How property and casualty insurers can prepare now for risks that fall out from financial crisis

Written by KPMG Perspectives

Sunday, 20 December 2009 18:04

Conclusion Pricing discipline NOW more than ever is the time to exercise pricing discipline. In pricing at a line of business, individual risk or coverage level, management should consider the risks—including inflation—to which the insurer will be exposed. For example, the risk premium for a long-tailed line such as workers’ compensation may need to be higher given the increased uncertainty around how the losses will eventually play out. However, expanding writings in a short-tailed line may be a very attractive prospect for an insurer to help mitigate the risk arising from long-tailed lines. Such factors should be considered in current pricing activities. Management should be asking: 1. Has the company developed pricing strategies that reflect elevated inflation risk? 2. Does operational management understand the financial impacts of risks they are underwriting in the light of a potentially inflationary environment? 3. Does operational management have the tools needed to evaluate the pricing risk and pricing impacts of inflationary scenarios? Hedging inflation risk ASSUMING that inflation may be coming, approaches to counteract its effects will be valuable. While understanding there is no perfect hedge, management should consider a wide variety of hedging approaches. These include: 1. Examining the investment strategy in light of the liability cash flows and how they may change in a more inflationary environment; 2. Adapting underwriting strategies to protect net liabilities in the event of inflation increa-ses, such as holding lower net limits, or indexing reinsurance retentions and limits; 3. Utilizing inflation-sensitive exposure base on policies written whenever possible; 4. Tailoring policy conditions, giving the insurer the ability to respond to inflation as it appears. Examples of this might include commutation clauses in reinsurance assumed contracts that expose the company to longer-term inflation risk, or limiting or eliminating guaranteed replacement cost coverage on property policies; 5. Matching the duration and expected cash flows of assets backing reserves with the duration and expected cash flows of liabilities; and 6. As Warren Buffett points out, the very best hedge against inflation is to maintain sound earning ability. He mentions personal skills, as well as owning quality companies. In the (property and casualty) P&C insurer context, keeping the company financially sound even in a challenging environment may be the very best hedge against the difficulties to come. P&C insurers are in a somewhat unique position regarding the financial crisis, in that for many, the government’s cure may bring about lasting implications that are at least as challenging as the financial crisis itself. While the inflationary risk may be painful, if it does come to pass, it need not be fatal if companies recognize the coming risk and take action. Companies with strong enterprise risk -management programs in place are better prepared to deal with inflationary risk now. There is no single solution, but instead, well-prepared companies will put in place a wide program of risk mitigation and hedging now to avoid the possibility of even more painful impacts in the future. (This article is an excerpt from a thought leadership document entitled “Skating to Where the Puck Will Be,” 2009, by KPMG Llp. The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act upon such information without appropriate professional advice after a thorough examination of the particular situation. The views and opinions expressed herein are those of the authors and interviewees and do not necessarily represent the views and opinions of KPMG International or KPMG member firms. For comments or inquiries, please e-mail Roberto G. Manabat at rgmanabat@kpmg.comThis e-mail address is being protected from spambots. You need JavaScript enabled to view it .)