While many insurance companies did not use inflation hypotheses in their reserving process until recently, the current inflation rates estimated by companies -of about 7%[1]– question habits. Some companies even add extra reserves to anticipate future “inflation-linked losses”. The need to integrate it in the technical provisions becomes a factor in the solvency of companies, so now the question becomes the “how”.
How to integrate the inflation into the reserving process?
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- The use of own data remains the most rigorous solution. Nevertheless, inflation changing from one type of claim to another, a precise granularity will be needed to properly study the inflation. That could be difficult to obtain: aggregated triangles among line of business will not be enough for instance. The insurers will have to study typical claims, the very definition of which is to be arbitrated inside the company.
- The market indexes still are the easiest solution because of their availability. The challenge is yet to ensure that these indices are appropriate for the company’s profile.
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The answers to these questions are company-related and depend on their data system and economical vision.
Once the inflation rates estimated, having the appropriate tool is key to secure and manage their integration inside the reserving process. With addactis® IBNRS®, we focus on a simple and user-friendly way to deal with those aspects, thanks to a step by step integration.
In addactis® IBNRS® the user can add as many inflation vectors as needed (based on CPI, wages, construction costs, spare parts costs…). For these vectors, it is possible to define if the inflation should be applied halfway through the period or at the end of the period, and if the defined rates are set yearly or by development period. Also, the user can add one or more future period if the future inflation rate needs to be specified by year.
Figure 3 – Inflation application to projected data
Figure 4 – Monitoring screen for comparison and decision purposes
Recently, the hypothesis that inflation was stable over time was commonly accepted (except for specific cases) because future inflation was de facto approximately equal to the past one. In such conditions, using the Chain Ladder method without an inflation vector was a common practice. But with the current geopolitical environment, the inflation has skyrocketed. Thus, even if past inflation is stable, it is no longer comparable to future inflation. Therefore, companies have to adjust their reserving process and can choose addactis® IBNRS® to do so.
[1] This figure comes from addactis market voice and depends on both business lines and geographical areas, with inflation rates of 7% to 10% in the industrial risk insurance; for motor damage, it typically ranges between 6% and 7%, because of an increase in the spare parts costs (including glass components, also used in the medical field, with high demand during the covid period); regarding bodily injuries on the French market, a very strong inflation was observed (around 15%) linked to the drop of interest rates (impacting annuities costs) and review of compensation calculations.
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