A sustained weakness in the pound against the dollar and euro would exacerbate the claims inflation pressure that nonlife insurers in the U.K. are already suffering.

The pound briefly dipped to its lowest-ever level against the dollar on Sept. 26 on concerns about the affordability of a package of tax cuts, the U.K. government announced Sept. 23. It has since recovered to about $1.12, but remains far below the $1.354 mark where it began 2022.

Ripple effect

The sharp drop highlights the challenges U.K. insurers face if the pound was to stay at permanently low levels. For instance, the U.K. typically imports between 70% and 80% of the parts used to fix vehicles and properties, according to Mohammad Khan, a partner in PwC's insurance and actuarial practice. Auto claims costs in the U.K. could be significantly impacted by a very weak currency.

"Any significant fall in the value of the pound vis-a-vis the euro or the dollar would obviously have an impact on claims costs," Khan said in an interview.

One caveat is that the U.K. imports many car parts from elsewhere in Europe, and the pound has fared better against the euro than the dollar. The pound fell to €1.115 on Sept. 28 and has since recovered to €1.141. However, Khan noted that a lot of parts also come from Asia, which is another way the U.K. is tied to the dollar.

Khan said inflation on motor damage claims is already between 10% and 14%, and inflation on domestic and commercial property claims at between 6% and 8% because of economic inflation and continued global supply chain bottlenecks.

While insurers can adjust for changes in the cost of repair materials by charging higher prices, there is often a lag because insurers cannot do so until a policy renews, according to Willem Loots, a senior director in the EMEA insurance group at Fitch Ratings. Policyholders may not be willing or able to pay higher prices, so the rise in the cost of living in the U.K. might restrict insurers from being able to hike premiums further, Loots said in an interview before the pound had recovered to current levels.

Overall, insurance prices are still playing catch-up with claims inflation. Khan noted that motor rates are rising at between 2% and 5% and home insurance prices range from flat to 3% increases.

"Even if you don't take account of the volatility in the market, price rises aren't yet keeping up with what we're seeing on claims," Khan said.

Part of a larger whole

The effects of the falling pound, while serious, should not be overplayed, according to analysts. But the challenge of wider economic inflation, which is boosting insurers' costs on many fronts, is a "bigger ticket item," Loots said. The pound's weakness is "an additional element" but not the main driver behind claims inflation, Paul De'Ath, head of market intelligence at insurance consultancy Oxbow Partners, said in an interview.

There could also be some benefits from a weaker currency. Fuel costs are linked to the dollar, and rising fuel costs tend to reduce car use and thus claims for insurers, according to De'Ath. A U.K. insurer with dollar assets would see the value of those assets increase, leading to potential investment gains, he said, but many companies typically have "significant" foreign exchange hedges in place that could cancel out any potential gains.

For U.K. life insurers such as Aviva PLC, Phoenix Group Holdings PLC and Legal & General Group PLC, a sustained drop in the pound could trigger collateral calls under instruments they use to hedge foreign exchange movements and lead to a short-term increase in liquidity requirements, much as the recent spike in U.K. government bond yields did for interest rate hedges.

But here, as with the interest rate hedges, insurers should be well prepared, according to Loots.

"It is something treasurers need to worry about but also one where treasurers are very accustomed to thinking through these risks and managing liquidity for them," Loots said.