Social Inflation’s Impact on Auto Insurance Claims

Social inflation is on the rise, and that spells trouble for auto insurers – as well as the policyholders who depend on them.

What’s social inflation? It’s a complex concept, but it boils down to this: when insurers face greater risk of getting sued, insurance premiums tend rise in order to balance the scale.

The complexity is in the details, as societal trends and perspectives bear an impact on how contracts are interpreted, what checks are in place for gratuitous litigation, how jurors feel about specific corporations and industries, how large the awards may get, and how all this affects the insurer’s ratios.

Let’s look at those causes a little more closely.

1) Social inflation can happen when someone – either a private company, or the government itself – subsidizes the cost to litigate. This may happen when the state removes regulations or costs around frivolous lawsuits (as recently happened in Florida, according to Insurance Information Institute [III]), or when private “investors pay plaintiffs to sue large companies – often insurers – in return for a share in the settlement (also reported by III).

2) Social inflation can take place when tort laws erode, lengthening the period of time in which a lawsuit can be filed or removing caps on punitive and noneconomic damages that can be awarded.

3) It can also take place when the opinion of the average juror skews in favor of the individual over the insurer, due to distrust in big corporations or a belief that a large organization can afford to take the hit.

4) Finally, social inflation can occur when jurors become desensitized to large awards. If the anchor (or reference point) for damages is normalized as exorbitant, jurors will be more inclined to award exorbitant damages – even if they’re disproportionate, and even if they’re not directly related to the case at hand. The desire to punish an entire industry by scapegoating a specific corporation can play a role here.

It’s probably clear, at this point, that social inflation is a problem for insurers whenever it may emerge. The fact that it’s on the rise again now after 20 years is of particular concern.

According to Swiss Re, “The benign US P&C loss cost environment of the past decade appears to be turning,” a fact that’s “most evident in commercial auto with adverse reserve development and rising premium rates for a number of years.” While premium rates “are firming,” this fact “may not be enough to offset escalating loss costs.”

In fact, Carrier Management reported that the inflection point we’re seeing now due to social inflation could be the primary threat to the P&C industry’s already-marginal profitability.

“Should people be concerned? In our opinion, the answer is yes,” said Robert Berkley, Jr., the CEO of W. R. Berkley, Carrier Management said. “Should people be surprised? In our opinion, the answer is no.” Having weathered the medical malpractice crisis of the early 2000s – in which claims spiked and severity spun out of control – recent memory is enough to remind us all that when social inflation happens, one way or another, society pays the bill.

“The people who really get punished are the people who ultimately have to buy insurance,” Berkley said. To borrow his words, social inflation is real. It’s here. And it’s in everyone’s best interest to find an answer.

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