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Understanding Inflationary Pressures and the Commercial Insurance Industry

By Alliant

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The U.S. Bureau of Labor Statistics (BLS) has reported a relatively stable inflation rate of 3.7% over the past year. While this may seem like encouraging news, especially after the near double-digit inflation numbers of 2022, it is essential to understand the causes of inflation, the impact on the commercial insurance market and how buyers can take proactive measures to minimize its effect and prepare for potential future uncertainties.

Driving Factors Behind Inflation
Widespread labor shortages and supply chain disruptions have been the predominant factors contributing to increased labor costs, production delays, higher material costs and supply shortages. These factors collectively contribute to higher prices for goods and services, causing inflation rates to rise.

Declining Labor Market
According to the BLS 2022-2032 projections, the labor force participation rate is expected to fall from 62.2% in 2022 to 60.4% in 2032. It was 63.3% prior to the COVID-19 pandemic and had been falling from a height of 67.4% in 2000. Projected employment growth is driven by labor force growth, which is constrained by population growth. As baby boomers are retiring, and the number of Gen Z workers entering the labor force is smaller than in previous generations, a declining workforce will continue to impact the economy.

47% of small businesses have job openings they can’t fill, according to a recent jobs report by the National Federation of Independent Business (NFIB). As these employers proactively adjust their compensation packages to attract new workers, larger businesses are not fairing much better as the labor force continues to contract.

Production Delays
Labor shortages can lead to delays in production as businesses struggle to find and maintain a reliable workforce. These delays can disrupt the supply of goods and services to the market. When supply is constrained, demand may outpace available products, causing prices to rise due to increased competition among buyers.

Supply Chain Disruptions
Disruptions in the supply chain, such as shortages of critical materials or components, can lead to higher costs for businesses. For example, if a manufacturer cannot obtain the necessary materials or parts for production, they may need to pay more for these items, which can contribute to increased costs and, consequently, inflation.

Systemic shocks are likely to arise from climate change, geoeconomic tensions and digital disruptions, according to Brookings Institute.

Demand Outpacing Supply
Supply chain disruptions can result in consumer demand exceeding the available supply of certain goods. This heightened demand can push prices up due to the scarcity of these products, resulting in inflation.

Commercial Insurance Market
Historically, in periods of high inflation, the commercial insurance markets faced challenges such as diminished reserves, erratic claims patterns and weakened underwriting performance. This resulted in significant losses for insurers and greater difficulties for policyholders in obtaining adequate coverage.

Currently, the commercial insurance industry is better positioned to incur losses to reserves compared to previous periods of extended inflation due to significant investment gains. Additionally, advances in financial reporting processes have given insurers added capabilities to identify and respond to loss trends; and with the emergence of AI, a new era in loss control and predictive analytics is emerging.

However, the uncertainty regarding the duration of ongoing inflation concerns may potentially threaten the insurance industry's long-term reserve levels and underwriting profitability. When examining lines of coverage, certain markets are vulnerable to the effects of increasing inflation.

Commercial Auto Market
In the auto insurance market, the expenses associated with vehicle repairs and consequent claims have experienced a notable upswing. This trend is attributable to labor shortages within the auto industry, resulting in increased labor costs, as well as disruptions in the supply chain for critical vehicle components, leading to elevated prices for these essential parts (and vehicles as a whole). Adding to the challenge is an increase in the frequency and severity of auto accidents in recent years, marked by a rise in collision rates and escalating medical treatment costs. The heightened costs associated with losses could erode underwriting profitability for auto insurance companies. In a market that has struggled to be profitable over the past decade, the increased loss costs may prompt auto insurers to raise premiums and impose constraints on coverage options for policyholders.

Commercial Property Market
In a high-inflation environment, the cost of materials and labor needed to repair or rebuild commercial properties following a loss can significantly increase. As a result, insurance companies may need to pay larger claims to cover the higher costs of property restoration, subsequently charging higher premiums to offset these increased risks. Additionally, labor shortages, especially in the construction industry, can increase construction workers' wages and salaries. Higher labor costs are a significant component of the overall expenses incurred in repairing or rebuilding damaged properties. This can contribute to increased claim costs for insurers, which can lead to higher premiums for commercial property insurance buyers. Supply chain disruptions can lead to delays in obtaining the necessary materials for property repairs. When materials are in short supply, their prices tend to rise. Insurers may need to cover these increased material costs when settling claims, contributing to higher premiums to cover added expenses.

Minimizing the Impact to Policyholders
Given the potential for increased premium costs, coverage restrictions and concerns about underinsurance due to ongoing inflation, policyholders should take proactive measures to mitigate these issues. These include:

  • Early Policy Renewal Discussions - Policyholders should discuss policy renewals early with their insurance professionals, especially in challenging market conditions. This provides an opportunity to stay well informed about the latest trends in inflation and prepare for potential policy changes, particularly in terms of pricing, before the renewal date.

  • Review Coverage Terms and Conditions - When meeting with insurance professionals, policyholders should request assistance in thoroughly reviewing their coverage terms and conditions, paying close attention to any exclusions. It is crucial to assess policy limits and sub-limits, if applicable, to determine whether they provide adequate coverage following a loss. If policyholders or insurance professionals identify underinsurance issues, consider updating the coverage and exploring the option of purchasing policy endorsements to ensure proper protection.

  • Reevaluate Property Valuations - In the context of commercial property insurance, policyholders should ensure their coverage aligns with accurate property valuations. With the rising costs of property repair and reconstruction, policyholders need to verify that the valuations specified in their policies are sufficient to cover the current expenses associated with recovery after a loss. Outdated valuations may leave policyholders underinsured if the cost of repairing or rebuilding their properties exceeds their existing coverage limits.

By taking proactive measures, commercial insurance buyers can enhance their preparedness and resilience during periods of high inflation, ensuring their insurance coverage remains effective and aligned with the evolving risk landscape.

How Can Alliant Help?
Alliant specialists work tirelessly to provide our clients a competitive advantage. We develop and implement market-leading strategies that help our clients plan and stay in front of emerging risk and potential business disruptions. Alliant brings the expertise, resources and experience to ensure insurance programs are comprehensive, forward-thinking and responsive in meeting complete risk management goals.

Alliant note and disclaimer: This document is designed to provide general information and guidance. Please note that prior to implementation your legal counsel should review all details or policy information. Alliant Insurance Services does not provide legal advice or legal opinions. If a legal opinion is needed, please seek the services of your own legal advisor or ask Alliant Insurance Services for a referral. This document is provided on an “as is” basis without any warranty of any kind. Alliant Insurance Services disclaims any liability for any loss or damage from reliance on this document.