Argentina remains one of the toughest markets in Latin America. During the last 18 months inflation has been high, interest rates have not followed price increases, local currency has been losing value and the difficulties sending money abroad continue. The insurance industry has been affected by constant policy changes which modify the rules, some very relevant as is a new regime for reinsurance by which contracting locally is mandatory and the obligation to comply with established quotas of “non-traditional” investments (insurer’s obligatory investment quotas have now recently increased). All of this requires constant adaptation, to the point where the Argentine market could well be considered for use as a ‘boot camp’ for insurance executives.

Although there is disagreement among the various government agencies and private groups who study the issue, the general opinion is that Argentina’s inflation rate is close to 30% annually. As a first consequence for local insurers, this undermines the ability to accurately estimate insurable interest values – especially when it comes to complex industrial and commercial risks.

But the most negative effect occurs once the amounts that are considered appropriate are established, since there will be immediate deviations as the value of the insured property increases due to inflation. Thus the insurance contract, which in its original formulation and intent was appropriate to provide full indemnity to the insured in the case a covered event should occur, will suffer serious distortion.

In this context, insurance will not fulfil its purpose of returning the insured to the same financial situation as before the loss if, when such event occurs, the value of the insured property exceeds the sum insured. When referring to first loss insurance, inflation is more likely to affect claims which are total losses or those in which damages are considerable. This is because those losses are more susceptible to surpass the sum insured, which has slowly become insufficient due to inflation. If damages are modest, or if inflation has not had time produce serious distortions, the sum insured might be sufficient despite the negative effects of inflation and thus the insured may receive full compensation.

But a different rationale will be applied if an average or ‘pro-rata’ clause is included in the policy. In those cases a claim payment will not solely be limited by the sum insured, but by the proportion between the sum insured and the value at risk (the current value of insured property). As values at risk tend to increase with inflation, unless the sum insured was exaggerated at inception the proportion between value at risk and the insured sum will always change affecting indemnity payments negatively. The insurance payment will be insufficient to repair or replace damaged property in the same proportion of insufficiency between the sum insured and value at risk. This insufficiency caused by inflation will be the case however minor a claim, and despite the fact that the sum insured itself might be greater than the damages being claimed.

In this fashion, the client is faultlessly unprotected to some degree, while the insurer is involuntarily impeded from paying damages in full. The insured will be more vulnerable to these distortions as the loss occurs closer to the end of the policy period, as inflation would have had more time to sink in.

Strictly speaking, one could argue that it is the customers’ responsibility to keep the sums insured at appropriate values. But from the point of view of commercial practicality, when policyholders receive less money than needed to repair or replace damaged property insurance loses its appeal, businesses suffers and the portfolio decreases. The insurance industry has responded to these issues proactively, seeking solutions that will better serve the customer’s interests. As will be discussed herein, there have been several attempts aimed at protecting the interests of policyholders.

One solution offered to policyholders is the inclusion of ‘adjustment clauses’ in the policies, by which coverage can be extended beyond the sums insured shadowing market value of property. These clauses usually have a cap which is often a percentage of the original insured amount, and might be 15 or 20%. But adjustment clauses are included by means of paying additional premium, which can be expensive. Additionally, they do not always guarantee a good result for the customer.

Another solution which has been used extensively is to agree to have the policy currency expressed in US dollars or another hard currency. This strategy assumes that the selected currency exchange rate will help compensate for inflation. There have been times when this has proven effective – but not today, perhaps mainly due to government controls over the exchange rates. In the past, special currencies were created to offset inflationary effects, such as the ‘Unidad de Fomento’ (UF) is used in Chile or the ‘Unidad Tributaria’ (UT) works in Venezuela today. Argentina introduced the ‘Unidad de Cuenta del Seguro’ (UCS) decades ago, but the initiative was abandoned when the local Peso was pegged to the US dollar in the nineties and never revived thereafter.

Currently, rather than passively wait while the sums insured and premiums lose value to inflation, local operators prefer to increase policyholders’ sums insured thus expanding the (absolute and proportional) insurance liability limits. In this fashion, insurers benefit from the collection of additional premiums while ultimately seeing sales grow.

In this line of action, there have been local insurance agents who have implemented the strategy of exaggerating values of sums insured to anticipate inflationary effects that would undoubtedly materialise over time. A more refined and efficient strategy has been to monitor insured values each semester, quarterly or as often as required to raise them as may be needed. But this plan is risky, because it is simply too easy to make mistakes when tailor-managing a portfolio of customers with different needs and views towards insurance. When such mistakes occur, the end result may be that the insured receives less than a 100% indemnity payment, which could have been avoided should the policy have reflected the true entity of the risk, leaving all involved pointing accusing fingers.

Being a situation that transcends the agents’ involvement, local insurance companies have also sought ways to tackle the problem. Traditionally, some insurance programs work on the basis of declared values during given periods of time. If variations exceed a percentage, say 10%, premium adjustments are made. But this solution is not practical for all types of policies.

In particularly difficult times such as when the economy suffered from hyperinflation, some companies have massively imposed adjustments in a specific line of business (such as auto), boosting sums insured on their own account while charging additional premiums as well. Today, there is a local tendency to issue quarterly or even monthly policies, containing a new adjusted sum (and, therefore, additional premium) at each issuance. These contracts are designed to automatically renew, for example every month for a year. This solution has been widely implemented in the auto market, which accounts for roughly half of total non-life premium in Argentina.
However, the strategy discussed above is far from ideal, as the demand for insurance products is elastic. Customers can only pay premium adjustments as their incomes may allow, and a typical effect of any inflationary process is the loss of purchasing power of the population. As insurance becomes more expensive, the demand will decrease. This is as bad for insurers as it is for customers.

In short, inflation and the business of insurance are simply not a good mix, and so far none of the measures implemented to try and tackle the impact of inflation have been entirely successful.

For the sake of brevity we have not referred here to the distortion that inflation causes on deductibles, or adjustment and or legal services fees, let alone the setting of reserves or insurer’s investment strategies. Insurance in Argentina today faces many challenges. Thanks to the tenacity and creativity of so many excellent professionals, the industry continues to adapt and grow moderately, despite the adverse context.