Originally published by R Street | Read Full Study
By Jerry Theodorou
Social inflation is among the most talked-about phenomena in property and casualty insurance and civil justice circles. There is hardly an insurer earnings call or industry conference where social inflation is not addressed. In this paper we analyze social inflation by exploring the following four questions:
What is social inflation?
Is social inflation real?
What drives social inflation?
What can be done about social inflation?
Social inflation refers to factors unrelated to general inflation in the economy that underlie rising court awards. Although there are some who deny the existence of social inflation, the preponderance of evidence shows that social inflation and its effects are real.
Although there are multiple drivers of social inflation, chief among them is the behavior of the plaintiff bar. In recent years personal injury lawyers have effectively deployed new strategies to secure large court awards, whether through jury verdicts or out-of-court settlements. The defense bar has been slower and less successful to push back against large “nuclear verdicts” that are out of proportion to damages. This has resulted in historically large losses across various liability lines of primary insurance and reinsurance.
Other drivers of social inflation include attorney advertising, litigation funding, phantom damages and a defense bar on the back foot in a world of torts with swelling court awards.
Insurers would do well to understand the drivers and potential impact of social inflation on future financial results. Just as the plaintiff bar has deployed creative new courtroom strategies to push awards ever higher, the defense bar should respond with strategies of its own to arrest the continued inflation of awards. Failure to do so will result in impaired insurer balance sheets and higher insurance premiums for all, amounting to a “hidden tax” burdening individuals and making businesses less competitive. Just as there are multiple drivers of social inflation, there must be a multi-pronged response, incorporating public policy action as well as defense bar retooling.
Social inflation refers to factors unrelated to general inflation in the economy that underlie rising court awards. Although there are some who deny the existence of social inflation, the preponderance of evidence shows that social inflation and its effects are real. A simple working definition of social inflation is that it is insurance loss cost inflation driven by non-economic factors. Non-economic factors are distinguished from economic factors, which also affect insurer loss costs. Known economic factors include:
The Consumer Price Index (CPI). The CPI has been rising at an uncharacteristically high rate in recent months, driving up the cost of all manner of goods and services, including those contributing to claims payments. The CPI rose 6.2 percent in the 12 months ending October 2021.
Supply chain constraints. Shortages of lumber and other building materials drive up the cost of property repairs. Shortages of microchips drive up costs to build and repair properties and to manufacture goods that include chips.
Medical inflation. The medical CPI is outpacing the all-items CPI. Liability insurance loss costs are heavily influenced by medical costs for injured third party plaintiffs.
Catastrophic injury costs. Recent advances in medical treatments for trauma victims, such as skin grafts for burn victims, robotic exoskeletons, and advanced prosthetics have extended longevity and improved patients’ quality of life, but come at high cost.
Non-economic factors, by contrast, relate to societal attitudes regarding responsibility and blame, which influence jurors’ and judges’ decisions and the magnitude of court awards.