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The Actuary The magazine of the Institute & Faculty of Actuaries

Peak oil, energy prices and economics

A session at the March 2011 Casualty Actuarial Society’s annual ratemaking seminar discussed the wide range of actuarial implications of levelling off of the world’s oil supply, the resulting rising gasoline prices and their economic impact. The presentation included recent examples of these issues impacting society in general and more specifically insurers such as the 2010 Deepwater-Horizon oil drilling platform blowout in the Gulf of Mexico and the nuclear power plant destructions in Japan earlier this year.

Gail Tverberg described the strong correlations between oil price spikes and recessions, population growth and increased fuel usage and between food prices and oil prices. General examples of the impact of recessions on insurers in the US were discussed. These range from a decrease in motor claims, high unemployment’s impact on workers compensation insurance, and homeowner insurers being impacted by falling home values and unoccupied homes. Additionally insurers are impacted by the amount of investment income. On the other hand new coverages such as for solar panels and electric cars emerge.

Tverberg explained that in general more recessions should be expected and that governments will be in worse financial shape. The worsening public finances may lead to roads not being repaired adequately, defaults on their bonds, and not being able to fix damage after catastrophes.

Actuaries need to consider a variety of changes and their impact on rate making. These range from the fact that homes with expensive solar panels may have increased theft risk depending on the installation location of the panels, to the possibility of homes with wind turbines being impacted by vibration and damage if the turbines are on top of buildings. Another example of changes is electric cars being added to motor policies. Electric cars are likely to be second or third vehicles and will also have low mileage because of their limited range.

Example of the economy’s impact on homeowners insurance ratemaking are that if home prices continue to decline, some insureds may not keep up their homes because they don’t have the money to carry out necessary maintenance. This in turn may lead to more claims due to causes such as leaky roofs. Other possible changes include a shift in mix towards older homes (may raise the average loss amount), and struggling homeowners shopping around more for better insurance rates more (may lead to increasing loss ratio).

Another impact of higher oil prices is a likely reduction in the number of miles driven, which may have a favourable impact on claim frequency. On the negative side accidents may be more costly as auto repair costs rise with the price of oil, and roads deteriorate due to the high cost of asphalt and poor government finances.

The economic changes may also impact catastrophe pricing. Following natural disasters, governments may be slower to both fix infrastructures and provide basic services which will lead to longer business interruptions. Government may also intervene in settlements such as in the Deepwater Horizon oil spill.

Finally increasing long term inflation rates may lead to more defaulting bonds which will lead to lower investment returns than anticipated. This may lead to a negative view of long-tail insurance lines and a positive view of short-tail lines by insurers.

The presentation concluded that while a solution to the bigger issues would be great, currently it is not clear that one exists. To find out more information and join the Resource and Environment Group please visit http://www.actuaries.org.uk/members/pages/resource-and-environment-member-interest-group or contact us at migs@actuaries.org.uk