Fitch flags emerging inflation risk

Several European insurance sector outlooks could move to ‘deteriorating’ if high inflation persists and interest rate rises become more significant, according to Fitch Ratings.

Fitch has analysed the potential impact of an economic scenario with mid- to high-single-digit inflation throughout 2023 and 10-year interest rates increasing by a combined 300bp in 2022 and 2023.

The rating agency said that non-life insurance sectors would typically be worst affected, particularly those with a high proportion of long-tail business where higher-than-anticipated claims inflation could lead to reserve deficiencies. 

It added that high inflation could also lead to margin pressure for short-tail business in markets where strong competition or societal pressure limit insurers’ ability to increase prices. Non-life insurance companies that already have weak reserving levels or lack pricing power are most at risk of negative rating action due to the adverse impact of claims inflation on margins and capital:

“The European non-life sectors most under pressure would be in Italy, the UK and France. Italy has a high proportion of long-tail motor third-party liability insurance, the UK market is particularly competitive, and French non-life insurers  already face government demands to give rebates to customers struggling with inflation.”

“Life sectors with large books of traditional life policies backed by assets of shorter duration than liabilities would be net beneficiaries from rising interest rates. The French and German life sectors are the most notable examples, and we would expect the positive effects on capital and medium-term earnings to offset the negative short-term effects of increased investment volatility, higher lapse rates and lower new business volumes. However, financial market volatility and lower asset values would be detrimental to margins in life sectors with a high proportion of unit-linked business.”