Despite increases in reserves, insurers may not have enough to pay out due to inflation hitting profitability and solvency, according to the UK prudential regulator. 

In October, the Prudential Regulation Authority told firms about the effect of inflation on general insurance claims, but in a follow-up letter on Friday to chief actuaries of general insurers and Lloyd’s managing agents, the watchdog said it noted the average reserve increase in a sample of 16 firms “may not be sufficient to support future claims in relation to the total economic inflation forecast to pass through the economy”. 

Nylesh Shah, the PRA’s chief actuary for general insurance, added firms widely acknowledged that there would be “a lagging effect” as inflation materialises, which may ultimately lead to higher claim settlement costs.   

In addition, on some longer-tailed lines, “it is a plausible outcome that claims inflation on some lines of business may lag economic inflation”. 

Another risk Shah outlined was that firms might be releasing reserves while uncertainty remains due to inappropriate claims inflation assumptions. He was also concerned that inflation could yet be observed in some business classes and that firms  “overstate their profitability”. 

Another issue he raised was a “significant gearing effect” in terms of the financial position of a firm where future claims inflation assumptions are optimistic. 

He said: “This gearing impact - on technical provisions, own funds, capital requirements, and profit - could result in a deterioration in solvency ratios if there is a need to react to claims inflation once it appears in the data.” 

On the upside, Shah said companies that have a better monitoring of the impact of the changing economic environment are likely to respond faster and more appropriately to emerging claims inflation trends, especially where the monitoring results are communicated and discussed across all functions. 

For instance, he said some firms appeared to have a more company-wide approach to claims inflation monitoring by creating an ‘Inflation Committee’ or a cross-disciplinary team with participants from various business functions to monitor trends. 

Other firms had developed a ‘house view of inflation’, Shah noted, which might allow them to better monitor claims inflation than those who rely solely on a standard actuarial reserving process for monitoring. 

“Having a firm-wide consensus as to how much claims inflation is expected to develop, in conjunction with a good understanding of how much claims inflation is already reflected in claim settlement costs and established case reserves, should support reserving teams to understand how much needs to be reserved to support expectations for further claims inflation development,” he said. 

Shah encouraged all firms to review the PRA’s findings and consider how each of the points outlined in the letter may impact their firm during the mid-year reserving and capital assessment processes and beyond. 

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