Inflation forecasts impact MTPL pricing models

Reinsurance has been a complex landscape to navigate in recent years. Geopolitical events, war, an increase in natural disasters and disrupted supply chains have all altered models and impacted profit margins – but for the European MTPL market, Covid-19 and inflation changes have been the main disrupters.

While the pandemic led to a drop in traffic volumes and claims frequency (in the EU, the average distance driven dropped by 30% with a 17% decrease of road traffic accidents between 2019-2020), the increase of empty roads and inconsistent speed limit enforcements resulted in more high-speed collisions and large claims.

Once restrictions were lifted in 2021, claim volumes increased but remained 20-30% lower than pre-pandemic levels. The Belgian Federal police reported further shifts in 2022 as weekend collisions rose by 157% in the first quarter of 2022 compared to the same period in 2021 – and France saw a 44% increase in road fatalities compared to the same six-month period in 2021.

Published towards the end of 2022, QBE Re’s European motor report presents key insights into how we understand these recent data patterns and the claims environment to determine pricing strategy in the MTPL market.

Importantly, the report also shows how current forecasts for the impact of inflation indicate that responses from reinsurers should be tailored to address unpredictable conditions, in which significant technical rate increases are expected at the next renewal.

Measures & Data

Much of the reinsurance pricing process looks at historical claims data in the context of the renewal year’s expected socio-economic landscape. While the observed number of claims is corrected with the frequency index and rescaled for the new exposure, the claims value must also be adjusted, specifically to reflect changes to inflation.

To that end, two measures are essential to the model: the wage inflation (economic) and superimposed inflation (social).

Using wage inflation to rescale prior year claims makes sense for cases where most of the compensation will be directly linked to the claimant’s loss of earnings (e.g., severe bodily injury) alongside the cost of their care.

However, this does not wholly represent the inflation of the average large claim. Superimposed inflation is formed from other relevant variables (e.g., technological progress, increasing medical knowledge, legalities) which work together to drive costs up.

On-levelling past losses to an appropriate current value therefore cannot be based on wage inflation alone, so we use an annual social inflation of +1.5% in addition. Using this hybrid inflation measure, historical claims data from across a period of years becomes comparable – and more importantly, helps us refine estimates for similar claims arising during the renewal year.

Inflation impact on reinsurance pricing

It is necessary to ensure our models are always updated and accurately represent the current economic framework. You’ll notice that our annual pricing process always accounts for one additional year of inflation to the prior year claims and correcting for potential errors in prior inflation forecasts.

(See below, for example, the OECD’s June 2022 wage inflation projections compared to the corresponding June 2021 forecasts.)

In the recent past, inflation has been mostly stable and low in Europe, resulting in subtle adjustments and only a small shift in the pricing models – but this is set to change.

Let’s run an example:

The graph shows that 2021 OECD forecasts for the wage inflation in 2022 were a lot lower than the corresponding forecasts published in 2022.

The original OECD forecast for French wage inflation in 2021 was 3.69%.

The latest forecast is 5.19%; that’s a 1.49 percentage point difference.

In 2022, the difference between last year’s forecast and the current one is 3.1 percentage points, while for 2023 we have a current forecast of 4.8%.

Therefore, whilst we might usually see ‘year on year’ inflation uplifts of between +1% and +3% in Europe, for France in 2022, we see a cumulated inflationary uplift of +9.57% over the 2021 result.

In Belgium, we would see an inflationary uplift of a little over +14%, pushing driving claims costs up significantly compared to estimates in 2021.

Excess-of-loss reinsurance layers

However, these inflationary uplifts do not directly translate to the increases we expect to see in the burning cost in excess-of-loss reinsurance layers. Due to the gearing effect (also known as leverage effect), the impact on excess-of-loss layers can actually be much greater.

As inflation levels are comparably high this year, reinsurance buyers might want to consider adapting with the stability or indexation clauses. Indexation clauses have been disregarded in periods with low and/or stable rates of inflation but may become more relevant and limit the transfer of inflationary curves to the excess layers.

Conclusions

This year, the challenge for the industry centres around balancing the needs of both reinsurers and (re)insureds in a fair and transparent way, as the market returns to a ‘new normal’ post-pandemic. Businesses will now be looking to navigate inflation rates alongside soaring supply costs, social inflation, and geopolitical instability – but there are opportunities available.

While the impact of the high inflation environment on reinsurance will be significant, our full report shows that rate changes could be mitigated by adapting the stability or indexation clause or changing the base date from 2023 to 2021. By increasing the deductible of the programme or increasing retention levels reinsurance buyers can maintain a similar level of volatility in their portfolios.

Downloads

• European motor report summary (PDF 82KB)
• European motor report (PDF 2.9MB)