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The economic climate's impact on insurance providers’ balance sheets

Economic climate impacts insurers' balance sheets, requiring accurate valuation and risk mitigation for liabilities and assets. Read more in our latest blog.

The current economic climate is having a profound effect on insurance companies’ balance sheet valuations. Spiralling inflation and interest rates are affecting their future estimations of both liabilities and assets. 

Incorrect valuation of these liabilities and assets can have significant implications for an insurance provider. This could be through regulatory fines, an overall impact to the company’s solvency, or loss of investor confidence. It is therefore critical these providers retain an accurate balance sheet when valuing both assets and liabilities.

Insurance providers should assess whether the changing environment represents a one-off valuation shift or a trend expected to continue impacting the size and duration of their future cash flows. 

Liability valuation methods and asset investment strategies are under increased scrutiny by external auditors and regulators. Review and adaptation of these − in response to dynamic economic shifts − is more important than ever. 

Understanding future liabilities: Claims risk management

Holding sufficient reserves to pay insurance claims is often a large part of an insurance provider’s balance sheet liabilities. In order to maintain an accurate assessment of best estimate claims reserves, insurance providers need to consider the following as a result of the ongoing environment:

  • The impact of excess levels of goods inflation.
  • Labour cost increases.
  • Applicable discount rates when calculating present value.
  • Exchange rate movements.
  • Changes to consumer behaviour, such as social inflation.

These factors affect claims frequency and severity, as well as cash flow duration. Appropriate insights should be incorporated into reserving methods to limit the risk of undervaluing liabilities.

Effects on claims frequency

  • Cost of living and bottom-line pressures are expected to increase the propensity to claim.
  • Growing demand for cheaper goods to alleviate cost pressures will see an increase in theft and resale of many consumer goods. Subsequently, policies offering theft cover would expect to see rising claim numbers.
  • Current economic conditions are expected to directly impact crime policies and the prevalence of fraudulent claims.
  • Supply chain disruptions have significantly impacted business interruption claim numbers.

Effects on claims severity

  • The rising cost of goods and labour have amplified the cost of repairs – particularly within insurers’ motor and property insurance portfolios. 
  • In many instances, there is a widening gap between declared values to insurers and the actual cost of replacement.
  • Supply chain issues are expected to affect business interruption, construction, and delayed start up exposures, due to the delay in projects being started and completed and the increasing complexity of these cases. 
  • Rising defence costs, loss adjuster fees, and administration costs are impacting overall loss costs across a range of business classes.

Effects on cash flow duration

  • The financial landscape is likely to see claimants eager for quicker settlements to ensure earlier pay outs. 
  • Conversely, lump sum premium payments may become less appealing, with policyholders preferring to pay in instalments. This would result in earlier cash outflows and later cash inflows.

Maintaining a suitable investment strategy

The economic environment is expected to have a substantial impact on insurance providers’ profitability outlook – and consequently – premium pricing and investment strategy. 

For insurance providers pursuing an investment strategy primarily focussed on asset-liability matching, the changes to liability cash flows may affect current assets suitability. If outflows occur sooner and inflows later, it may be desirable to shorten investment interest rate duration to compensate and better match the interest rate curve.

Matching claims (less premiums) with investments may prove difficult. However, it takes on far greater importance when interest rates are higher and experiencing increased volatility, as they currently are. If not appropriately managed, interest rate changes could significantly impact the income statement – plus reduce capital.

However, if high interest rates persist, then investment income is likely to increasingly contribute to insurers’ profits. This will provide opportunities to harvest the “time value” of premiums received before claims are paid.

Addressing future liabilities and valuations risk

Insurance providers concerned with how current economic headwinds are impacting their balance sheet should review current processes and ensure valuations and strategies accommodate the ongoing volatility. 

Liability valuations should focus on the incorporation of suitable inflationary uplifts − potentially with more granular inflationary assumptions across a portfolio. While high interest rates can offer benefits to an insurance provider’s income statement, it remains prudent to validate asset investment and liability matching strategies to limit any adverse impacts of interest rate changes.

Meet the authors

Sheena Shah

Sheena Shah

Senior Actuary, Marsh Advisory

  • United Kingdom

William Gibbons

William Gibbons

Senior Investment Consultant, Mercer

  • United Kingdom

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