Latam Briefing: Argentinian Inflation
Argentinian insurers have long struggled with inflation, leading to difficulties in maintaining policy limits and premium rates and challenges from government capital controls. How have they overcome these challenges?
The insurance market has struggled of late to adapt itself to inflationary pressures that have not been part of its operational environment for over three decades.
Companies have concerns about the impact of inflation on the value of claims and exposures as prices increased by 6.5% a year in the US, 7.9% in Germany and 9.2% in the UK in 2022. Boards across the market are re-evaluating their business strategies to take into account the roaring prices.
Just imagine if they had to deal with that kind of situation every single month.
To have a glimpse of what a worst-case inflationary scenario means for underwriters, one only has to look at Argentina, an economy where the official inflation index reached 5.1% a month in December, closing 2022 at almost 95%.
The Inflationary Tango
Argentinian insurers have had to dealt with inflation for the best part of five decades. (They enjoyed of a few years of respite in the 1990s.) As a result, they were forced to grasp how to live in such a challenging operational environment.
“Argentinian professionals have the culture and the skills to live with inflation. We have developed many tools and solutions that allow us to mitigate the impact of inflation on the business,” says Alcides Ricardes, the head of Broking Retail at WTW in Buenos Aires.
They have also learned that their jobs do not get any easier even as they become more used to inflation. “For years, all the market has done is to survive,” says Gustavo Trías, the general secretary of AACS, an association of Argentinian insurers.
Surviving implies the constant adjustment of business practices to mitigate the direct and indirect impacts of inflation on insurers’ balance sheets. For example, over the years, Argentinian insurers have reduced the length of their policies to better reflect price increases on premium rates and limits.
“In the retail insurance market, companies tend not to issue annual policies any more,” says Carlos Estebenet, a law insurance expert based in Buenos Aires. “They prefer to sell monthly, quarterly or half-yearly policies where insured values and premium prices can be adjusted.”
However, insurers are also prevented by law from directly linking premium rates to inflation indices, so the have had to come with creative solutions such as the creation of policies with clauses according to which they are allowed to unilaterally increase limits and rates based on their own estimations of what is needed to guarantee the payment of an eventual claim.
Which can be a hard sell for clients, notes Sebastián del Brutto, the president of AAPAS, a brokers association. The clauses are aimed at guaranteeing that the payment of the claim will be high enough, despite inflation, to compensate for the losses suffered. However, Brutto points out that contracts usually state that limits will not go up by more than 50% a year.
“But we know that they will not be that high,” he says. “And the inclusion of this clause in the contract means an extra charge for the client.”
All things considered, the adaptation means plenty of extra work for insurers and brokers alike and the risk of alienating clients, which no insurers can afford to, as Argentina, despite its challenges, has a very competitive insurance industry, where more than 190 companies vie for a premium cake that, in real terms, has not grown for half a decade. The level of competition undermines their ability to increase prices and limits to keep up with inflation.
In the corporate insurance sector, one of the solutions found by the market has been to sign contracts in dollar amounts, rather than in the local peso. Ricardes estimates that between 60% and 70% of all insurance contracts sold to companies are written in dollar today.
But that entails its own set of challenges. As part of its policies to avoid capital flight and the floundering of the currency, the Argentinian government has implemented capital controls that make it hard for companies to get hard currency in and out of the country.
Furthermore, insurance contracts must use the official currency rates, determined by the government, which hovers around 50% of the non-official rate, which is believed to be much closer to actual market values. The non-official dollar rate informs many of the price increases applied by suppliers of goods and services and which will constitute the cost of a claim. Trías notes, for example, that prices of car parts, which are mostly imported, were up by more than 100% in mid-2022 on a year-to-year basis. At the time, annual inflation rate hovered around 64%.
The official exchange rate is also the one used in the reinsurance policies purchased by Argentinian underwriters in international markets. Many insurers in the country make plenty of use of reinsurance, as they need to manage their capital efficiently to be able to survive in a very competitive market. But capital controls have made it very hard for insurers to purchase dollars at the official rate to pay for their reinsurance contracts.
According to Trías, for three months already some companies have fallen behind in their payments because they cannot obtain authorization from the Central Bank to purchase dollars in the official market. Some have seen a number of contracts cancelled for lack of payment.
“With treaty insurance it is sometimes easier to solve it, as the insurer can compensate with claim losses,” he says. “But in Argentina the most common kind of contract is of facultative reinsurance, as it is not a catastrophic market.”
Dollar scarcity affects many economic sectors in Argentina, spurring new interest by the Argentinian government to discuss alternatives to the greenback. The economy minister has recently floated the idea of a common currency for South American countries, and discussions have been made in the Mercosur trade bloc about the topic.
But analysts say that the most realistic alternative is the creation of a new currency which use would be limited to trade and financial transactions between the member countries, which is the option that has the most support within the Brazilian government.
With inflation expected to reach more than 100% in 2023, it is hard for Argentinian insurers to see the light at the end of the tunnel in the short term. To break the inflationary cycle, it will be necessary to implement dramatic economic policy measures that are unlikely to be adopted before the presidential election, which is scheduled to happen at the end of the year.
Which does not bode particularly well for the market. According to AACS, the insurance market as a whole closed 2022 with losses. Although technical results were positive by 2%, investment returns were 8% negative. One reason for that was that investment portfolios have an exposure of around 40% to Argentinian government bonds, which investors do not want to touch with a bargepole at the moment.
In December, AM Best kept its outlook for the Argentinian insurance market to negative, mostly due to the country’s dire macroeconomic situation.
“Persistently high inflationary levels have pressured insurers´ solvency margins. This is the result of increasing premium risk and underwriting leverage, non-investment grade fixed income exposure, and counterparty risk, to name just a few factors which impact balance sheet strength,” says Salvador Smith, a senior analyst at AM Best. “High inflation has also pushed some industry players to set low business retention levels, thus raising their credit risk profile.”
Underwriters have, however, developed ways to manage their capital in a way to somewhat mitigate the impact of inflation.
“Insurance companies tend to safeguard solvency against asset and underwriting risks through a set of diverse mechanisms. They include long positions in dollar denominated government backed obligations such as dual bonds; proportional and non-proportional reinsurance structures, which account for expected inflation rates; consistent pricing adjustments on its products and fronting agreements, to name just a few.”
An adjustment in accounting rules made in 2020 has also helped insurers to reduce the distortion caused by inflation on insurers’ balance sheets. They are reigning on costs, looking at M&A possibilities and deploying digital strategies that help to automate the constant adjustment required by the inflationary environment.
But market observers say that some companies are in practice rolling their obligations into the future, by means, for example, of extending judicial litigation for several years, knowing that inflation will eat into the value of their debts.
“If one day inflation settles down, half of the players in the market will disappear,” Trías forcasts. “That is what happened in the 1990s.”