Social Inflation and its impact on commercial insurance

“Social inflation” is a term that likely will be heard after spending enough time in commercial insurance. While it can be difficult to define, this term is top of mind for insurance companies, businesses, lawyers and risk managers alike.

Social inflation refers to all ways insurers’ claims costs rise over and above general economic inflation, according to the Geneva Association. More narrowly defined, social inflation refers to legislative and litigation developments that impact insurers’ legal liabilities and claims costs.¹

“Social” in “social inflation” refers to changing public sentiments toward “big business” and evolving views about who is entitled to compensation for injury and loss.¹⁵ At its core, social inflation revolves around holding perceived wrongdoers accountable for their actions, often by way of greater legal damages.

While social inflation isn’t a new influence, levels of social inflation have accelerated in recent years, directly impacting the cost of insurance. This article explores the various factors fueling social inflation, its impact on commercial insurance lines and ways stakeholders can respond to this trend.

Drivers of social inflation

A number of factors are driving social inflation’s presence. Some of these elements are behavioral and political, rising from changing views of the general public. Others are institutional and legislative, handed down via court rulings, regulators and legislators.

The following are seven key drivers of social inflation.

1. Mistrust of corporations/businesses—Public approval of large businesses and corporations is historically low.² Juries are increasingly likely to sympathize with plaintiffs who sue businesses, resulting in more wins for plaintiffs and larger compensatory damage awards. There’s also a public perception that large, well-funded businesses and insurance companies can easily afford the cost of any damages, no matter how excessive.
2. Aggressive marketing and plaintiff acquisition efforts—Plaintiffs’ attorneys have increased their advertising budgets dramatically in recent years.³ Reaching a larger audience has led to more claims being filed and the expectation of larger settlements. Joining this trend, an entire sub-industry known as “lead generators” exists to connect potential plaintiffs with attorneys. Along with lead generators, plaintiffs’ attorneys spend about $1 billion a year on television ads alone. In addition to traditional broadcast and print media, law firms spend millions of dollars advertising on digital platforms in search of plaintiffs. Attorneys have also begun using social media and data analytics to help find and recruit the most pro-plaintiff jurors.⁴
3. Strategies by plaintiff attorneys—In recent years, plaintiffs’ attorneys have deployed a new set of aggressive approaches to litigation strategy. For example, the American Association for Justice, a plaintiffs’ attorney organization, sponsors groups of lawyers that study similar legal cases and share information and successful strategies. Because much of defense attorneys’ work involves proprietary information, they are less likely to pool resources this way, which could put them at a disadvantage.⁵
   Plaintiffs’ attorneys also use data analytics to form specific narratives. For instance, they might examine data collected from a fleet of trucks’ on-board logging devices to shift the focus from an individual to an employer. In this scenario, a case involving the actions of one allegedly negligent truck driver becomes one about a trucking company with a record of ignoring safety standards.⁶
4. Third-party litigation funding (TPLF)—TPLF involves an outside investor providing financial backing to plaintiffs in exchange for a cut of the lawsuit’s ultimate settlement or jury award. If the lawsuit is unsuccessful, plaintiffs are under no obligation to repay the funds. A relatively new force in the legal world, TPLF is difficult to measure because many jurisdictions do not require plaintiffs to disclose whether they’ve received outside funding.⁷ However, there is widespread agreement this new, multibillion-dollar investment class is pervasive enough to impact settlement outcomes.⁸ Critics of TPLF say it clogs the courts with frivolous lawsuits, reduces plaintiffs’ incentives to settle cases in a timely manner and shifts the balance of power so unfairly that defendants feel compelled to settle lawsuits even when the case against them is weak.⁹
5. Tort reform rollbacks—During the 1990s, states began to seek ways to curb frivolous lawsuits and excessive jury verdicts. Those efforts, known as tort reform, focused in part on limiting noneconomic damages—i.e., ones based on harms that are difficult to measure, such as pain and suffering, inconvenience or emotional distress.¹⁰ By 2019, 38 states had rules capping noneconomic damages. However, many such reforms are now being rolled back. The supreme courts of at least eight states have found noneconomic caps unconstitutional. Further tort reform rollbacks will likely incentivize plaintiffs to seek higher settlements from insurers and defendants.¹⁰
6. Legislation expanding liability—A statute of limitation is a legal time frame during which a lawsuit may be filed. Once a statute of limitations expires, a plaintiff is barred from filing suit. In recent years, multiple state legislatures have retroactively extended or attempted to extend statutes of limitations. Retroactive extensions create additional liability and costs not considered when an insurance policy was issued.¹¹
7. Normalization of nuclear verdicts—Very large verdicts, often referred to as nuclear verdicts, are on the rise. Typically defined as greater than $10 million, nuclear verdicts are a central element of social inflation. Once made public, nuclear verdicts often become the minimum benchmark for the next litigation, which, in turn, attracts more plaintiffs seeking greater damages. This trend has been most evident in commercial auto lines, where, for example, average verdicts against trucking firms rose from $2.6 million in 2012 to $17 million in 2019.¹²

How does social inflation impact commercial insurance?

Social inflation has a profound effect on insurance policies designed to cover liabilities, including but not limited to general liability, commercial auto, products liability, directors and officers (D&O), employment practices liability, and excess and umbrella policies.

In particular, claims that involve bodily injury tend to absorb most of the impact of social inflation. In these cases, defendants might be liable not only for the current medical bills associated with the injury but also for estimates of all future health care costs. Estimating future healthcare costs is highly speculative and open to differing opinions, partly because no one knows what medical technologies will exist in the future. This uncertainty can be leveraged to ask for very high settlements in these cases.

Noneconomic damages, also known as general damages, are another factor contributing to high bodily injury payouts. These damages are for harms that are subjective and difficult to measure, such as emotional distress, inconvenience or loss of companionship. According to risk management experts, when juries want to “punish” a defendant for what they view as unethical behavior, they often do it by awarding large noneconomic damages.

Social inflation has led to claim losses rising faster than economic inflation in recent years. For example, from 2013 to 2018, commercial auto claims losses increased an average of 10.9% per year, compared with an average rise of 1% a year from 2007 to 2013. From 2012 to 2018, medical malpractice claims losses increased by an average of 3.2% yearly, more than twice the annual rate of economic inflation. And from 2014 to 2018, product liability claims losses increased by an average of 17.4% per year.¹³

Such accelerated claims losses have resulted in rising premiums. According to the Council of Insurance Agents and Brokers, commercial casualty insurance premiums in all lines of business rose an average of 8.7% in the last quarter of 2021, marking the 17th consecutive quarter of premium increases. Commercial auto and umbrella premiums both rose 8.1% in the second, third and fourth quarters of 2021. Finally, D&O liability premiums rose 7.9% in the second quarter of 2022.¹⁴

Another impact of social inflation is a reduction in insurance capacity. Capacity refers to the amount of insurance available from an insurance company or the market in general. Lack of capacity has been especially difficult for umbrella and excess liability insurance, forms of coverage that are triggered when the limits of an underlying policy, such as general liability or commercial auto, are exhausted. As social inflation grows, these markets are becoming firmer, with underwriters paring back limits, requiring greater levels of underlying insurance, or requiring higher deductibles or retentions.

What can insureds do?

There are steps insureds can take to help both counter social inflation and insulate themselves from its effects.

• Strengthen risk management practices. Organizations can reduce the risk of severe loss events with a proactive plan to manage exposures. They should engage with their insurance partners to implement best practices that reinforce a culture of safety, compliance and operational excellence. The risk of losses can be minimized by reinforcing a culture of safety and working with loss control experts to address exposures. Failing to implement proper risk management techniques is one of the key drivers of large court settlements and jury verdicts.
• Report claims immediately. It’s important for insureds to report claims as soon as possible. Prompt reporting allows claims experts to get a head start on case assessment, proper documentation and investigation of potential damages.
• Coordinate with attorneys. In today’s litigious environment, claimants often obtain legal counsel earlier in the process, even for minor incidents. While early involvement of attorneys may be necessary for an insured or business owner, it’s important that these efforts be closely coordinated with the insurance carrier. When insurance professionals are involved from the start, they have more time to provide adequate investigation and defense. This results in claims being handled in a more efficient manner. Incidents handled quickly are less likely to turn into bigger problems later on.
• Set realistic safety standards. Safety policies should avoid goals the organization cannot live up to. If a policy says employees will inspect the sidewalk hourly, it must be done and documented every time. If this is not feasible, adjust the policy. Policies should be reviewed at least annually to ensure they are being strictly followed. Also, avoid language stating safety is the organization’s “top” or “first” priority. Courts may interpret this language too broadly. Safety should be stated as important, just not more important than everything else.
• Retain quality employees. An organization is only as safe as its employees make it. With this in mind, hiring standards should be maintained even in today’s competitive labor market. Retaining quality workers should also be a priority. Claim incidents are more likely to occur with inexperienced employees in new roles. Incidents can ultimately drive up a business’s insurance premiums and/or can damage its reputation.

Social inflation creates a challenging environment for both businesses and insurers. Although they may not be able to control macro-level trends such as social inflation, they can take proactive steps to strengthen their risk management programs and reduce their exposures.