Tag Archives: social inflation

New Paradigm for Reinsurance

The global reinsurance industry has been battered by several years of underperformance. It has been hit by natural catastrophe losses, both modeled and unmodeled, social inflation, declining investment returns and diminished reserve releases and is now facing an unprecedented globally systemic loss in COVID-19. Have we now reached the point where the global reinsurance market can morph into a new paradigm, allowing a more responsible and sustainable market to emerge? Or are we seeing a reworking of old approaches that have failed to deliver the sustainable, efficient solutions that primary insurers, policyholders and increasingly society seek?

Moments like this do not come often. Arguably, the last opportunity for a reset was 20 years ago in the aftermath of the 9/11 tragedy. So, what has gone wrong, and how can we build back better?

The harsh fact is that, with a consistent weighted cost of capital in the 7% to 8% range, the global reinsurance industry has not covered its cost of capital for the last six years. A prolonged soft market has led to under-reserving on many long-tail lines, a problem that is being exacerbated by social inflationary pressures. Overreliance on pricing models that have proved unreliable has led to unsustainably low pricing, which eventually requires disruptive correction.

Despite the unsatisfactory performance, capital has continued to flow into the global reinsurance market, most notably in the very significant expansion in insurance-linked securities (ILS) over the last 10 years but also through retained earnings on existing reinsurers, which have been bolstered by investment returns. Without the constraints of capital limitation to control excessive competition, the inevitable result has been underperformance as reinsurers chased top-line growth at the expense of profit.

Fortunately, the reinsurance industry remains well-capitalized, with capital levels above the end of 2018 and only slightly reduced on the capital levels at the end of 2019. Because capital constraint is clearly not going to limit pricing competition, we must look elsewhere for drivers that will help to put discipline and structure around achieving sustainable, adequate returns.

Investment income offers a potential solution. Unlike previous hard markets, when investment rates were much higher, current investment rates remain pitifully low, and are likely to remain so for years because nearly all governments are pursuing fiscal expansion as a result of COVID-19. Most reinsurers’ investment holding periods are four to six years, and they have to face the reality that low investment returns will continue.

Faced with the loss of the investment crutch, reinsurers have no option but to concentrate on improving underwriting results to generate enough margin to reward their capital. With a 7% to 8% cost of capital and return-on-equity (ROE) targets of 9% to 10%, reinsurers now need to run combined ratios in the low 90s, something the industry has not achieved for many years. This requires a back-to-basics underwriting approach to ensure that each unit of risk accepted is appropriately priced within a reinsurer’s overall portfolio. This approach inevitably means rate increases, along with changes to terms and conditions, neither of which will be easy to achieve in a global environment where many policyholders are under significant financial stress.

Reinsurers have a delicate path to navigate, but the strong capital position should let the industry ensure that risk is appropriately differentiated, and that pricing corrections are applied on a case-by-case basis in a sustainable fashion that clients can manage.

See also: 4 Post-COVID-19 Trends for Insurers

More important than addressing the short-term issues is to avoid the mistakes of the past and build a better future. Reinsurers must enhance their value to society and build long-term demand. Here, the COVID-19 situation helps, as it has moved the discussions about uncorrelated tail risk from theory to practice, and with it the demand for reinsurance. At the same time, the increased reliance on underwriting profitability is emphasizing volatility management, where again reinsurance plays a major role. Risks such as cyber and climate change also fall into the uncorrelated tail risk category, and again reinsurers have a pivotal role to play. Finally, there is the enormous opportunity represented by the uninsured economic gap. Finding innovative solutions to help society narrow the gap will lead to a complete reframing of the reinsurance market.

Achieving this will require dedication, long-term vision and the ability to build partnerships with organizations that the reinsurance market has never interacted with before, many in innovative public-private partnerships.

The opportunity to build back a better reinsurance market is clearly before us. The test will be whether reinsurers can develop transparent solutions that bridge the gap between capital that requires reasonable sustainable returns and new risks that threaten society. If the reinsurance industry fails to grasp this opportunity, it will be doomed to suffer the fate of so many, with the current generation repeating the mistakes of predecessors.

You can find this article originally published here.

How Analytics Can Tame ‘Social Inflation’

“Social inflation” is considered one of the major emerging risks that the insurance industry must face. While people may misconstrue the term as relating to the rising impact of social media on online behavior of netizens, it has actually to do with increasingly hostile legal environment that insurance carriers are facing today. This manifests in the form of much larger verdicts, liberal treatment of claims by boards, more aggressive plaintiff bars, etc. This article explains the trend and describes measures that carriers can deploy to keep a check on increasing legal expenditure.

Here are some signs of the phenomenon:

  • A major P&C insurer anticipates $40 million in quarterly legal costs for property losses alone
  • There is a 94% increase in assignment of benefit (AOB) lawsuits in the state of Florida in the last five years
  • An increased probability of “nuclear verdicts” (> $10 million) is a real trend. In 2018 alone, the top 100 verdicts ranged from $22 million to $4.6 billion

Here are some factors driving the trend:

  • Litigation Funding: Propelled by easy capital availability, a new class of plaintiff attorney funding model has emerged in the last 10 years. Essentially, this model provides funding for legal expenses to plaintiff attorneys in exchange for a portion of the judgment or settlement. The model is good in the sense that it levels the playing field against large, well-funded corporations, but the unintended consequences (for insurance companies) is an exponential increase in attorney representation and pursuit of aggressive legal strategies. Approximately $9 billion has been committed to this “industry.”
  • Rising anger against big corporations: The very premise of the big corporation versus the individual scenario is driven by anger. The perception among the consumers and the jurors is that a corporation has only one goal: profit. Stagnation of incomes/wages is another contributing factor to this mindset. Big businesses in America like to talk about the good jobs they provide, but median salaries in the U.S. have been flat for decades. This is not because of a failure of workers to become more productive; there were gains in productivity, but they did not go to workers. Gains mostly flowed to the organizations and their shareholders, including executives who received sizable stock-based compensation. Hourly compensation for workers remained practically flat.
  • Large verdicts being driven by general social pessimism and jury sentiments: New and interesting patterns are being observed in jury behavior, especially in personal injury and liability claims. Emotion and trust play a big role in how a jury rules. Some of the key reasons behind these large verdicts are: jurors’ distrust in big corporations and their lawyers; jurors paying less attention to lengthy testimonies and complex explanations; impact of social media on how millennial jurors view the court system; impact of emotional stories on how a jury thinks; and the “what if it were me?” attitude influencing how jurors approach justice. 

Leaving aside the financial burden from social inflation, which is quite significant on its own, increased litigation also affects carriers in other ways. There can be inaccuracies in reserving, which is based on counsel’s estimates of litigation spending. There can be negative press and poor customer engagement/satisfaction. And claims can increase in complexity, delaying settlement. .

Many insurers are either in the early stages of dealing with social inflation or are not moving as fast as they’d like on the problem. The most common reasons include:

  • Claim handling practices are often inadequately data-driven
  • There is limited ability to foresee litigation
  • There is lack of trust in analytical models
  • The company takes a semi-reactive approach for claim settlement and negotiations
  • Assignments are inefficient, either to claim handlers or attorneys

What can insurers do to manage this growing challenge?

See also: The Data Journey Into the New Normal

Enter machine learning and artificial intelligence

Use of analytics from first notification of loss (FNOL) until the claim is paid is now a norm rather than a competitive edge. All large carriers invest heavily in use cases such as fraud detection, severity-based claim assignment, automatic loss estimation, recovery optimization, etc. However, given the complex nature of how litigated claims are handled, only a few top U.S. carriers are able to weave these capabilities effectively into business processes. Insurance carriers that successfully use analytics to drive business process change in claims litigation will stay ahead of this massive threat.

There are two unmistakable trends that carriers need to leverage:

  1. Aggressive use of information sitting in claims and policy systems (structured attributes, adjuster notes) to develop signals around plaintiff attorney behavior. These signals then need to be deployed within claims operations to encourage early case assessment and litigation prevention.
  2. Use of increasingly clean and comprehensive sources of external litigation information (from state courts, where most insurance litigation lies) to inform your litigation strategy. This includes past verdicts information by venues, judges, attorney firms, case types, etc. A thoughtful use of this information can help claims adjusters and defense attorneys devise the litigation strategy to avoid worst outcomes. There are multiple firms providing research tools that are based on these. Our recommendation, however, is for carriers to ingest the information, merge it with internal claims data and develop models and tools providing a comprehensive view

How carriers can leverage this trend

Carriers can use predictive and descriptive analytics solutions in claims management to mitigate the problem. At a high level, such solutions can lower ballooning legal costs by avoiding litigation and optimizing litigation strategy. Both these approaches call for incorporating advanced analytics processes and models at the key steps of the claim settlement process. This includes:

  • Advanced analytics and machine learning models to predict and avoid litigation and post-suit strategy formulation
  • Natural language processing (NLP) to leverage unstructured data and extract additional insights
  • External data ingestion to augment internal data and enhance model accuracy
  • Enhanced data management capabilities

Any insurance claims raised can result into any of the three possible outcomes: claims without litigation, claims that involve litigation without trial and claims that involve litigation with trial. With the help of the aforementioned technologies, carriers can engineer the following mechanisms in the claims management process (Figure 1) to optimize the legal expenditure for a given product:

  1. A – Prediction of litigation likelihood 
  2. B1 – Defense counsel selection
  3. B2 – Law firm benchmarking 
  4. C1 – Attorney insights 
  5. C2 – Prediction of settlement failure
  6. D – Legal activity duration, legal expense prediction
  7. E – Case-level insights 

See also: Growing Risks of Social Inflation

Conclusion

Claims data within insurance companies is being increasingly seen as a key asset, not a byproduct of the claims process. However, the path to using internal and external sources of data to drive business outcomes is long and arduous. It is becoming increasingly important for carriers to incorporate insurance analytics processes geared toward optimizing legal spending. To achieve this, insurers require a combination of capabilities to these engagements, i.e. ability to handle big data, ability to develop advanced analytics solutions and knowledge of “what, why and how to deploy” in claims business processes.

Six Things Newsletter | July 28, 2020

Growing Risks of Social Inflation

Paul Carroll, Editor-in-Chief of ITL

“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… continue reading >

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Growing Risks of Social Inflation

“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.