industry has a proven track record. In return for such support, it is incumbent on policyholders to ensure that valuations are accurate and correctly calculated. That exercise becomes all the more challenging when excess claims inflation is creating uncertainty, putting policyholders at risk of potentially being under-insured across their portfolio of risks, perhaps particularly with regard to property, stock and contents, plant and equipment, and business interruption. Cyber liability can also give rise to under-insurance.

Under-insurance can leave the policyholder unable to claim for the full loss and make them susceptible to the ‘average rule’, reducing further the sums they may recover under their insurance.

To assist policyholders and to reduce underinsurance disputes, ideally insurers will work closely with their insureds to encourage them to:

  • Conduct regular reviews and update asset values—at each renewal at the very least—to close the gap between declared values and replacement values, thereby reducing the risk of underinsurance.
  • Explore risk mitigation strategies, such as setting aside emergency funds to deal with excess claims inflation.
  • Restructure supply chains to minimise disruptions, perhaps by using local suppliers.
  • Discuss the impact of specific undervaluation clauses on their business in the event of a claim.

To ensure adequate product pricing and realistic claims reserving, insurers may also be considering taking steps commonly seen in historical periods of a hard insurance market, including:

  • Increasing premiums.
  • Increasing the value of policy deductibles/excesses in line with the rate of inflation.
  • Increasing their scrutiny of claims values and appropriate policy limits of indemnity.
  • Increasing claims reserves, not only to reflect the rate of inflation, but also to factor in excess claims inflation, including social inflation.
  • Reintroducing specific clauses into policies to address the risk of undervaluation if asset values are not updated.

Without adequate allowance for the impact of claims inflation, insurers will potentially be exposed to inaccurate reserves and additional challenges when adjusting claims, including under-insurance, gaps in cover and the development of unexpected or unanticipated claims. As with many challenges, the position can be assisted greatly by strong relationships and channels of open communication between insurers, policyholders and their brokers to help navigate risks in volatile times.

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