As the global economy seemingly recovers, inflation may damage reinsurers’ future profitability on all lines of business, according to Stamford, Conn.-based Towers Perrin.

The time between when a reinsurance premium is paid and a claim is settled is highly susceptible to inflation. For example, Towers Perrin estimates that a 3% rate of  inflation would mean that claims that cost $1 million today would cost a reinsurer $1.113 million on average to settle at a later date. Projecting 5% inflation mean that same claim would end up costing the reinsurer $1.195 million to settle.

“When it comes to reinsurance contracts, where several years often elapse between rates being set and claims being paid out, inflation is a potential threat and can become a real problem," says Ross Howard, COO Europe for Towers Perrin’s reinsurance brokerage business. "Historically, inflation has caused larger future claims, and, in the current climate, the industry is not likely to be able to factor this into pricing.”

What's more the company says inflation impacts claims frequency as well as severity. Citing historical loss ratios for casualty lines, Towers Perrin notes the impact of inflation can be clearly seen with a two-year lag.  Indeed, an inflation high point of 3.4% in 2000 was followed by a loss ratio of 99% on casualty lines in 2002.  To the contrary, a 2002 low point of 1.6%  inflation corresponded with loss ratios falling to 73% in 2004.

While inflation is an industry-wide threat, the company says that casualty lines are likely to be hardest hit.

“Reinsurers are already looking hard at their casualty books, and the impact of inflation on profitability may lead to reinsurers reducing their casualty writings next year,” adds William Eyre, Jr., managing director of Towers Perrin’s reinsurance brokerage business.

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