Insurers' Social Inflation Problem

In the face of aggressive action by plaintiffs attorneys, the insurance industry is steadily losing a battle it hasn’t really begun to even engage in.

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Social inflation has become somewhat of a buzzword in insurance circles in recent years, especially over the past year. The phenomenon is responsible for driving up risk and the cost of claims across a range of lines, ultimately affecting insurer profitability. 

But for all it is talked about, very little is being done about it. Insurers know it is there – they can see it in their results – but, as an industry, we are struggling to define it, measure it and come up with a credible response.

This matters because the plaintiffs’ bar is doing quite the opposite: committing significant resources to understand and exploit litigation opportunities. The insurance industry is steadily losing a battle it hasn’t really begun to even engage in.

Before we get into what needs to be done, let’s take a quick look at what social inflation is and why it is a growing problem today.

At its core, social inflation is an industry-wide rise in claims costs over and above normal economic inflation. More specifically, it is added inflation caused by shifts in societal views toward litigation and plaintiff-friendly legal decisions. 

U.S. litigation has risen for seven consecutive years, topping 8.9% growth for the last year data was available, compared with an average of 3% for the previous two decades. And the level of compensation awarded has also increased, especially in large cases. The number of verdicts of $20 million-plus was 300% more than the annual average between 2001 and 2010. 

The impact of societal trends goes well beyond just high-profile, nuclear verdicts. Social inflation pushes up the cost of claims to such an extent that pricing now does not accurately reflect risk. If this persists, it could ultimately affect capacity and even availability across whole lines of business.  

There are two important drivers of social inflation today: The first is rooted in societal shifts that stem back to the 2008 financial crisis, which left a deep sense of anger and distrust toward large businesses. This has contributed to a tendency among juries and judges to sympathize with plaintiffs’ framing of issues. This is especially visible among the millennial generation who now occupy positions of influence in the legal system and sit on juries.

The second: Law firms and related third parties are deploying sophisticated tactics to monetize the societal trends for higher payouts. For example, some legal entities are investing in powerful data, analytics and technology to identify and exploit liability opportunities. They are also increasing marketing spending; funding liability activities for potential plaintiffs; conducting social media tracking; and adopting behavioral science to influence juries. 

Indeed, a whole sub-industry of consultants and lawyers has evolved to cultivate a claims culture and improve trial outcomes.

Where does this leave the insurance industry? We should be supportive of valid claims and work to resolve claims as efficiently as possible. But, to put it bluntly, we are playing catch-up on the issue of social inflation. As an industry, we are masters in understanding most claims trends, but, when it comes to broad, litigation-related trends, we rely on high-level data and guesswork. 

This imbalance between the insurance and legal entities must be addressed. We as an industry must become experts in social and legal trends, just as we are in other types of claims trends. 

See also: Growing Risks of Social Inflation

Societal shifts need to be respected and managed sensitively. But losing the analytics arms race against the legal system only serves to undermine a healthy functioning insurance market that is vital for society. 

The thoughtful application of the right data and analytics in the insurance industry can move us forward. 

First, we must recognize that social inflation is a human risk. Human behavior can be analyzed and even predicted in much the same way as traditional perils such as natural catastrophes. It requires a different set of tools and data, specifically non-traditional data. Unlike traditional data, it is not based on records but gathered from “live” activities such as internet activity, social media trends and smart technology. These data points provide clues about human behavior, which, with the support of advanced analytics, can be analyzed at scale to create a powerful predictive model. 

By analyzing claims and policy experience together with behavioral data and other non-traditional data, insurers can build a detailed understanding of the link between behavioral indicators and liability. In doing so, we can build predictive social inflation models that can measure levels of social inflation and price risk appropriately – and then take action where necessary. 

Liability insurance has a critical societal function. It exists to protect individuals and businesses from risks such as potentially crippling legal fees. It underpins an innovative and vibrant economy. To leave social inflation unchecked is hazardous not only for the insurance industry but also for the business community it serves and the wider economy. 

The industry and individual insurers should hasten to start paying more attention to this issue – and begin taking action to mitigate and counter the trend. That journey starts with intelligent application of non-traditional data and advanced risk models.

Paul Mang

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Paul Mang

As Guidewire's Chief Innovation Officer, Paul Mang supports senior executives of insurance organizations in refining their innovation strategies to achieve growth objectives. Mang also leads the analytics and data services go-to-market team to help clients leverage analytics to deliver greater value to policyholders.


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