The UK finds itself in a perilous economic position at the moment. The rapid rise in energy prices, which has seen the cost of gas and electricity increase by more than 400% and 300% respectively in little more than a year, is forecasted to continue upwards. This has in turn driven increases in the rate of inflation not seen since the 1980s.

Having reached a 40-year high of 10.1% in July, the UK Consumer Price Inflation rate declined slightly to 9.9% in August, however, current forecasts from the Bank of England suggest it could rise to as much as 13% in the coming months as the colder weather intensifies the impact of the energy price rises.

The impact of this inflationary spiral, which the BOE has already predicted will prompt a recession that will last for longer than a calendar year, will hit hardest on UK consumers and industry, with heavily inflated fuel costs and other key areas of expenditure such as food and input costs also rising at near record-highs.

However, while expected to be less extreme, the impact on the UK non-life insurance sector is also set to bring a new set of challenges.

Analysing the likely impact on the sector under a scenario where inflation remained at mid-to-high single digit figures through to the end of 2023 at the same time as interest rates rise by a combined 300 basis points, FitchRatings has warned that the sector would be significantly exposed.

Based on its assessment, the ratings agency has assigned a deteriorating outlook to both the operating margins and reserves held by non-life insurers with the performance in terms of volumes and investments forecasted to remain neutral at best.

Rise in costs of claims prompt profit warnings

Such unfavorable fortunes as a result of these new inflationary pressures have already started to materialise in the motor and car insurance sector, where increases in costs for both replacement parts and labour costs have been exacerbated by delays and disruptions within the automotive supply chain.

With its costs of claims already running at an estimated 10% higher than last year, the country’s second largest car insurer, Direct Line, was forced to respond by issuing a profit warning in July and cancelling a planned £50m share buyback scheme as a direct response to the new cost pressures it is facing.

This came just days after its competitor Sabre Insurance Group saw its value fall by nearly 40% after it revealed a 12% increase in claims costs and reported that its combined operating ratio, an important metric of profitability within the sector, would be in the mid-90s for the full year, a sharp decline on the previous year.

Similar pressures have also impacted on the UK property insurance sector, where even steeper cost increases on materials are believed to be at risk of creating an “insurance gap” among policyholders. Over the past year, the cost of cement, imported wood, and structural steel, have risen by 15%, 24%, and 46% respectively.

“Rapid inflation in building costs risks creating an insurance gap,” said Chance Gillian, head of global property delegated authorities, at Chaucer, a Lloyd’s of London brokerage. “Policyholders need to review their coverage to ensure that they will not be left underinsured should their homes and business premises suffer damage.”

Insurers look to refocus on ‘essential products’

And so, with insurers coming under increasing pressures and policyholders increasingly squeezed by the ongoing cost of living crisis, how might the sector respond to minimise the risk of any insurance gap opening up?

One recent development that has served to make things even more complex, is the fact that many insurers have been barred from offering discounted policies in order to attract new customers so that that those customers who remain loyal are not unfairly penalised.

In the past, this practice would see companies offer an introductory rate for the first year of a policy, in order to attract new customers away from their existing provider, with the price reverting to the standard rate in subsequent years.

Speaking to the ICAEW, Willem Loots, a senior director within the insurance team at FitchRatings, explained that this means providers are now only able to change pricing at the point of renewal. “Insurers are able to increase premium rates on policy anniversaries.”

But he added that this would provide limited relief in the short term. “In practice, such increases tend to lag higher claims costs, thereby causing near term margin pressure.”

Faced with this reality of higher claims costs at the same time as offering discounted rates has been barred, companies within the sector are increasingly looking to offer products and policies that provide more basic levels of coverage in return for a lower cost premium.

In response to the cost-of-living crisis that its chief executive, Amanda Blanc, referred to as “the worst in decades” in its latest results, the FTSE 100 insurer Aviva stated that it will focus its efforts on launching more affordable products.

Combatting higher costs can avoid insurance gap

“What we have definitely seen over the last few months is customers looking to buy more value-based products,” said Blanc. “The essential product as opposed to the products that have got more bells and whistles.”

This is a strategy that Admiral, the largest car insurance provider in the UK, is also employing, having recently confirmed that it will launch new essential products to contend with higher prices and increased pressures on consumers.

Speaking to the ICAEW, Elisha Walia, chief of staff at the global insurer Aon, explained that the industry will need to keep a strong focus on the impact of inflation. “We need to monitor inflation closely and recognise the additional pressure that this is putting on budgets. An implication of the high inflationary environment is that there is an increased risk of underinsurance for both personal and commercial insurance”

However, Walia stressed that amid such pressures, it was also important that the industry continue to promote the importance of having sufficient coverage, so that insurance did not start to be seen as “a nice to have”.

In order to maintain sufficient levels of coverage while trying to keep the costs of claims down amid the current inflationary spiral, one approach open to the industry is to increase their activities around risk mitigation, where advice and support to policyholders is provided to reduce the need for claims in the first place.

This has already proven effective within lines of business such as cyber insurance, where providers routinely provide proactive support to reduce the risk of attacks, and is expected to become more common in other areas.

Furthermore, insurance providers, particularly those in the home and motor sectors, can also seek to mitigate the impact of inflation by securing discounts on the services and supplies they purchase either through buying in bulk or securing multi-year deals.

This is an approach that both Aviva, which owns and operates its own car repair network called Solus Accident Repair Centres, and commercial insurer Hubb have stated offer significant potential to alleviate the pressures of the current environment.