The Impact of Elevated Inflation on US Insurance Companies

1. Investment Research Services REPORT The Impact of Elevated Inflation on US Insurance Companies

2. The Impact of Elevated Inflation on US Insurance Companies The Impact of Elevated Inflation on US Insurance Companies The US inflation is on a rising trend post the COVID-19 pandemic, driven by commodity shock and supply disruption, and was at a 40-year high of 8.6% in May 2022. The elevated inflation remains a cause of concern for the insurance companies, especially for the property and casualty (P&C) insurers, which experience high claims expenses when inflation rises. In the P&C category, the auto insurance companies are severely impacted due to rising repair as well as vehicle parts/equipment costs. Fig. 1: US CPI (all urban consumers) breaking multi-year records 10% 8% 6% 4% 2% 0% Jan-20 Mar-20 May-20 Jul-20 Sep-20 Nov-20 Jan-21 Mar-21 May-21 Jul-21 Sep-21 Nov-21 Jan-22 Mar-22 May-22 Source: US DOL 2

3. The Impact of Elevated Inflation on US Insurance Companies Impact of Inflation on P&C Business Lines Non-life (P&C) insurance Direct written premium proportion % Business lines and sensitivity to inflation Auto insurance accounts for the largest pie of P&C business and is severely impacted by elevated inflation. The claim expense of auto insurance arises due to the physical damage of vehicles (driven by commodity prices) and bodily injuries (impacted by the medical care cost inflation) Auto Insurance 41.6% Commercial Property Insurance Homeowners' Insurance General Liability Insurance Workers' Compensation Insurance Other P&C Insurance Commercial property insurance is adversely affected by construction materials, repair, and labor inflation 17.8% Homeowners' insurance is impacted by an increase in the cost of construction materials, repair, and labor General liability provides coverage for personal injuries as well as property damage/loss 16.2% 16.0% Workers' compensation is minimally impacted by inflation as insurance benefits are associated with the employee's earnings 7.2% Others include fidelity, surety, and other P&C business lines that are less affected by inflation 1.2% Source: US DOL Life Insurance – Inflation has a limited effect on life insurance claims, which are primarily driven by assumptions related to mortality & morbidity rates, life expectancy, interest rate, and equity market performance 3

4. The Impact of Elevated Inflation on US Insurance Companies Rising Inflation Deteriorates the Performance of Auto Insurance Companies Reflecting improved loss ratio (a percentage of total claims expenses to the premium earned) during the pandemic, auto insurance companies reported strong profitability in 2020. The frequency of claims declined significantly due to social distancing and shelter-in-place restrictions that were established to stop or slacken the spread of the pandemic. However, as the states began to lift restrictions post 1Q21 and vehicle miles travelled (VMT) started to return to near pre-pandemic levels, insurance companies observed a significant increase in the severity and frequency of claims, resulting in a higher loss ratio and lower operating margins. Fig. 2: Rising inflation led to the decline in operating income Fig. 3: Loss ratio of PGR and ALL is deteriorating post 1Q21 100% 8 6 75% 4 50% 2 0 25% 2020 2018 2019 2021 2017 4Q20 3Q20 2Q20 4Q19 3Q19 4Q21 1Q20 2Q19 3Q21 2Q21 1Q22 1Q19 1Q21 All-Pre- Tax Operating Income PGR Auto Underlying Loss Ratio PGR-Pre-Tax Operation Income All Auto Underlying Loss Ratio Source: ALL and PGR filings, SGA Research Source: ALL and PGR filings, SGA Research Factors impacting the loss ratio of auto insurance companies The insurance loss ratio is affected mainly by the severity of claims, the frequency of claims, and the change in premium rates. • driven by the number of claims reported at a particular time and can be impacted by the economic activity of a country. Frequency of losses – The frequency of claims is • amount per claim, which increases with the rise in input costs such as inflation in parts and repair costs, labor costs, and medical costs. This includes physical damage as well as personal bodily injuries severity. Severity of losses – The severity of losses is the • impact of the rising loss cost trend due to an increase in the frequency and severity of losses. Pricing - Companies take price action to offset the High severity of losses driven by elevated inflation The severity of losses has been the driving force behind the deteriorating auto insurance companies’ margins. In the recent quarters, the severity has increased significantly on the back of rising used car prices, growing repair costs and labor costs, expanded medical inflation, and higher attorney representation rates (known as social inflation). The rising value of used cars and trucks leads to higher physical damage severity when there is a total loss of the vehicle. 4

5. The Impact of Elevated Inflation on US Insurance Companies Fig. 4: Used cars and trucks CPI moving upward driven by supply disruption (auto plants shutdown and shortage of semiconductor chips) 220 180 140 Jan-20 Mar-20 May-20 Jul-20 Sep-20 Nov-20 Jan-21 Mar-21 May-21 Jul-21 Sep-21 Nov-21 Jan-22 Mar-22 Source: US DOL, SGA Research Increasing replacement costs and rising labor costs also contribute to physical damage severity. Motor vehicle parts and equipment prices in the US are growing at double digits, adding pressure on the loss cost trends. Motor vehicle maintenance and repair prices are also following the suit of used car vehicle prices. Allstate (ALL), one of the prominent auto insurers in the US, experienced a 19.6% increase in physical damage severity in 2021 as compared to pre-pandemic levels. Fig. 5: Rising CPI of US motor vehicle parts and equipment, y/y Fig. 6: US motor vehicle maintenance & repair CPI (y/y) follow suit 20% 7% 6% 16% 5% 12% 4% 8% 3% 4% 2% 0% 1% -4% 0% Jan-20 Jan-22 Apr-20 Oct-20 Apr-22 Jan-19 Jan-21 Apr-19 Oct-19 Jul-20 Apr-21 Oct-21 Jul-19 Jul-21 Jan-20 Jan-22 Apr-20 Oct-20 Apr-22 Jan-19 Jan-21 Apr-19 Oct-19 Jul-20 Apr-21 Oct-21 Jul-19 Jul-21 Source: US DOL, SGA Research Source: US DOL, SGA Research Casualty severity claims also saw an uptick and led to further deterioration of the loss cost trends. Casualty severity is driven by severe injuries and rising medical care inflation. The personal and bodily injuries claims increased for both The Progressive Corporation (PGR) and ALL in the second half of 2021 and 1Q22. 5

6. The Impact of Elevated Inflation on US Insurance Companies Fig. 7: Medial care CPI upward trend continued since Sept 2021 400 6% 5% 300 3% 200 2% 100 0 0% Mar-20 May-19 Sep-20 Jan-20 May-22 Mar-22 May-20 Nov-20 May-21 Jan-22 Mar-19 Nov-19 Sep-19 Jan-19 Mar-21 Jan-21 Sep-21 Jul-20 Jul-19 Jul-21 Jul-21 Change YoY Medical Care CPI Source: US DOL, SGA Research Frequency of claims returns to pre-COVID levels There are several factors such as changes in miles driven, weather, distracted driving, or others that can influence the frequency of claims, which in turn could significantly affect an insurance company’s earnings. The frequency of claims reduced drastically in 2020 due to pandemic- related restrictions. However, with VMT returning to pre- pandemic levels the situation is now changing, and auto insurers are observing a rising frequency of claims. For most auto insurance companies, property damage frequency increased by double digits in 2021. Fig. 8: VMT revert to pre-COVID levels 310 270 Billions of Miles 230 190 150 Jan-19 Apr-19 Jul-19 Oct-19 Jan-20 Apr-20 Jul-20 Oct-20 Jan-21 Apr-21 Jul-21 Oct-21 Jan-22 Aprr-22 Source: US Federal Highway Administration, SGA Research Price hike to offset the impact of inflationary pressure To deal with rising loss cost trends, auto insurance companies are constantly increasing the premium rates. During the pandemic, the companies passed on the benefits of a lower loss ratio to the consumer in the form of lower premiums. They expected the frequency of claims to rise only at a modest rate. However, the recent increase in frequency resulted in significant losses for auto insurers, and to offset these losses, the companies decided to hike insurance premiums. The premium rates are expected to rise by a high-single-to-double digit in 2022. 6

7. The Impact of Elevated Inflation on US Insurance Companies Fig. 9: Motor vehicles insurance CPI (y/y) shows the rate hike trend for auto insurers 20% 10% 0% -10% -20% Jan-19 Apr-19 Jul-19 Oct-19 Jan-20 Apr-20 Jul-20 Oct-20 Jan-21 Apr-21 Jul-21 Oct-21 Jan-22 Aprr-22 Source: US DOL, SGA Research Outlook With the inflation continuing at record levels, the auto insurance companies are expected to accelerate the pace of rate hikes which is likely to outpace the loss cost trend. Moreover, the value of used car vehicles is expected to decline due to the ease in supply of new vehicles, supporting the underwriting margins of the companies. On the other hand, rising repair and maintenance costs, parts and equipment costs, and medical care costs, along with the increasing frequency of claims are expected to further pressurize margins. 7

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