Effects of Inflation on the Insurance Industry from Insurers to Insureds

If you’ve visited a grocery store lately, you’re well aware that the price of everything is going up. Way up. After about 14 years of consistently low inflation (which was barely worth mentioning even during the 2007-2008 financial crisis), 2021 saw a 7 percent inflation rate that still keeps climbing as of mid-2022. To put things in historical perspective, experts say inflation in May 2022 is the worst since 1981. 

The insurance industry is often described as “recession proof” but it’s definitely not inflation-proof. Without needing a degree in economics, we’ll try to cover the what, why, and how of inflation – specifically, how it impacts the insurance industry from several angles. Please note, we said without needing a degree in economics. This topic is infinitely more complex than we can cover here, so we hope to provide a good starting point for your future curiosity. 

What is inflation? 

According to the International Monetary Fund, inflation is the rate – that is, how quickly or how slowly – prices of goods and services rise over a period of time. Most of us are familiar with the idea that inflation is when prices go up. But, more accurately, inflation is a decrease in the value of money so that it requires more money to purchase the same thing. 

Economists classify inflation into three main categories: 

• Demand-pull inflation: When consumer demand is higher than supply, prices go up. 
• Cost-push inflation: When it costs more to produce goods, prices go up.
• Built-in inflation: When the cost of living rises and employee wages go up in response. 

On top of these three types of inflation, the insurance industry has its own unique brand of inflation known as “social inflation.” Social inflation is the name given to the rising cost of insurance claims, beyond what can be attributed to overall inflation across all sectors of the economy. While social inflation is unique to the insurance industry, that doesn’t mean the industry isn’t equally impacted by the three types of inflation that affect the entire world. We’ll leave a deeper dive into social inflation for another time and cover general types of inflation and their impact in the insurance industry here. 

Why is inflation happening now?

Economists disagree on the exact combination of causes for the current worldwide state of high inflation. But there are a few common threads: Supply chain disruptions, low interest rates, energy shortages, increased consumer demands, rising wages and job growth, government borrowing and spending, and current events like the pandemic and war in Ukraine, just to name a few! We’ll cover a few of these below. 

Inflation and COVID-19 

The coronavirus, everyone’s favorite scapegoat du jour, is in fact partially to blame for the current state of inflation. Worker shortages and factory shutdowns from COVID-19 lead to supply chain disruptions. Many industries couldn’t get their hands on enough raw material to keep up with consumer demand. 

We’ve all heard of the microchip shortage, which impacted everything from computers to cars. On top of that, the coronavirus led to worker shortages from short-term illness, long COVID, death, and a newfound distaste for the current state of work (aka The Great Resignation). These issues contributed to lower supply while, at the same time, demand for durable goods was ever-growing. 

To that point, thanks to COVID, consumer goods have had a couple of gangbuster years. People weren’t spending much money on travel, dining, or leisure, so they put that money toward the new home appliances, gadgets, toys, and other “stuff” they needed to keep themselves entertained and comfortable during lockdowns. 

Then, once vaccines started rolling out and people felt safer doing more normal activities, it was time to make up for lost time and start spending money on services like travel and hospitality. As a report from Deloitte says, “there’s a limit to the amount of gym equipment and furnishings one can buy.” The sudden surge in consumer spending on everything people couldn’t do during the pandemic, particularly after a couple of years of strong spending on durable goods, was a recipe for inflation. This is a classic example of demand-pull inflation, as mentioned above. 

Inflation and the war in Ukraine 

When Russia invaded Ukraine in February 2022, the U.S. and Europe soon responded by banning the import of Russian oil. This action was supposed to deter Russia from continuing its war but, as of July 2022, Russia is undeterred and the price of gasoline in the U.S. is at a record high. The high price of oil translates into more expensive products across the board. It costs more to run manufacturing equipment and it costs more to transport items from the point of manufacture to the point of sale. 

It’s not just gas though. The war in Ukraine has created uncertainty that’s shaken global markets. Sanctions that the U.S. and other countries imposed on Russia have contributed to the already-disrupted supply chains, as Russia’s retaliatory sanctions halted exports of Russian products and much-needed raw materials to the West. While world leaders try to penalize Russia for its invasion, they’re now cautious about imposing any additional sanctions that could further the already-high inflation rate. The impacts of the war in Ukraine are an example of cost-push inflation, as a variety of factors have combined to make the real cost of products higher to make and distribute. 

The tight labor market and inflation 

The talent shortage is real. Companies across the U.S. have been struggling to find and keep workers even before the pandemic, but even more so now that most industries have recovered and are trying to return to pre-pandemic levels of employment. According to the U.S. Chamber of Commerce, there are currently 11.4 million open jobs and only six million unemployed Americans seeking work. 

Americans have left the workforce for a variety of reasons over the past few years. They’ve also chosen not to return for an equally diverse set of reasons. Whatever the cause, the fact is that competition is tough for skilled, and even unskilled, workers. And that drives wages higher. 

According to the Atlanta Federal Reserve’s tracker, wages have been steadily on the rise since 2009, with an enormous spike starting in mid-2021. Before inflation began to surge, both “nominal” and “real” wages (not accounting for and accounting for inflation, respectively) were going up, especially for those workers on the lowest end of the earning spectrum. Illustrating the concept of built-in inflation, it’s possible that the 2021 spike in wages, likely prompted by the labor shortage, itself factored into the burst of inflation we’ve seen over the last year. 

Corporate-made inflation 

No, this isn’t a new official category of inflation that just came into existence yesterday. But no discussion of today’s inflation situation would be complete without touching on the fact that mega corporations are showing their largest profits in decades – sometimes ever! 

While CEOs talk about the squeeze of rising labor costs and more expensive materials and supplies, they also brag about their record-high dividends and profit margins. It’s no secret that some companies are using the inflation narrative to jack up prices and make up for some of their lost revenue during the height of the pandemic. 

According to the Economic Policy Institute (EPI), “the historically large profit margins” we’re seeing across industries from tech to oil and gas just don’t add up. Past data suggest that profit margins should shrink while the proportion of money going to labor costs should rise. In fact, we’ve seen the complete opposite of that (record-high profit margins and lower than average labor costs) since the COVID-19 economic recovery period started in mid-2020. Thus, the EPI concludes, corporate profits are contributing more than Wall Street would like to admit to the rising cost of everything these days. 

How do insurance markets respond to inflation? 

The most obvious way insurance responds to inflation is by the hardening of insurance markets. A hard insurance market means higher priced premiums combined with more stringent underwriting requirements and an overall lower appetite for insurers to take on risk. And that’s exactly what the insurance industry’s been doing for the last 18 quarters – long before the current state of high inflation. 

Just because the insurance market hardened before inflation began to rise doesn’t mean it won’t keep on the same trajectory. In fact, the effect of inflation on insurance is likely to be insurers continuing to raise rates, reduce their appetite for risks, and focus more on risk prevention. 

What are the negative effects of inflation on the insurance industry?

As the cost of literally everything rises, insurers face the risk of claims costing them more than they planned. Insurance is built on the premise that insurance companies will take in enough premium dollars and spread risks across enough policyholders that they’ll have no trouble paying out claims. This premise can be turned on its head when unexpectedly large (and frequent) losses occur. 

Even before inflation, catastrophic losses have been wreaking havoc on the insurance industry. Natural disasters are only becoming more frequent and severe, and the costs to replace things that these natural disasters destroy (homes and cars for example) have spiked 30 to 40 percent or more (respectively) in the last two years. 

This sudden increase in prices hasn’t given insurers time to reevaluate their underwriting to ensure they’re charging enough in premiums to cover their increased risk. Any insurance company without a crystal ball may not have priced this year’s premiums high enough to hedge their bets against frequent, large, and unusually expensive claims. Yes, the insurance market has been hardening for the last 18 quarters, but even with premiums increasing steadily over time, the recent surge of inflation can quickly undo those gains and leave insurance companies high and dry through a combination of more frequent, more severe losses and inflated repair costs. 

How can inflation benefit insurance companies and insurance agencies?

Insurance companies can raise premiums, which means insurance agencies will earn more in commissions for each policy they sell. While this may seem necessary to ensure solvency, and not like a benefit, the catch is that inflation probably won’t last forever. Meaning, insurance carriers will continue bringing in more money with those higher premiums, and insurance agencies will continue earning larger commissions, while the costs of claims will (hopefully) go down as inflation eases up. 

Once the war in Ukraine is over, once the supply chain is back to normal, once the labor market loosens, once microchips are plentiful and the cost of a car is back in line with historic norms, insurance carriers should be able to enjoy at least a bit of relief as they bring in premiums they set during times of record-high inflation. Of course, it’s worth noting that what goes up must come down. When inflation and consumer prices normalize, it won’t be too long before consumers refuse to pay inflated prices and begin to discount-shop for their insurance again. If the insurance market as a whole remains hard, consumers won’t have many options. But if insurance softens again in the future, carriers may be forced to negotiate discounts that eat away at larger profit margins. 

What does inflation mean for insurance consumers? 

In the short-term, consumers should expect their insurance premiums to go up. We’re all consumers and we all know the facts of life. Prices are rising across the board right now and we know our personal and business insurance policies will be next (if they haven’t gone up already). 

However, consumers shouldn’t necessarily sit back, relax, and assume their current policies are the best they can do. In times of steep inflation, insurance carriers that offer inflation protection riders may have an upper-hand – at least when it comes to the savvy and informed insurance consumers. 

Insurance inflation protection is a rider that many insurance carriers offer on a variety of policies including homeowners insurance, auto insurance, life insurance, and long-term care insurance. It may not always be called “inflation protection” but the rider will provide some incremental increase, or degree of padding, on top of the regular policy, to make sure the insured will be able to fully replace what they’ve lost. 

For example, if you bought your car for $20,000 but two years later it’s valued at $27,000 due to inflation and the shortage of cars for sale, the inflation protection on your auto policy may “guarantee” to replace your car at fair market value if it’s totaled, rather than capping your reimbursement at the purchase price. This is just one example, and many consumers find riders like this well worth the extra premium cost, especially when the world is unpredictable. 

Inflation protection for your insurance organization

While the cost of pretty much everything continues to rise for your business (including labor, real estate, your own insurance, and more), you might be looking for ways to control costs and protect your bottom line from out-of-control inflation. One way you can do this is by investing in a technology solution that automates and streamlines your operations. 

AgentSync customers have found savings of both time and money, along with the increased revenue that comes from getting producers onboarded and ready to sell as quickly as the same day they start. We’ve also seen carriers save money and ensure compliance by automating Just-in-Time appointments for a large producer force. 

While AgentSync isn’t an insurance policy against inflation, it’s definitely a way you can rein in ballooning costs and keep your team happy by providing the most modern and enjoyable compliance experience out there. 

See what AgentSync can do for your insurance business today.

About AgentSync

AgentSync powers rapid growth for insurance carriers, agencies, and MGAs by offering modern tools for producer management. With its customer-centric design, seamless APIs, and automation, AgentSync’s products reduce friction, increase efficiency, and maintain compliance, ultimately helping to improve the broker onboarding, contracting, licensing, and compliance processes. 

Founded in 2018 by Niranjan “Niji” Sabharwal and Jenn Knight, and headquartered in Denver, Colo., AgentSync has been recognized as one of Denver’s Best Places to Work, as a Forbes Magazine Cloud 100 Rising Star, an Insurtech Insights Future 50 winner, and is ranked 88 in Forbes – America’s 500 Best Startup Employers 2022.