The Bank of England this week told insurers under its supervision it expects them to factor in social inflation and escalating claims costs when pricing and reserving this year, in what is further bad news for commercial insurance managers as they seek to secure adequate capacity at affordable prices.
In a letter to insurance company CEOs in the London and wider UK insurance market setting out priorities for 2023, Charlotte Gerken, executive director of insurance supervision at the Prudential Regulation Authority (PRA), and Shoib Khan, director of insurance supervision, also said that the Bank will be closely watching developments in cyber and climate change risk as they seek to ensure the sector remains resilient in the face of mounting pressures.
The bank stressed its view that exposure management for non-natural catastrophe risk, including cyber, remains “immature”. It intends to work with the insurance industry this year to improve matters and better manage risk in this area.
The leading non-life insurers and reinsurers have been using every opportunity of late to point to rising social inflation and claims costs as they prepare customers for another tough year. The underlying message is that they will have to stand firm on pricing in order to bolster reserves in the face of rising costs.
The Bank of England clearly agrees with this line. “For general insurers, 2023 will likely see a continuation of pressures on claims inflation, as we mentioned in our October 2022 insights from our recent thematic review across the general insurance sector. Our review identified a number of observations relating to how claims inflation differs by line of business and geography,” Gerken and Kahn state in the letter.
“There is uncertainty in the severity and duration of claims inflation expected, and there may also be a lag before it materialises. Consequently, this gives rise to additional uncertainty around future claim settlement costs. Therefore, we expect general insurers to factor general and social inflation risk drivers into their underlying pricing, reserving, business planning, and capital modelling,” they add.
Non-nat cat risk generally and cyber in particular is another area of concern for the bank.
“Our work in recent years indicates that exposure management capability in relation to non-natural catastrophe risk (including cyber) remains immature. Insurers, particularly those operating in the London market, will see this risk continue to grow and evolve as portfolio composition shifts towards casualty classes,” states the letter.
“Firms that are not able to size potential losses from non-natural catastrophe risks (including emerging risks) or establish commensurate risk management measures are exposed to the risk of outsized losses and may underestimate capital requirements. Over 2023 we intend to work with the industry to enhance practice and better manage risk in this area,” continue Gerken and Khan.
The other big worry for the bank is financial risks arising from climate change.
“While a number of more immediate risks have heightened for the sector over the last 12 months, climate change continues to present an increasing, material risk to firms and the financial system. In 2022 we started actively supervising firms against our supervisory expectations. Our recently published letter to CEOs highlighted the progress made by firms since the publication of SS3/19 – Enhancing banks’ and insurers’ approaches to managing the financial risks from climate change – and provided feedback on the Bank of England’s Climate Biennial Exploratory Scenario (CBES) exercise,” explains the letter.
“Firms’ ability to meet the PRA’s supervisory expectations will be assessed on an ongoing basis through supervisory engagement, firm-specific deep dives, and thematic work. We expect firms to be able to demonstrate how they are responding to our expectations and to set out the steps they are taking to address barriers to progress. We will keep a range of supervisory tools under review where we consider that firms are not adequately addressing risks or are making insufficient progress,” it adds.