Tag Archives: social inflation

How Social Inflation Affects Liability Costs

Social inflation is a term you frequently hear in risk management these days. It refers to a public, anti-establishment sentiment that has a far-reaching impact on businesses and the insurance industry. Last year, Out Front Ideas with Kimberly and Mark discussed the impacts of social inflation with a panel of experts. Our guests were: 

  • Mark Bennett, vice president of large casualty claims for Safety National
  • Oliver Krejs, partner for Taylor Anderson
  • Aref Jabbour, senior consultant for Trial Behavior Consulting
  • Andrew Pauley, government affairs counsel for the National Association of Mutual Insurance Companies (NAMIC)

Jury Trials

While only 5% of lawsuits result in a jury trial, knowing the potential outcome for a defendant shapes the future of underwriting and pricing risks in the industry. Because of the impact on rising costs, it is critical to explore what is causing the public to shift sympathy in support of the plaintiff.

Over the last five to six years, we have seen a steady increase in awards by juries. We have also witnessed an increase in the number of cases going to trial, especially in cases valued up to $1 million.

What is happening with liability juries to drive these large reports? One of our experts breaks down the major areas of concern.

  • The perception of the value of money has changed since the financial crisis. Juries believe that defendants can pay out larger sums of money to a plaintiff. Much of this is based around our daily exposure in the media to larger verdicts, desensitizing the public and making such verdicts appear more common and acceptable. Juries also believe defendants should pay even if there is substantial evidence they were not at fault, because the plaintiff deserves compensation. 
  • Media outlets and social media are affecting public opinion. Anyone with a social media account can attest that ideas expressed there are more extreme and less filtered than what someone would be willing to say in person. These publicly expressed ideas become validated in people’s minds, which are hard to change. For example, we are seeing an increase in jury awards against police officers, even in cases where the evidence supports that the officer acted appropriately. There is a true struggle to overcome these types of societal prejudices as media-based opinions become more prolific. 

Bad Faith, Litigation Financing and Other Challenges

Expansion of bad faith claims, litigation financing and the statute of limitations also challenge insurers. One of our guests summarized these issues: 

  • Bad Faith — The original intention of bad faith was to hold an insurer responsible when particularly egregious acts have been committed and when a worker has been intentionally put in harm’s way. However, some states have lowered the standards for claims. Insurers can get hit with punitive damages after one minor claim. Often, the claim can simply result from missing a statutory deadline, so no one was harmed, but the claim is used to punish the insurer. One of the most common effects of bad faith litigation is added costs to the system. Florida, for example, has long been known as one of the most challenging jurisdictions for insurers in the context of bad faith, and vehicle owners recently paid $1.2 billion in added costs based on outcomes of bad faith litigation. 
  • Litigation Financing — This has become a regulatory vacuum where companies or individuals finance litigation in exchange for a percentage of the settlement/verdict. This results in longer litigation and more cases going to trial, and can also create a conflict of interest among parties. It creates a major concern for expansive litigation and furthers the need to investigate the motivations behind these cases. We see more instances of hedge funds getting involved simply because of the return on investment it provides them. These situations don’t always mean the plaintiff will be better off. For example, in one case in New York, the plaintiff was allowed to borrow $27,000, and the case settled five years later for $150,000. The lending company took $100,000, the attorneys took the rest, leaving $111 for the plaintiff.
  • Statute of Limitations — The guidelines for when a claim can be filed have been changing rapidly on a state-by-state basis due to loosening laws across the country. These changing laws significantly affect public entities, school districts or other institutions, specifically relating to the ability of a claim to be filed retroactively in a childhood sexual assault case or abuse claim. Some states have expanded the limitations beyond expiration dates, some allow for a period of discoverability and some allow for a lookback period. California, for example, passed a law allowing for a lookback period that extends the time a file can be claimed up to five years. The law has extended previous claims of viability from the age of 26 to the age of 40. However, the court’s interpretation will determine whether these claims can be filed based on current policies. 

Litigation Solutions

Although we often cannot avoid litigation, there are measures we can use to prevent excessive jury awards. While none of these guarantee a favorable outcome, our guests suggest them as a general approach.

  • Change how cases are worked up from the beginning. A specific case that came out of Texas’ fifth circuit sought to change a law to closely mirror a direct action state like Louisiana, allowing the layers below an insurer to settle out and fund the case, leaving the excess carriers above them with the obligation to defend the case. Litigation changes like this will result in excess carriers having to completely adjust due to changing defense costs and exposures. Understanding how to educate the jury, providing expert testimony and getting all parties on the same page will need to be in the basic setup of a case.  
  • Advocate for early intervention and get all parties on the same page. Before litigation begins, you should ask yourself what your discovery process looks like. Are you interviewing all potential witnesses and figuring out what the fact pattern may look like? Do you know the answers to questions that the jury may seek later on in trial? Do you have the facts that will allow you to empower the jury? Ensure that there is a consistent message and always take more of an anticipatory approach than a reactive one.
  • Educate the jury on what is reasonable and factual. Because of social inflation’s impact on a jury’s prejudice, it is imperative to empower jury members with facts and reason. For example, do you know what the jury views as a reasonable award that would properly compensate the injured? In hospital charges, billings are often inflated up to 300% to 600% higher than what the facilities regularly accept from insurance companies. 

See also: Insurance Outlook for 2021

Legislative Solutions

Tort reform is a key element in combatting these rising jury awards. Stakeholders need to educate legislators on the societal costs of these large awards. This is no easy path. Businesses need to get involved with state and local bar associations and work with PACs on legislative efforts. 

The awards being seen today are from accidents that happened several years ago. That means the industry is probably looking at several more years of accident year combined ratios above 100% before rates are adequate for the reality of the exposures being faced.

Framework for Litigation Spending

The U.S. P&C industry has significantly lagged behind other U.S. and global industries in reducing unit costs over the last 15 years, and spending on managing claims litigation or contingent liabilities is a major reason. Most large P&C carriers spend 5% to 8% of gross written premium under various categories like external counsel, expert fees and internal attorney costs. This spending is considered a necessary evil so carriers can manage the right settlement or trial outcomes as well as protect their reputation. However, our experience with some of the largest U.S. P&C carriers demonstrates that there is a general lack of strategic insight in managing this large spending bucket and consequently a missed opportunity to reduce expenses.

Social inflation is an accelerating trend in the last decade, and COVID-19-related litigation is likely to complicate the situation for commercial insurers significantly. The systematic increase in litigation funding and rising wealth inequalities have added significant fuel. Many CEOs have publicly raised social inflation as a continuous challenge to profitability.

Sudden economic changes brought by the pandemic have created both risks and opportunities for P&C carriers. On the one hand, extended closure of courts and delays in litigation are likely to drive more plaintiffs to look for faster settlements. On the other hand, there is a high degree of uncertainty because of potential legislation regarding coverage exclusions in business interruption policies. Carriers need to respond to events as they occur, state by state, with great agility, empathy and data-based objectivity.

It is important for insurance carriers to have a robust litigation management strategy. We have identified five key levers in managing litigation spending:

1. Being Data-Driven

Having a data-driven claims team is the first prerequisite for leveraging the power of analytics for litigation. Exploration of claims, litigation and financial data leads to surfacing the need for advanced analytics intervention. Extraction and processing of external court data is challenging and often expensive, but a few carriers have seen tremendous return on such investment.

2. Well-Defined Metrics

Most carriers struggle with a homogenous and widely accepted (internally) definition of litigation spending and its categories. Claims, finance, general counsel, internal trial division, procurement, legal ops – are all the departments that have slightly different ideas of what actually is a dollar spent on litigation, and consequently what and how that expense can be reduced. As a start, a strategic initiative to harmonize the definition and reconcile the differences in metrics (as they flow through multiple databases and reports) should be launched. Such an initiative has very high return on investment as it tends to bring into focus the opportunity for the carrier.

3. Advanced Analytics Capabilities

A few carriers are building models to predict litigation propensity or even to predict outcome based on use of staff versus outside counsel. In addition to data science and analytics model deployment experience, prioritization of the advanced analytics resources toward litigation spending management is a key requirement.

See also: P&C Commercial Lines in 2021

4. Data Infrastructure

Quality and freshness of data flowing into the descriptive and predictive analytics workflows is a key determinant of the value of litigation analytics. Poorly built and broken data pipelines may cause delayed and incorrect execution of the analytical models and may not yield insights to act upon in spite of successful validation of early models. A robust data management strategy is important to ensure collection, cleansing and preparation of critical data elements for analytics execution.

5. Attitudes and Behavior

Perhaps the most important factor holding back P&C carriers is a lack of the right attitudes and behaviors. An economically optimal view needs to be developed for leadership to take an informed decision in every litigated claim (sue or settle) or even potential litigation. Serious adoption of insights by operational staff is usually the last and most critical point toward data-driven success. In our experience, a strategic approach to litigation management requires mixing experienced litigation adjusters skills with data science, engineering and process design experts.

Conclusion

There are no silver bullets in systematically reducing litigation spending. In our experience, the carriers using most, if not all, of the principles discussed here are way ahead. Their desire to manage litigation spending better made them methodical and data-driven. We can say with almost certainty that, as the situation with COVID-19 accelerates, changes in claims litigation combined with the effects of social inflation mean that these carriers are better prepared to face the future.

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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