While not new, industry professionals
struggle to mitigate the problem
By Tom Rea
Social inflation continues to be a hot topic across the insurance industry, as increasing claims severity remains an ongoing threat to long-term profitability and industry professionals try to figure out how to mitigate the problem.
The social inflation phenomenon, as described by the Insurance Information Institute (I.I.I.), generally refers to societal trends toward higher claims settlements, increased litigation and exorbitant jury awards. Though the term social inflation is not new, the I.I.I. notes, it has become “increasingly common as insurance companies try to describe the contemporary forces that they believe are accelerating loss costs.”
There has been a lot of debate over what’s fueling the current social inflation trends, with industry experts such as the I.I.I. attributing them to an increase in several factors:
- Investor-funded lawsuits, also known as litigation funding. About $17 billion was invested in global litigation funding in 2020, with more than half deployed to U.S. litigation funding companies, according to a 2021 report from Swiss Re. Many states do not require plaintiffs’ lawyers to disclose litigation funding, creating an unknown exposure for insurance providers.
- Nuclear verdicts® of $10 million or more from sympathetic juries who distrust large companies. A 2022 report by the U.S. Chamber of Commerce Institute for Legal Reform found nuclear verdicts went up in frequency and severity between 2010 and 2019, with the median verdict up 27.5% during that period. A report by the Insurance Research Council (IRC) notes that nuclear verdicts of $20 million or more were up 300% in 2019, compared with the annual average between 2001 and 2010.
- “Runaway litigation” by plaintiffs’ attorneys filing class-action lawsuits or inflated claims that insurers are then forced to defend.
Nearly every line of business—from commercial auto to general liability to professional liability to property to workers compensation—has felt the impact of social inflation over the past several years.
Claims with a bodily injury component have become particularly volatile, difficult and expensive for insurance providers. For example, the average auto bodily injury claim payment grew 5.5% between 2014 and 2019, which was three times the rate of inflation, according to a report by the IRC. Attorney representation on auto bodily injury claims also grew from 47% in 2002 to 52% in 2017, the IRC reported.
In the professional liability space, claims are triggered by allegations of negligence or misrepresentation by the insured. Because of social inflation, professional liability insurance providers are increasingly being pulled into underlying bodily injury claims by plaintiffs’ lawyers attempting to extract a higher settlement amount.
Claims severity is consistently rising as a result, with claims that may have been settled for $100,000 once upon a time resolving for 10 times that amount in some cases.
This is a worrying trend for professional liability insurers, especially given the U.S. Chamber of Commerce Institute for Legal Reform’s finding that “awards stemming from negligence or other unintentional conduct and primarily targeting businesses … account for the vast majority of nuclear verdicts.”
The impact of social inflation on insurers is uncharted territory, as it has become difficult to anticipate how a particular matter might be resolved through settlement or in court, or how to manage risk in a book of business adequately.
As noted in a 2021 report by Milliman, “Social inflation causes disruption to data, metrics and forecasts,” and “strategies that historically were used to control claim costs are no longer as successful or applicable.”
Numerous insurance providers now are struggling to effectively underwrite to reduce their overall exposure to social inflation. Many are responding by enacting coverage restrictions and tightening capacity, putting them at a competitive disadvantage with other companies that are not treating the issue with the same level of seriousness.
This tactic may also be limiting competition in the market for clients, putting agents in a difficult position as it is harder to find their clients the coverage they need, or coverage is more expensive and limited.
Insureds, who generally don’t realize the extenuating factors fueling these changes, are understandably frustrated when they must pay more for less coverage and may express their frustrations to their agents. If clients choose to decline or reduce important coverage to save money, they may be vulnerable to costly losses, and agents could be exposed to professional liability claims.
For example, there have been professional liability claims against managing general agents when a client was either uninsured or underinsured and didn’t have the coverage to defend an underlying bodily injury claim. Third-party administrators have also been significantly impacted by underlying bodily injury claims where their clients alleged that the claims weren’t settled quickly enough or for the right dollar amount.
In one instance, an underlying bodily injury claim resulting from a car accident, valued at approximately $100,000, became a multimillion-dollar professional liability claim against a third-party administrator. In another professional liability claim with underlying bodily injury damages, the payout was expected to be $40,000 to $60,000, but it ended up being settled for $100,000.
The impact of social inflation on insurers is uncharted territory,
as it has become difficult to anticipate how a particular matter
might be resolved through settlement or in
court, or how to manage risk in a book of business adequately.
Education and client communication
The term social inflation doesn’t mean much to many people outside of the industry, which is why education and communication are so key to alleviating the issue and limiting an insurance professional’s E&O exposure.
Here are some steps that insurance professionals can take to mitigate risk for themselves and their clients:
- Provide clients with information and resources on what social inflation is and how it is increasing insurance costs, as well as examples of its impact on claim costs in the client’s industry.
- Be aware of and knowledgeable about the coverage and risk management options available to the different professional clients you serve.
- Clearly communicate with clients about what their coverage includes, and what it doesn’t, as well as what their coverage limits are, and coverage solutions that are available to address policy gaps, such as excess coverage.
- Educate clients on how they can protect themselves from expensive litigation through risk management or coverage and provide risk management opportunities.
Perhaps most important, agents must document all client communications, particularly when coverage is offered and declined or if clients go against an agent’s advice related to policy limits. If an agent’s coverage recommendations or other critical policy conversations are not documented, it is much harder for insurance providers to defend against claims.
There are no signs that social inflation’s negative impact on industry profitability will be slowing any time soon and, unfortunately, it may only be worsening as the mechanisms that support it, such as litigation funding, continue. A report from market research firm RationalStat notes that claimant demand for litigation finance will propel growth in the global litigation funding investment market by around 9% between 2022 and 2028.
Many industry leaders are working hard to sound the alarm on social inflation and how it is impacting the overall market, but the industry as a whole must come together with a united voice and strategy. This may include supporting advocacy efforts for legal reforms to combat third-party litigation funding, or making uniform coverage changes to reduce exposure.
Agents also should be open with their insurance providers and broker partners about what they need to be successful and efficiently service their clients. For example, some professional clients, such as architects and engineers or accountants, may have more risk management opportunities, while miscellaneous professional classes don’t have any.
Insurance providers need to hear from agents about what is lacking so the industry can offer better resources to mitigate risk overall.
Ultimately, social inflation is an industrywide issue that will not be solved by one particular segment or company. By getting on the same page and effectively communicating with all stakeholders, we can hopefully begin to reduce social inflation’s potential for long-term harm.
Tom Rea is executive vice president of Berkley Service Professionals, a Berkley Company. He has nearly 25 years of experience in the industry, predominantly in specialty professional liability insurance, and has created several successful miscellaneous professional liability products and teams from the ground up. He is based in Glastonbury, Connecticut, and can be reached at email@example.com.