How stagflation could impact the auto insurance industry

The insurance industry has a lot on its radar right now, but one blip that's growing louder on the dashboard is the prospect of stagflation: that worrisome economic state characterized by stubborn inflation, lackluster growth and rising unemployment. While stagflation is far from a sure thing, persistent inflation is causing consternation among insurers thinking ahead about premium pricing.

Although the U.S. economy has remained relatively healthy – despite higher consumer prices – the impact of stubborn inflation coupled with a stagnant economy would put extra pressure on carriers and consumers alike.

Stagflation’s negative impact

Stagflation has the capacity to significantly raise the costs of services, labor and materials. Meanwhile, carriers are concerned about higher claims payouts and their policyholders worry about costlier premiums.

Consider how, for example, inflated expenses for repairs, replacement parts and new vehicles can ramp up the severity of claims in the car insurance sector. At the same time, a stagnating economy can cause unemployment jumps, resulting in more uninsured motorists – amplifying the risks for insured drivers and increasing the cost of claims involving uninsured drivers. It's no surprise that Americans tend to postpone, decrease or cancel insurance coverage when economic conditions worsen and unemployment escalates. We have already seen increasing premiums put pressure on American motorists, with the Insurance Research Council reporting that 1 in 3 drivers were uninsured or underinsured in 2023.

Tariffs on vehicle parts, imported cars, metals and other items could also contribute to this predicament, raising costs for vehicle repairs and replacement parts – all at a time when rates are already up 19% from 2023 and 78% over the past decade.

Decreased consumer confidence and wider economic uncertainty can pressure policyholders to reevaluate their auto insurance coverage; they may prioritize liquidity by shopping for cheaper premiums, raising deductibles or reducing coverage levels. In a stagflation environment, these preferences – coupled with amplified cancellation and lapse risks – can disrupt premium income streams and compress profit margins for carriers already facing rising claims costs.

Carriers could feel the squeeze

Consider how inflationary pressures on vehicle replacement, repair and medical expenses can strain capital reserves and increase liabilities for auto insurers. If investment income underperforms over this time, insurers could encounter stress on capital reserves as claim expenses outpace both investment yields and premium growth.

The industry also faces growing operational costs in the face of stagflation. Pressured by steeper reinsurance rates, surging labor expenses and costlier technology expenditures, those companies deficient in operational efficiency or scale could flounder while attempting to remain competitive. Carriers will likely have to rethink their products, streamline distribution tactics and reevaluate underwriting practices to protect their margins. That could lead to a tighter market characterized by less capacity, more judicious underwriting and more stringent policy terms. Forward-thinking insurers already invested in tools such as artificial intelligence, automation and data analytics will likely fare much better.

In a lingering stagflationary environment, rating agencies and regulators are expected to increasingly scrutinize the risk exposure, pricing plans and financial health of insurers. These firms must prepare themselves for prolonged volatility in this scenario by thinking ahead and implementing effective risk management strategies. We could also see more mergers, acquisitions and overall industry consolidation as smaller and more vulnerable players struggle with liquidity while well-capitalized companies benefit from  economies of scale and diversified risk. Monoline players in the most impacted lines can expect to be the first targeted for acquisition.

Looking back and moving forward

The last time the U.S. experienced stagflation was in the 1970s, when a slower economy stifled growth prospects while inflationary pressure undermined underwriting margins. This time around, carriers may experience similar results as they grapple with retaining market share while pricing their products for what the market will bear. That's especially true at a time when consumers are more resistant to premium increases and regulators often move at a snail's pace to greenlight rate increases.

Stagflation isn't a certainty, but in today’s volatile economic environment, it’s not outside the realm of possibility. Insurers are in an increasingly healthy position in the core property/casualty markets, recovering from tumultuous years plagued by pandemic-fueled inflation. But stagflation has the potential to slow down a market that is currently primed to focus on growth.

To protect themselves and remain competitive, carriers should proceed proactively with best practices. That means taking steps such as reevaluating asset-liability approaches, fine-tuning pricing models, and putting dollars into digital and operational dexterity. Consumers, meanwhile, must stay nimble, shopping around for the best rates as different factors drive insurance premiums higher at a time when they may want to moderate their spending.

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David Seider is chief commercial officer at The Zebra. Contact him at [email protected].