Insurance industry investment performance is expected to rebound this year but claims inflation is likely to remain a major challenge for some time, Finity says in its annual Optima report.

Return on equity is forecast to improve to 7.5% from 3% in the past financial year, with the investment result expected to swing to a $3 billion profit compared to a $2 billion loss that reflected the impact of rising interest rates and market volatility.

But a separate article released with the Optima report highlights the ongoing difficulties generated by claims inflation, which has been fuelled by extended supply chain pressures as a result of ongoing covid impacts and more recently the war in Ukraine.

“Claims inflation is a major challenge and will be for 2023 and, we think, beyond that as well,” Finity Principal Susie Amos says.

“The rapidly evolving and changing inflationary environment is a real risk to insurers’ future profitability.”

Short-tail classes have felt the effects most sharply to date, and the article notes the difficulties of responding to inflation by increasing premiums or through supplier contracts.

“Achieving sustainable outcomes for all stakeholders becomes a greater challenge, given the inflationary burden is ultimately borne across some combination of stakeholders along the value chain,” the article says.

“Where too much is borne by suppliers, supplier failure is a real risk; while too much borne by customers acts to further deepen affordability and underinsurance challenges. Investment in risk mitigation is even more critical in an inflationary environment to reduce claims exposures for the benefit of all.”

Gross earned premium rose 10% in the past year mainly in response to claims inflation in personal lines and commercial property classes and the continuation of the hard market in commercial lines. Gross earned premium is forecast to increase 12% in fiscal 2023.

The reported insurance margin improved to 3.2% from 0.1% supported by covid-related business interruption reserve releases. A further $500 million in releases is assumed for this year following a recent High Court decision on the second industry test case, pushing the margin to 4.2%.

Optima lead author and Finity Director Andy Cohen says claims inflation and reinsurance costs are headwinds while economists have varying views on likely peaks in inflation and interest rates.

“We are forecasting a bit of a bounce back in return on equity, but it’s still below target, and it’s very contingent on those investment markets behaving themselves, and getting back to a more normal outcome without the wild swings we’ve seen,” Mr Cohen told insuranceNEWS.com.au.