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July 26, 2020

Growing Risks of Social Inflation

Summary:

Social inflation, an on-again, off-again issue for the insurance industry for decades, is on again, and the pandemic may make it worse.

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“Social inflation,” an on-again, off-again issue for the insurance industry for more than four decades, is on again as a major factor in insurance claims and, thus, rates. The issue, related to beliefs and trends that lead people to expect ever-higher compensation and for juries to grant it, has been growing for several years and seems to have accelerated since last summer.

The pandemic and the economic crisis that resulted may exacerbate the problem for insurers — or may mute it. There are arguments on both sides. Some see social inflation being dampened as financially strapped people and businesses become more willing to settle a claim and as the logistical complications that come with less face-to-face interaction drag out negotiations and judicial proceedings. Some see social inflation increasing as people feel wronged and try to take out their anger on those that they distrust and that have enough assets to make them tempting targets — read, insurers (among others).

Me? I see the pandemic boosting social inflation.

The term goes back at least to 1977, when Warren Buffett used it in his annual letter to shareholders of Berkshire Hathaway. The issue is often described in extreme terms — like the guy who sued for $67 million over a $10 dry cleaning bill — but shows up in all sorts of more pedestrian ways. People increasingly are inclined to bring the lawyers in, rather than take the settlement offer from an insurer, and claimants insist on higher amounts. The problem builds on itself — this is the “social” part of the inflation — because who wants to take what feels like a lowball offer when others have been receiving more in similar situations? (The dry cleaning plaintiff lost his suit and had to pay court costs, but no one seems to remember that part of the story.)

The issue surfaced from time to time in the decades since Buffett used the term, then steadily increased starting five or six years ago, according to this white paper from The Institutes. The paper notes that, from 2013 through 2018, commercial auto claim losses increased at an annualized rate of 10.9%, compared with a 1.0% annualized rate in the prior six years. The trends were similar in personal auto and medical malpractice. In product liability, incurred losses grew at an annualized rate of 17% from 2014 through 2018, after decreasing at an annualized rate of 7.1% in the prior five years. 

These trends became very public last fall when Travelers added hundreds of millions of dollars to reserves and cited social inflation.

To understand where we go from here, it may help to look at what The Institutes’ white paper lists as the main drivers of social inflation. I’ll quote from the paper and address each issue, or group of issues, in turn.

“Changes in underlying beliefs about the appropriateness of filing lawsuits and expectations of higher compensation”

Although it’s hard to predict what will drive “underlying beliefs,” the white paper says that income inequality has driven many people to demand more and notes a general distrust of corporations. The result is anger.

The paper says: “In its 2019 annual report on emotional states around the world, Gallup reported that 22% of Americans reported feeling angry ‘during a lot of the day yesterday’ — the highest level of anger measured by Gallup in more than a decade.”

Although Gallup didn’t ask people to identify the source of their anger, I’m sure we can all imagine some reasons, and I’d guess that anger has risen, not dropped, in the crazy year that is 2020.

So, I suppose it’s possible that financially strapped people and businesses will be more inclined to settle, but I don’t, in general, expect that people will become less litigious or demanding of compensation.

“Rollbacks of previously enacted tort reforms intended to control costs

“Legislative actions to retroactively extend or repeal statutes of limitations”

If we project those factors forward to imagine the likely effect of the pandemic, it’s hard to see legislatures taking any actions on tort reforms or statutes of limitations that would reduce social inflation. State legislatures have been moving in the other direction, with many trying to find ways to make insurers liable for costs of the pandemic even when business interruption policies don’t cover such costs. And, if people remain angry, well, legislators who want to be reelected (as in, all of them) tend to react to anger among citizens.

“Increased attorney advertising and increased attorney involvement in liability claims

“The emergence and growth of third-party litigation financing

“Increasing numbers of very large jury verdicts, reflecting an increase in juries’ sympathy toward plaintiffs and in their willingness to punish those who cause injury to others

“Proliferation of class-action lawsuits

If people do somehow change their underlying beliefs about filing lawsuits and about seeking big awards, then, yes, these drivers of social inflation will fade. But history suggests that it’s wrong to expect society to become less litigious. When Thomas More was chancellor of England under King Henry VIII in the 1530s, he often had no cases on his docket. When John Jay was the first chief justice of the U.S. Supreme Court, he heard only four cases and resigned after six years, in 1795; he was elected governor of New York and thought that position was more important. As for litigation today….

Lawyers have made loads of money through advertising and “litigation financing” — having third parties provide funds so plaintiffs can afford to continue a court fight much longer than they could have on their own — so lawyers won’t back off unless there’s a huge change in public attitudes.

Lawyers have also become more effective at winning “nuclear verdicts” — judgments that are at least $10 million and that can reach the billions of dollars — by tapping into what is referred to as the “reptile brain” of jurors. The strategy tries to trigger the “fight or flight” response in people, using techniques to make them so scared of the defendant that they react in a highly instinctive, emotional way that overwhelms rational arguments.

If the approach is working — and it certainly seems to be producing bigger jury verdicts — why would lawyers back off?

While the pandemic has made all of us humbler about our ability to predict, I just don’t see any reason to expect social inflation to abate because I don’t see any of the pressures going away. I think that the pandemic will encourage cash-strapped people and businesses to ask for bigger settlements and that sympathetic juries will be inclined to go along.

Stay safe.

Paul

P.S. Following my own advice from last week’s Six Things about the need to find a devil’s advocate to challenge your thinking, I found a very different take on social inflation. Here is a consumer group, affiliated with a law school, arguing that insurers manufacture social inflation claims to justify rate increases.

P.P.S. Here are the six articles I’ll highlight from the past week:

The Real Disruption of Insurance

The future of insurance isn’t incremental change: Technology is enabling direct threats to carriers, not just their partners and providers.

Expanding Options for Communications

Messaging and platforms, business texting, chatbots, voice and even augmented reality can help customers–while cutting costs.

How to Thrive Using Emerging Tech

A survey finds that 75% believe AI can provide a competitive advantage through better decision-making, and early adopters report gains.

Optimizing Experience for Life Beneficiaries

Focusing on beneficiaries can not only help facilitate the claims process but also provide life insurers with opportunities for growth.

4 Keys to Agency Modernization

Agencies must modernize to survive, but where do you start? Here are four guideposts that can help.

COVID-19: Next Steps in Construction

As more projects resume, contractors can draw lessons from areas where work was never halted to reduce risks and rebuild momentum.

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About the Author

Paul Carroll is the editor-in-chief of Insurance Thought Leadership. He is also co-author of Billion Dollar Lessons: What You Can Learn From the Most Inexcusable Business Failures of the Last 25 Years and the author of a best-seller on IBM, published in 1993. Carroll spent 17 years at the Wall Street Journal as an editor and reporter; he was nominated twice for the Pulitzer Prize. He later was a finalist for a National Magazine Award.

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