A Strategy for Property-Liability Insurers in Inflationary Times

The primary business of the insurance industry is insurance underwriting. The insurance business is also engaged in the investment of funds generated by its underwriting activity as well as the capital and surplus. Thus, the operating results of insurers are affected by two components: underwriting results and investments returns. Historically, both of these components have been negatively correlated with the rate of inflation. Since insurers have considerable (but not complete) discretion in determining their investment mix, they are free to structure their investment portfolios to balance the adverse effects of inflation on underwriting profit margins. Thus, an investment strategy that correlates investment returns positively with the inflation rate is desirable during inflationary times. The purpose of this paper is to develop a method of inflation immunization for the property-liability insurance industry. The inflation immunized investment portfolio, based on experience during the period 1951 through 1981, involved a significant investment in Treasury bills. The strategy for reducing the effect of inflation on operating results presented in this analysis is one means by which insurers may cope with an inflationary environment.