Trends to Watch: Social and Economic Inflation is Creating Volatility
The global economy in 2022 faced significant challenges, stemming in part from strength in demand in the face of ongoing supply chain disruptions, as well as the Russia-Ukraine conflict, both of which served to drive up prices substantially, especially for energy. While in Q4, signs of an easing – such as lower energy and commodity prices – emerged, and inflationary pressures started to abate, the World Bank warned that risks of new supply disruptions were high and noted that elevated core inflation may persist. This could cause central banks to respond by raising interest rates more than currently expected, worsening the global slowdown. The World Bank expects global growth to slow to 1.7 percent, down from the 3 percent growth expectation put forth in June 2022. If growth slows to that level, it would mark the third-weakest pace of global growth in nearly 30 years, with only the 2009 and 2020 downturns being worse.
Global inflation and economic slowdown have introduced new sources of volatility – not only to individual consumers but also to companies’ operations and risk management approaches. For example, during inflationary times, property and business interruption values may increase materially and staying on top of valuations takes on greater importance. Outdated valuations may leave businesses underinsured if the cost of repairing or rebuilding their properties exceed their existing coverage limits. Inflation has also impacted risk leaders’ views on risk itself. Aon’s Global Risk Management Survey ranks inflation-related risks such as Business Interruption (#2), Commodity Price Risk/Scarcity of Materials (#4) and Supply Chain/Distribution Failure (#8) among their top 10 risks over the next three years.
For insurers, inflation has driven up loss costs, and impacted pricing, although it is too early to know what impact higher inflation will have on longer-tail lines as claim factors, such as medical and litigation costs, take time to unfold. As costs rise, insurers may need to rely more on operational efficiency and investment earnings to help minimize any shortfall between premium revenue and claims payouts.
Aon can help. Alternative placement structures and other solutions can help businesses rethink access to capital and have greater control over risk outcomes. Many risk managers will choose to retain more risk, but it is important to be strategic and thoughtful in these decisions so that the agreed risk assumption is an informed decision for the organization and its key stakeholders.
The Impact of Inflation on Claims Trends
While social inflation remains predominantly, but not solely, a North America phenomenon, economic inflation is truly a global issue. Both will continue to drive loss costs to higher levels.
Social inflation, often also referred to as nuclear verdicts, is a shared frustration for our clients and our insurers. As an industry we will continue to discuss this topic but we will remain in a position of spectator in many regards. It is the legal system that underpins this topic. Friction between clients and insurers, which we will seek to mitigate, will likely relate to settlement values of underlying cases and to the selection of law firms to represent the interests of insureds and insurers. Economic inflation brings into question the validity of policy limits and values which, in turn, casts a light on how claims can be assessed and adjusted. All Aon clients are advised to ensure policy limits are adequate at the time of renewal. In layered or quota share programs, economic inflation is likely to trigger the involvement of higher layer insurer participants in certain claims, potentially adding to the adjustment complexity.
Aon’s perspective is that both forms of inflation will add to loss costs, with social inflation being of greatest impact for losses in scope within North America, but with economic inflation being of greater overall impact for our industry on a global basis.