Aon | Professional Services Practice
Lessons Learned: Impact of Inflation on the Professional Indemnity Risk Environment
Release Date: June 2024In 2022 and 2023, the potential impact of economic and claims inflation was a worry for insurers, reinsurers, and professional service firms. Although headline economic inflation has declined from its peaks, it is useful to recap how actuaries, insureds, and underwriters reacted to the elevated inflationary environment over the last few professional indemnity (PI) renewal cycles.
Economic Inflation vs. Inflation
in Professional Indemnity Claims Costs
During the 2022 and 2023 PI renewal cycles, there were significant increases in economic inflation.
Underwriters and actuaries faced the question: to what extent would PI claim costs also inflate?
There is a possibility of claims inflation following economic inflation in most lines of general insurance, but it impacts different segments to varying extents and at differing timescales. For example, the inflationary impact has been more evident in property and construction, whereas in professional indemnity, a long tail class of business, it takes longer for the consequences of claims cost inflation to become apparent.
Inflation can also differentially impact the components of insurance claims costs where the impact of economic inflation is arguably more pronounced on defense costs. Defense costs typically comprise 30-40% of professional indemnity claims costs based on internal Aon analyses of historical claims from accounting firms, law firms, and consulting firms.
From the standpoint of professional service firm captives, captive management have taken a prudent and measured approach in considering the impact of inflation on the pricing of their professional indemnity policies. The objective has been to maintain rate stability within captive pricing, rather than make knee-jerk reactions.
Beyond economic inflation, both commercial and captive insurers have also had to consider the impact social inflation, the support given to suits by litigation funding, and so-called “nuclear” verdicts.
Considerations for Insureds
In the elevated economic inflationary environment of the last few years, risk managers of professional service firms have needed to review the possibility of increased premiums and retentions, assess overall limits purchased, and review and monitor changes in contractual obligations:
Insurance Rate Environment In the professional indemnity commercial market, underwriters have consistently been concerned about increasing defense costs, particularly for complex claims matters. This, combined with underwriting challenges, such as the general increase in high quantum claims, has created rate pressures, particularly in excess layers.
Limit Adequacy Potentially increasing claims costs may erode aggregate professional service firms’ professional indemnity limits at a faster pace than originally projected. It is important for risk managers to review the adequacy of their firm’s total limits in the current and expected future environment. Regularly conducting limit adequacy studies using benchmarking and other data-driven metrics around industry claim data is always recommended.
Contractual Obligations Increased diligence should be exercised around customer and client contracts and any changes in limits of professional indemnity being requested by professional service firm clients. There has been a general uptick in contractually required limits and some of this may be due to concerns around inflation.
Contact
The Professional Services Practice at Aon values your feedback. To discuss any of the topics raised in this article, please contact Henry Lim .
Henry Lim
Managing Director
Montreal
View Articles by Henry Lim
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