Claims inflation — solvency warning issued to insurers
Insurers will need to exercise caution before releasing reserves for investment purposes to ensure compliance with Solvency 11.
Claims inflation — the extra cost paid by Insurers to settle a claim — has been the most pressing issue faced by general insurers over the last 18 months. It has been driven by a combination of factors, to include increasing wage and raw material costs and the spiralling cost of care.
In the context of the Bank of England’s recent warning to insurers on the potential impact of claims inflation, we consider the relevance of claims inflation to insurers and what steps can be taken to mitigate its impact.
The headline figures
Last measured in May 2023, the UK’s rate of inflation stands at 8.7% — down from its peak of 11.1% in October 2022. Core inflation, which strips out the price of energy, food, alcohol and tobacco is 7.1%. Wage inflation presently sits at an average of 7.6% in the private sector and 5.6% in the public sector.
Inflationary pressures have affected sectors differently — acute labour shortages for example in the care industry have been caused by a combination of Brexit, mandatory vaccinations and an increasing core of an economically inactive working population.
In this sector, the average cost of care has risen by 11% according to the UK Care Guide — measured between February 2022 and February 2023, though there are regional variations with higher costs faced by those living in the South compared to the North. Average hourly rates commanded by care providers are now commonly £18 to £20 per hour, with a range in the bracket £15 to £30 per hour. Our own data suggests a rise in care costs in the order of 15% over the 12 months to December 2022.
The Bank of England predicts that the headline rate of inflation will fall to 5% by the end of 2023, though it is worth noting that previous predictions have fallen short of what has actually eventuated.
The relevance of inflation to insurers
The portfolio of risks underwritten by insurers varies, which means that they will be impacted by inflation in different ways and by often different factors.
By way of example, the cost of motor vehicle repairs has increased by 40% over the past five years (2018 to 2022), according to an analysis of warranty claims carried out by Intelligent Motoring (as reported by Fleet News) principally driven by rising raw material and labour costs.
Property insurers have been met by rising raw material and labour costs in addition to labour shortages, which in turn has led to longer reinstatement periods which adds pressure to ancillary costs (Insurance Post, 15 February 2023).
Liability insurers have also borne the brunt of inflationary pressures in the form of:
- Awards for general damages uplifted for inflation.
- Wage rises impacting the cost of settling a claim for loss of earnings.
- Claims for the most seriously injured will inevitably involve a substantial claim for care and often a lifetime package calculated on a multiplier and multiplicand basis. Given the rising labour costs referred to earlier, the impact upon catastrophic personal injury claims in quantifying damages is truly significant.
Claims inflation matters to Insurers — not only allowing them to accurately and competitively price the risks they seek to underwrite, but in being able to set accurate financial reserves for existing and future claims liabilities. The regulatory requirements applicable to insurers and re-insurers are set out in Solvency II – which covers the financial capital resources they need to hold, governance, accountability and the duty of disclosure.
Inflationary pressures are not simply confined to damages recovered by claimants — in the liability field they are felt in level of costs recovered by third party solicitors. Guideline Hourly Rates — the hourly amount charged by third party solicitors when conducting a case - were recently subject to formal review and revision for the first time since 2010, through the work of the Civil Justice Council. Its recommendations and those adopted by the Civil Procedure Rule Committee include the range of uplifts to be applied to the 2010 levels and for hourly rates to be uplifted in the future by SSPI (a measure of services-based inflation), on 1 January each year.
Cases pursued under the Fixed Recoverable Costs regime (FRC) are also not immune from inflationary pressures. The expansion of the existing regime, planned for 1 October 2023, will now incorporate most personal injury claims having a value of £100,000 or less. The Ministry of Justice have confirmed that the scheme figures set out in the work of the Civil Justice Council in 2019 will also be uplifted to take inflation into account.
Damages recovered by seriously injured personal injury claimants are also likely to rise when the Lord Chancellor announces the new Personal Injury Discount Rate (PIDR). The PIDR is a percentage figure used to calculate how much defendants have to pay in damages to claimants in serious personal injury cases when damages are paid in a lump sum.
The panel of experts who will advise the Lord Chancellor is set to convene for the first time in July with all market commentators believing that a further reduction in the discount rate will be “a certainty” — further increasing the pressure on indemnity spend.
The Bank of England warning
In a letter to the chief actuaries of insurers, Mr Nylesh Shah, (Bank of England Actuary), urges insurers to “monitor the hit to reserves from ongoing claims inflation and act accordingly”, warning that:
“…there is a risk that persistently elevated claims inflation might result in a material debtor of solvency coverage for some firms unless they take appropriate mitigating actions”.
Mr Shah’s letter goes on to state that “the average increases applied may not be sufficient to support future claims in relation to total economic inflation forecast to pass through”.
The Bank of England warning may be interpreted as acceptance that inflation has become at least in part “baked in” to the economy over the last 12 to 18 months and is likely to persist to a greater or lesser extent for the rest of this year and into 2024. Insurers will need to exercise caution before releasing reserves for investment purposes to ensure compliance with Solvency 11.
As Mr Shah recommends, they should ensure that there is “a firmwide consensus on how it should develop and establish how much claims inflation is already reflected in claim settlement costs and established reserves”.
Our view is that insurers should revisit individual claims reserves in all but the most minor of personal injury claims — working through how each individual head of damages is likely to be impacted by past and future inflation.
In relation to the class of claims most impacted by claims inflation — catastrophic personal injury — our own Predict (2.0), an augmented intelligence, predictive analytics tool used in high value personal injury claims, seeks to offset challenges around claims lifecycle and the containment of indemnity spend as well as reserving accuracy. Predict (2.0) takes into account historic claims inflation and allows the user to model future inflation to an anticipated settlement date.
Although the financial ramifications of claims inflation to insurers are and will be significant, there are conversely encouraging signs on the number of claims notified to insurers. Levels of motor injury, employers’ and public liability claims are significantly below levels seen prior to the pandemic in 2019, meaning that overall indemnity spend of the whole portfolio is likely to be broadly similar for insurers underwriting risks in those markets — with the reduction in frequency offset by a higher spend per case.
Regardless of whether the headline inflation rate does actually fall in line with the Bank of England’s predictions, the issue of claims inflation will remain the primary concern of insurers for both the immediate and foreseeable future.