Prices are currently rising at their fastest rate in 40 years, with the current rate of inflation standing at 9.4%. Greatly exacerbated in 2022 by the conflict in Ukraine, the cost-of-living crisis is affecting everything from petrol to groceries – and it’s showing no sign of letting up yet.

This upward pressure on prices is by no means just a 2022 phenomenon, however. While Russia’s invasion of Ukraine has indeed been a catalyst for skyrocketing fuel and food prices, it was preceded by 18 months of severe global shortages of key items such as building materials, car parts and semiconductors – largely driven by the COVID-19 pandemic – which had already been pushing up prices to unprecedented levels.

In the current economic climate, it is not just consumers who are feeling the strain. Businesses across all industries and sectors are feeling inflation’s bite as rising business costs eat into profits. And this also goes for the insurance industry.

Rising claims costs

The main way in which inflation is currently impacting the insurance industry is through rising claims costs, which are eating into profits and causing a loss of confidence across the sector. This is particularly evident in the motor sector at the moment, with data from Allianz suggesting that labour costs, repairs and parts have increased by 6.5%, 6.6% and 9.1%, respectively.

In July, motor insurer Sabre issued a profit warning and cut its dividend, stating that the cost of claims year on year was up 12% due to higher prices for car parts, labour and replacement vehicles. The ensuing fallout wiped almost 40% off the firm’s share price. In the same month, Direct Line also issued a profit warning, leading its own share price to plunge by 13%.

This continuing upward trend on claims costs is also affecting the property insurance sector, with AXA citing supply chain disruption, high costs and labour shortages as primary reasons behind claims inflation. These factors are being compounded by increasing claims for property damage as a result of climate change-related weather events such as storms, floods and fires.

 Businesses risk underinsurance

As we know, underinsurance happens when an individual or business is not insured for the full amount they need in the event of a claim. Inflation can unintentionally lead to underinsurance when a policyholder maintains their current level of cover despite the increased cost of paying out on a claim.

Unfortunately, we are also seeing many people purposefully reducing their level of cover or cancel policies altogether as a way of saving money as the cost of living rises. In fact, recent research from the Insurance Post and Consumer Intelligence found that one in 10 people surveyed had cancelled an insurance product within the last six months. It’s therefore unsurprising that, according to figures from BIBA, underinsurance is now affecting between 40% and 45% of claims.

How are insurers mitigating inflation risks?

In Goldman Sachs’ latest annual global insurance survey, rising inflation was considered by respondents to be the top risk to investment portfolios. But what can insurers do to reduce the risk of inflation to their profits and portfolios?

A publication from the Swiss Re Institute made the following four suggestions:

• Re-pricing insurance risks to reflect higher claims costs
• Diversifying and steering new business towards products with lower risk profiles
• Linking premiums and covers to inflation to stablise and avoid onerous re-pricing exercises
• Reinsurance can help mitigate some of the financial risk posed by inflation.

In the short-term, though, it looks as though high inflation is here to stay. It will therefore be ever more vital to communicate regularly with policyholders to help them understand the cover their policy provides and to warn against the risks of underinsurance.