Emerging headwinds
On a recent visit to the London market, the key topic of concern was claims inflation and its impact on books of business. Everyone understands that world events such as Covid-19 and the Ukraine war have caused supply chain issues that have led to sharp price increases in everything from groceries and timber to oil and gas. Inflation is running at annual rates above 5% but it feels worse. Interest rates are rising. Understanding inflation and its impact on insurance is critical as it has a major impact in planning, pricing, capital setting and reserving. This blog will attempt to address our experience of rising costs post Covid-19, current claims inflation and what we can expect in the short term.
Inflation measures v. insurance construction costs
The rate of inflation may give a good guide to how much prices are rising across a ‘basket of goods’, but does it provide a measure for claims inflation? The reality is not exactly – certain lines of insurance business may be more exposed to particular price increases that may be weighted down in a basket of goods. For instance, property and motor are currently exposed to significant price increases on materials due to supply chain interruptions – some would say at a rate galloping faster than the inflation numbers. We will consider this further below.
This is one of the first occasions we can recall where the interest in claims inflation is focused more on the property classes. Generally, we have been asked to analyse inflation in liability claims. As these tend to be focused in economic loss, general damages and legal fees, coupled with legislative and court trends, they aren’t as strongly impacted by these latest supply chain disruptions. However, across all classes of insurance we also need to understand whether social inflation – considered roughly to mean the increase in claims costs over and above general economic inflation – is also impacting claims costs.
A recent Swiss Re Institute Sigma report looking at the global economic environment says property and casualty (P&C) insurers face a difficult, transitional year as claims inflation kicks in while the earnings benefit of higher interest rates lies further ahead.
They predicted in the short term that property and motor will likely be hit hardest, as price rises in construction and car parts outstrip those in the wider economy. In the longer term they expected lines of business with longer tails to be more exposed to sustained elevated inflationary headwinds. Swiss Re expects the Ukraine conflict, as well as renewed lockdowns in China, to cause further disruptions to the auto supply chains, prolonging bottlenecks for new cars and spare parts and creating upward pressure on car part prices in the short-to-medium term.
Property – background
Low Interest rates and rising housing demand have stimulated the construction industry leading to elevated demand for materials and labour. Recent shortages in supply have been both demand and supply chain related. As interest rates rise we expect some cooling in the construction sector which is expected to take some pressure off demand and hence supply. As it stands, we have seen an annual increase in material costs of timber, board and joinery prices of over 20% (Source: ABS*, further analysis available on request), while metal products have seen an increase of 16.2% over the last 12 months. The demand for labour has also increased professional fees by around 5% in the last year. Most construction projects are 10- 15% more expensive currently than 12 months ago. For insurers the added complication is natural disasters like flood have caused high demand for construction services in concentrated areas of high volume claims that don’t have enough trades available, exacerbating the cost issues.
The graph below of USA lumber prices is a pretty stark picture of the rollercoaster ride since 2020. While prices are significantly below their spike, they remain almost 50% above pre Covid-19 prices. Expect that to fall further as demand is bitten by higher interest rates, providing some hope the worst of price volatility is behind us. However, the building sector in Australia remains strong so there should be a floor at a minimum level likely to be above pre Covid-19 prices. We have seen in USA and Australia interest rate rises that may yet dampen demand.
As we will consider in analysis of our claims experience, the steep rise in construction costs may lag in its impact on claims as larger claims tend to have contracts set at the outset and may not be finalised as yet (given the average duration of +$250K claims is over a year).
Casualty – Liability – background
There have been some factors that have contributed to an increase in claim costs in liability classes, even if the increases are more modest than on the property side.
There have been some disruptions during Covid-19 that have created delays and cost issues:
In some jurisdictions we have seen mandated court closures and delays in the court system due to unavailability of personnel because of COVID-19 infections or close-contact isolation. Our panel solicitors have advised that some courts prioritised conferencing equipment for criminal matters, and some civil trials were delayed and we are still working through the backlogs.
Investigation reports were taking much longer through Covid-19 (average 2 – 3 months, rather than 30 days), because of site visit restrictions, and having to interview people individually, rather than getting people together. Your average claim is hence taking longer to resolve, our data suggests at least 4 weeks longer.
Plaintiff costs have risen – in part due to delays
We have seen more aggressive worker to worker recoveries – particularly at the lower end where they may previously not have been pursued. For instance, in Victoria the VWA are now pursuing claims for $30k – $40k recoveries.
We also saw a number of general injury claims being resurrected just prior to being time barred. This is a function of third Party solicitors turning to historical files to drive revenue. Due to a downturn in new actions due to Covid-19 they are reviving old claims from Third Parties who had previously not pushed their claim.
As previously mentioned, the key elements of claims inflation in bodily injury claims are economic loss, general damage awards and legal costs. Economic loss is expected to increase in line with inflation and the rise in award rates of around 5%. (The latest minimum wage increase in Australia was 5.2%) There has been some evidence of increased litigation rates (in NSW we saw 2021 as a five year high in Supreme Court personal injury filings – up 20% on 2020) and increased general damage awards during the pandemic and legal costs have also risen, in part due to increased rates and in part due to social and logistic factors related to the pandemic. It would seem reasonable that in the short term claims inflation in the short term in liability classes will at minimum match the general rise in inflation – around 5% currently.
Social inflation
Of concern is the possible overlay of social inflation. Higher litigation awards, increased claimant expectations, the rise of litigation funding and speculative contingency actions may all play a role. While litigation funding has been mainly directed at shareholder class actions that impact financial lines (and D and O in particular), the threat of class actions related to bodily injury remains a significant exposure. Certainly we have also seen supply chain shocks and Covid-19 disruption that impact all classes, sometimes beyond claims inflation. Nearly all classes suffered from delays in investigation reports and court and government processes, and we all know delay is the enemy of effective claim resolution. At this stage we would suggest higher general damage awards are driving cost increases in severity claims which may be seen as social inflation. Our numbers suggest this isn’t a serious problem as yet as cost increases seem contained to close to the general inflation numbers.
Our experience
We have been comparing average claim costs finalised pre and post Covid-19, over a period of 2 years prior and 2 years post February 2020. Across a sample size of over 25,000 claims, across property and liability, the trends we see are:
Property
While average claims costs are up around 15% annually over the last 2 years, this is driven largely by claims above 100k, which have had an increase in number and proportion. For the two years prior to Covid-19 around 97 per cent of our claims were below 100k. This has shifted to 96% post Covid-19. The number of claims above $100k and less than $1m increased by 20% and the average value of that claim saw an increase of around 10% by year. To break this down further, the most significant change in activity was above 250k where claims activity doubled post v pre Covid-19, including the number of claims over $1m. They remain an insignificant overall number (at something like .002%) but nevertheless have an outsized impact on the overall average costs.
Duration of claims over this period has been interesting – claims under 100k have been extended by around 20%, or 3 weeks, but claims above 100k have actually been shorter by about 10%.
This is across a sample size of around 14,000 claims.
Overall in property we have seen cost increases driven by an increase in activity and costs of claims above $250k, with claims in the $500K- $1m band the biggest movers (doubled in number, up 14% in costs over 2 years). These larger claims could see us pegging claims inflation at up to 7% in property, but the numbers at the lower level suggests a dampening to more like 5%. Meaning rate increases of 4-6% should cover historical claims inflation.
It is possible – as we are talking finalised claims – that some of the construction costs increases are yet to filter through, as many of these damage claims may have been repaired on set price contracts prior to the supply chain issues. Larger claims over 500k take from a year to 3-4 years to resolve. So it remains possible that claims inflation will manifest more in claims resolved over the coming year or two.
Liability
- Average claims costs up 4.5% by value annually (under 100k)
- Average duration extended by 9% or 4 weeks (under 100k)
Our insurance liability book data also posed quandaries for us. Overall, there has been a significant increase in the average cost of claims, but this is driven by an increase in numbers of larger claims. Claims under 100K were up 4.5% in value, and claims in the $100K- $1m range increased 3% annually over last 2 years. An increase in claims over $1m of 200% drove the overall increase in average costs. Part of this is composition of our book, that includes a significant construction component that is maturing, and part must be due to an increase in severity claims in line with increases in litigation rates and court filings post Covid-19.
Across our corporate book which is largely high frequency low value liability claims the changes are not as pronounced, with minimal change in average claim costs after Covid-19, and no discernible change in duration. These claims are largely not litigated.
This seems to confirm the thoughts that the bulk of the claim cost increases in liability are driven by litigation and higher value claims.
Professional liability is also showing slower cost growth relative to property and liability. We expect this to change if we see a recession in the short to medium term. This tends to be a driver of Professional Indemnity claims.
Is there a number?
What has been the rate of increase for claims costs over the last 2 years?
Based on our data and research we think property claims have advanced 5 – 7% annually over the last 2 years. However current increases in costs of construction and materials may see this increase more in the short term, as Swiss Re has warned.
Liability claims have shown more moderate growth at 2- 4% but could be expected to grow at around 5% or marginally higher over the year ahead.
I suppose the question becomes whether premium rate increases in these lines of business outstripped claim inflation? Or are they just catching up? Noting if claim inflation is say 6% and your loss ratio is 66% you would need around 4% premium increase to cover the added cost of claims.
For underwriters, the road forks ahead. Whilst we are seeing interest rate increases that will boost investment returns in the medium term, the current rate of inflation will continue to bite if they have not been supported by rate increases.
