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Download Deflation-1001101 - Insurance Information Institute
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Deflation and Its Effect on the P-C Industry Insurance Information Institute October 2010 Steven N. Weisbart, Ph.D., CLU, Senior Vice President & Chief Economist Insurance Information Institute ♦ 110 William Street ♦ New York, NY 10038 Office: 212.346.5540 ♦ Cell: (917) 494-5945 ♦ [email protected] ♦ www.iii.org Deflation Basics 2 Definition Deflation is A falling general price level Note: N t thi this iis diff differentt ffrom A fall in the rate of increase of the general price level; This is called disinflation A fall in the prices of some items or category of items For a prolonged period That is expected to continue indefinitely Sources: http://www-personal.umich.edu/~alandear/glossary/d.html; http://en.wikipedia.org/wiki/Deflation; I.I.I. 3 Primary Causes and Major Bouts of Deflation Deflation results from some or all of A surge in productivity, generally from technological i innovation ti A steep and prolonged drop in the money supply A steep p and p prolonged g recession Note: this is different from a fall in the rate of increase of the price level Major US Bouts of Deflation 1920-22 1930-33 Sources: http://www-personal.umich.edu/~alandear/glossary/d.html; http://en.wikipedia.org/wiki/Deflation; I.I.I. 4 Broad Impact of Deflation Deflation causes… Consumers to delay buying things They Th expectt to t buy b those th things thi later l t att lower l prices i A drop in the level of aggregate demand, from the delay in consumption A transfer of wealth From borrowers and holders of illiquid assets To savers/lenders and holders of liquid assets and currency A drop in the level of business investment Following the drop in aggregate demand Slack in capacity if the economy is in recession Increased likelihood of lower profits or losses as selling prices drop below costs Sources: http://en.wikipedia.org/wiki/Deflation; I.I.I. 5 What History Teaches Us About Deflation f and the P-C Industry y 6 1920-1950: Inflation, Deflation and the P-C Industry’s y Combined Ratio* Combined Ratio Combined Ratio Price Index Price Index 110 26 Declining CR Almost Completely a Result of Sharply Lower Loss/LAE Ratio 105 24 22 100 20 18 95 16 90 From 1930 to 1933 the Price Level Dropped pp 24% 14 1950 1949 1948 1947 1946 1945 1944 1943 1942 1941 1940 1939 1938 1937 1936 1935 1934 1933 1932 1931 1930 1929 1928 1927 1926 1925 1924 1923 1922 1921 12 1920 85 From Year-end 1929 Through 1932, the Industry’s Combined Ratio Rose from 96.3 t 104 to 104.9 9 as th the CPI D Dropped. d B Butt ffrom 1933 into i t the th 1950 1950s, the th Combined C bi d Ratio R ti Remained Below 100 Even as Prices Slowly Rose, Then Shot Up after WWII. *From 1920-1934, stock companies only Sources: Best’s Aggregates & Averages; http://www.rateinflation.com/consumer-price-index/usa-historical-cpi.php?form=usacpi 7 1920-1950: Inflation, Deflation and P-C Industry y Profitability* y ROAS Return on Average Surplus Price Index 15% Price Index 26 From 1930-32 ROAS was below 1 2% b 1.2%, but was 5.1% 1% iin 1933 and d 10% or higher in 1935-36 From 1930 to 1933 the Price Level Dropped 24% 24 10% 22 20 5% 18 16 1950 1949 1948 1947 1946 1945 1944 1943 1942 1941 1940 1939 1938 1937 1936 1935 1934 1933 1932 1931 1930 1929 1928 1927 1926 1925 1924 1923 1922 1921 1920 0% ‐5% 14 12 The Significant Deflation from 1930-32 Punished the Industry’s ROAS, But an Improving Economy (and Slight Inflation) Helped Achieve ROAS in Double Digits in 1935-36. *stock companies only Sources: Best’s Aggregates & Averages; I.I.I.; ; http://www.rateinflation.com/consumer-price-index/usa-historicalcpi.php?form=usacpi 8 Deflation’s Effects on the P-C Insurance Industry Lower Claim Severities Particularly for property claims, severity drops for many items that insurers pay for Rate contingency margins increase At least until rate construction reflects persistently declining claims se severity, erit margins will ill be higher than other otherwise ise d due e to high trend assumptions arising from use of historical data Reserve Releases? Reserves may develop beneficially to become “redundant” Lower Claim Frequency as Fewer Claims Reach Deductible, ete t o Levels e es Retention Less Use of Reinsurance Lower costs Î risks burn through their retentions less quickly reaching policy limits less quickly quickly, 9 Insurance Information Institute Online: www iii org www.iii.org Thank you for your time and your attention!
