Key takeaways
- While economic inflation in Asia has been less severe compared to Europe and the US — and is currently showing signs of a slowdown — it's forecast to track at a higher baseline level over the short to medium term.
- Inflation has had complex effects on various aspects of the Asian non-life market, including underwriting, reinsurance, investment and capital movement.
- Accelerating inflation and rising interest rates have recently boosted investment earnings and equity returns, and insurers that have adopted proactive measures have mitigated negative effects and maintain stability.
Economies in Asia Pacific (APAC) experienced their highest rate of inflation in over a decade in 2022. The pace of rising prices has slowed somewhat in 2023, but insurers in the region are still feeling the effects across their businesses — and are developing strategies to mitigate them in response.
Different lines of insurance business experience inflation differently, so while decreases in the headline inflation rate experienced across the economy might be taken for a good thing, insurers still need to carefully manage their exposure to rising prices in certain specific areas — such as wage growth or rising legal costs.
The economic landscape in APAC
Most of the developed world has experienced a jump in inflation in the years following the COVID-19 pandemic, but it's been less pronounced in Asia than in Europe and the US, for a number of reasons. Asian governments tended to deploy less fiscal stimulus during the pandemic, central banks have been more cautious, and labor supply has remained resilient. Economies in the region also have a closer proximity to manufacturing hubs.
Nonetheless, inflation in the region has risen over the past two years, reaching a peak in the second half of 2022. Recent figures suggest that core inflation has generally stabilized, notably in emerging markets such as Indonesia, Malaysia, the Philippines and Thailand. However, headline rates in some countries remain above government targets, indicating that inflation is unlikely to return to pre-pandemic levels (circa 2%) in the near future.
A nuanced picture: How rising inflation impacts on Asian insurers
While headline inflation — usually measured in terms of the Consumer Price Index (CPI) — appears to be tracking down, it may not be the best metric for every line of insurance business. The appropriate index depends on underlying cost drivers and the dominant peril. Whilst CPI is broadly indicative of household prices, services and transport, there are also wage, medical and social inflation to consider, with varying impacts on Property and Liability, Medical and Health Liability, and Casualty claims, respectively. A notable dynamic is that inflation of global construction material costs is falling faster than that of construction labor costs. By extension, where wage inflation continues to be high, elevated costs for claims where wages are a core component are likely.
Notwithstanding the notable differences by line of business and tail — where longer-tailed lines should theoretically result in more significant pricing adjustments due to the relative inflation impact — inflation indices are nuanced across APAC, and cultural and societal dynamics also need to be well understood when formulating mitigation strategies. For example, jury awards and legal cost inflation are less problematic in Asia than in the US.
Furthermore, price regulations — tariffs — may reduce the ability to adjust prices for specific lines or markets. There's also keen competition between carriers in the APAC region, particularly in retail markets where policyholders regularly switch providers to secure better prices or even opt to cancel or reduce cover due to affordability challenges. Again, this competition hinders their ability to adjust pricing in line with inflation. This hindrance is particularly relevant for the APAC region, where economic dynamics and susceptibility to inflation vary, potentially intensifying insurance supply and demand dynamics.
The commercial lines sector has benefited from favorable adjustments in rates, which have been both early and robust. This benefit is exemplified by higher rate increments in lines such as General Liability (GL) and Professional Liability (PL) over several years. This makes for a sharp contrast with short-tail retail lines such as motor and household, where pricing has been largely reactionary. It should also be noted that various mitigants such as indexation and total-sum insured (TSI) coverage adjustments have reduced the need for explicit pricing adjustments. More generally, since most portfolios in Asia are dominated by short-tail classes, the underlying drivers of inflation are more muted. This situation has made the topic less pertinent in renewal discussions.
A notable area of caution is Property insurance, which is vulnerable to Nat Cat damage. Loss costs are impacted by the costs of materials and construction, which are linked to input prices such as the Producer Price Index (PPI). This impact is more pronounced when considering notable Cat-related losses such as those in Australia and the Philippines, which have resulted in significant demand. However, it's challenging to isolate the impact of inflation from demand surge and the frequency of Nat Cat events.
Investment dynamics and capital
Asian central banks have raised interest rates to combat inflationary pressure, although some have maintained a longer-term accommodative monetary policy, e.g., China, Japan and Vietnam. Rising interest rates have helped boost investment income and somewhat counterbalance the underwriting results impacted by inflation. Some Asian central banks have slowed increases and are expected to cut rates when consumer inflation moves to a target level, although this move may take a while.
As the US Federal Reserve hiked its policy rate aggressively, Asian currencies depreciated across the board against the US dollar between the end of 2021 and the third quarter of 2022. This depreciation had been an issue for companies with international business, where large currency movements resulted in capital volatility due to the mismatch. Loss reserve positions are dependent on the degree to which future rates are in ‘excess’ of historical rates, the length of the claims patterns (i.e., the reserve duration) and the persistence of excess inflation into the future. As a result, policy reserves vary by line of business, with longer-tail classes being more sensitive to excess inflation. Gallagher Re analysis suggests that five percentage points of ‘excess’ inflation can lead to a ~60% change in ultimate cost for 10-year liabilities, compared to a ~30% change for 5-year liabilities.
Reported capital was impacted negatively by market movements in 2022 from unrealized investment losses. However, markets have rebounded in 2023, boosting earnings for many APAC insurers because of higher reinvestment yields. This boost has been reflected in both reported and regulatory capital models that are based on market-consistent balance sheets. But in the APAC region, where solvency frameworks are mostly risk-based capital (RBC) or Solvency I regimes, the application may be inconsistent.
For example, in some markets in Asia, insurers can choose whether to apply explicit inflation discounting when reserving, which may lead to asset/liability mismatches, if assets are valued on a market-consistent basis and liabilities are not. The adoption of IFRS 17 and the enhancement of RBC frameworks in several APAC markets, such as South Korea, Malaysia and Singapore, are expected to alleviate these impacts.
Reinsurance challenges
Against this backdrop, the global (re)insurance market is grappling with cautious capacity and capital availability.
The non-Life insurance markets in the APAC region have been impacted by escalating reinsurance costs and stricter coverage terms, particularly in areas impacted by meaningful Nat Cat losses, such as Australia, the Philippines and Malaysia. Whilst reinsurance rates have experienced risk-adjusted increases in both loss-free and loss-impacted portfolios, levels are more muted compared to the US and Europe, with inflation discussions also being less of a headline influence. Nevertheless, cedants have confronted rising reinsurance rates, diminished proportional capacity, lower reinsurance commissions, increased retentions and more restrictive terms during renewals. Additionally, expense ratios have trended higher due to increased acquisition costs and reduced commission income from reinsurance.
Strategies to navigate the challenges of inflation
Insurers with strong risk management and nimble strategies have weathered inflationary pressures more effectively. Comprehensive risk management includes stress testing claims against inflation scenarios; assessing economic impacts; regular monitoring and pricing and reserve adjustments; and adjusting reinsurance coverage to current needs.
Also, the contract design for original policies needs to respond to inflationary pressure; with some insurers adopting innovative underwriting practices and refined policy responses, such as percentage deductibles and updated total insured values (TIVs) to allow for more precise pricing.
To manage reinsurance costs, increased retention levels and inflation uncertainty, prudent insurers have adopted several proactive measures, including structured reinsurance and multi-year arrangements that capture the benefits of time diversification. Retrospective solutions like loss portfolio transfers and adverse development covers, particularly on long-tail classes, are also effective in managing inflation uncertainty or boosting solvency levels.
Exploring both traditional and alternative risk transfer solutions can mitigate the issue of limited appetite in some markets, particularly related to frequency activity. Certain types of financial and insurance products directly address the impacts of inflation risk e.g., indexed property policies, offering options to adjust coverage limits based on inflation indices, while inflation-linked bonds provide returns linked to inflation rates.
Globally, Cat bonds and parametric (re)insurance have gained traction, not necessarily due to their explicit coverage of inflation, but rather in response to capacity withdrawal and shifts in reinsurer appetite. Parametric (re)insurance in particular, which pays out based on predefined event triggers (e.g., magnitude of an earthquake), removes inflation uncertainty from capacity providers.
Given the expectations for ‘stickier’ inflation dynamics, cedants should consider tailored reinsurance solutions, both traditional and non-traditional, to help proactively manage inflation risks. Partnering with firms that have extensive market coverage, data-driven insights and customized strategies can assist with this.
Gallagher Re’s structured reinsurance capabilities
Structured reinsurance is designed to meet insurers’ need for capital efficiency, reduce earnings volatility and improve their profitability.
With inflation generating higher uncertainty, intuitively insurers would be looking to at least maintain coverage. However, this strategy can be challenging, given the higher attachment points in today’s hardening market, with pressure on retentions leading to prohibitive pricing or capacity withdrawal from the traditional reinsurance space. One potential solution is a structured multi-year excess of loss program, targeted at working layers.
Such transactions have two key features: the first is the multi-year duration, which leverages time diversification to reduce volatility for more efficient risk transfer; and the second is a profit commission (PC) feature.
With such a transaction, the client is often able to maintain the desired attachment point, benefit from stability in pricing and capacity over a multi-year horizon, and potentially be rewarded for good experience via the PC (versus simply accepting hardening traditional terms).
Gallagher Re highlights:
- Leader in Asia: We are Asia’s leading structured reinsurance broker.
- Simplicity in approach: We improve simplicity, drive competitive pricing and create flexibility for our clients.
- Key deals: We have more than 60 placements in the region, with the majority since 2014.
- Strong relationships: We have a strong transactional relationship with market leaders.
- Established framework: We have an established framework for broking and evaluation.
