Triple-I fields many questions from consumers and the media about exactly how inflation affects insurance premiums. As we explain in a new Issues Brief, the relationship between inflation and interest rates is in a way straightforward – and yet the outcome is not necessarily what one might expect.
As material and labor costs rise, so do the costs of repairing and replacing damaged homes and vehicles. If premiums did not reflect these increased costs, insurance companies would quickly use up the funds they set aside—”policyholder surplus”—to ensure they could afford to keep their promises to pay all claims. If losses and expenses exceed revenues by too much for too long, they risk insolvency.
But insurance companies do more than pay claims: They employ people (labor costs) and run businesses (supplies and energy costs); and if they are to continue in business they must earn a reasonable profit.
So as inflation and replacement costs rise, one can reasonably expect a proportional increase in auto and home insurance premiums. However, as the charts below show, prices remained relatively flat during 2021’s sharply higher costs that coincided with the height of the covid-19 pandemic.
In addition to not raising rates commensurate with rising costs, personal auto insurers — expecting reduced losses because fewer drivers were on the road during the lockdown — returned about $14 billion to policyholders through cash refunds and account credits. Although loss ratios dipped briefly and sharply in 2020, they have since climbed steadily to exceed pre-pandemic levels.
With drivers fully on the road again, this losing trend is expected to continue.
It is important to remember that the reductions in CPI and replacement costs listed above do not represent cost reductions but rather reduced growth rates. These and other forces—such as adverse trends in accident deaths and population shifts to disaster-prone regions—will continue to put upward pressure on premium rates.
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