Social inflation and decades of insurance litigation abuse

The insurance industry can no longer rely on current strategies and responses to these threats.

PartnerRe said in a 2010 white paper that social inflation is the increase in insurance losses caused by higher jury awards; more liberal treatment of claims by workers’ compensation boards; and increased use of social media, among several other factors. (Credit: syahrir/Adobe Stock)

The scourge of legal abuse in insurance is hardly new or even recent but rather has been insidiously growing throughout the industry for decades.  Referred to today as social inflation, the stakes are higher and so-called “tort reform” seems elusive.

Related: The three-headed monster threatening insurance

Some 86% of Americans agree that state and federal lawmakers should address the abuses of the U.S. legal system, according to a study conducted by the American Property Casualty Insurance Association (APCIA) and Munich Reinsurance America, Inc. (Munich Re U.S.). The insurance industry can no longer rely on current strategies and responses to this threat, nor can it continue to absorb and pass along the associated costs to policyholders.

The history of ‘social inflation’

The term “social inflation” was first coined by Warren Buffett in 1977 in a letter to Berkshire Hathaway stockholders, where he defined it as “a broad definition by society and juries of what is covered by insurance policies.”  In 2010, reinsurer PartnerRe expanded on the definition in a whitepaper stating that social inflation is the increase in insurance losses caused by:

In addition to the fact that all of these abuses have continued to worsen, today’s operating environment has become even more challenging for carriers. Having undertaken record rate increases in 2022 and 2023, consumers and regulators have begun to push back. Putting further pressure on growth and profitability, a growing number of insurers have suspended auto and property policy renewals in unprofitable jurisdictions and in some cases withdrawn from the market completely until rates become more attractive.

As multi-line carriers emerge from the shadow of general cost inflation and hold their breath for the predicted more active 2024 hurricane season, the longer tail of liability claims looms like a dark cloud. Reserve accuracy comes into question with the long-tail effect in mind.

For instance, fear of adverse trial decisions tends to pressure settlements upward, but this is just one social inflation’s tentacles. Jury verdicts of $10 million or more, known as “nuclear verdicts,” as well as higher plaintiff awards in general can cause insurers to settle cases more frequently and at higher settlement amounts than in the past, distorting both reserving and loss payment patterns.

The lines of business most affected by social inflation are commercial auto, professional liability, product liability and directors’ and officers’ liability insurance, according to AM Best.

The problem with litigation funding

In addition to the cumulative economic challenges presented by all the foregoing, along came litigation funding around 2015. Litigation funding (also known as legal financing) is the mechanism or process through which litigants can finance their litigation or other legal costs through a third-party funding company in exchange for a sizeable portion of any award or settlement.

Litigation funding has had the effect of encouraging litigation and larger awards, which may otherwise have not been viable. Some of the results of this trend, according to a recent RAND Research Report, include:

In recent years, litigation funding has experienced explosive growth. It is now a multi-billion-dollar industry worldwide, with an estimated $15.2 billion in commercial litigation investments in the United States alone.

There are dozens of funding firms operating globally, both public and private, some backed by private equity investors. The global litigation funding market was valued at $18.2 billion in 2022 and is expected to grow at a compound annual growth rate (CAGR) of 13.2% through 2028. Some estimate that the market will reach $13.7 million in 2023 and surpass $24.7 million by 2032.

Only four states have litigation funding laws: Wisconsin, West Virgina, Indiana and Montana.

In March 2024, the American Property Casualty Insurance Association (APCIA) and Munich Reinsurance America, Inc. (Munich Re US) released survey results that concluded a majority of Americans are not aware of the negative impact plaintiff lawyers’ tactics, including predatory advertising and the use of third party litigation funding, have on their household costs via the “tort tax”, whether or not the household is involved in civil litigation. The survey was conducted by The Harris Poll and included interviews with more than 2,000 U.S. adults.

This research also found that many Americans are not aware that the plaintiff lawyer keeps a high percentage of a settlement or jury award, and a large amount may go to third party investors who have no relationship to the claimant, other than to profit from their misfortune. Once people understand this, most Americans (86%) agree state and federal lawmakers should address the abuses of the U.S. legal system.

Attorney involvement

Plaintiff attorney firms specializing in personal injury cases are expanding nationally and recruiting clients through aggressive advertising budgets. Morgan & Morgan is the largest such law firm in the country, with a network of over 1,000 attorneys and offices in every state.

Last year, trial lawyers spent more than $2.4 billion on local TV, print, billboard and radio ads across the U.S. Claimants are bombarded with attorney marketing letters shortly after even a minor accident.  After all, plaintiff attorneys are well incentivized by commanding some 30% to 50% of the settlement amounts.

The degree of attorney representation rates in claims is a key metric and barometer of average claim settlement amount changes. Higher attorney fees serve to drive up claim costs in several ways, including lengthier claim cycle time, greater legal defense costs and ultimately higher settlement amounts. These cases also tend to focus consumer awareness of the potential rewards resulting from such litigation against insurers, further fanning the flames.

In a 2023 research survey, LexisNexis Risk Solution found that of auto insurance claimants who hired an attorney, 57% decided to do so before submitting the claim and 71% said the attorney encouraged them to seek additional treatment.

A study by Sedgwick found that of litigated commercial auto claims, 55% of them have attorney involvement before, or the same day as, the report to carrier date. This measure was at 43% only four years ago. Meanwhile, 67% of litigated claims have attorneys involved within the first 14 days of being reported.

The insurance industry response

Considering the combined effect of all of these challenges, carriers can no longer afford to passively stand by as their profitability is eroded and the business becomes untenable. Rising rates of litigation, jury awards and claims severity are contributing to higher liability costs. All of this is passed on to consumers and businesses through premiums.

A complex interplay of factors underscores the need for further research to isolate social inflation from other contributing elements. Although the insurance industry has spearheaded tort reform laws in several states, any organized industry pushback against litigation abuse remains disproportionate by a wide margin.

But not all industry leaders agree on the most effective strategies to combat it. Evan Greenberg, chair and chief executive officer of Chubb, explained recently that social attitudes pitting the little guy against big U.S. corporations are a key driver of the spiraling costs of jury verdicts.

“We are not the sympathetic face to show” to change those attitudes, Greenberg said of insurers during the S&P Global Ratings 40th Annual Insurance Conference. Corporations, he said, are now motivated to lead battles that will be waged state by state and county by county, noting that a social inflation fix will not be found at the federal level.

Looking ahead: A call to action

The insurance industry can no longer rely solely on current strategies and responses to this threat, nor can it continue to absorb and pass along the associated costs to policyholders. Tort reform is slow and arduous and ineffective in addressing today’s trends.

We suspect that more carriers will take the lead and begin to deploy new, comprehensive short- term strategies to combat social inflation head-on. Such efforts will likely include actions designed to push back on the plaintiff bar in problematic jurisdictions; avoid litigation from the onset; bolster legal defenses altogether; and perhaps take more risk via trials.

Insurance industry associations including the APCIA will play a key role facilitating exchanges of information between carriers wishing to adopt best practices while broadly supporting legal tort reform in an effort to ensure the long-term health and viability of the industry.

There is no better time to start than right now.

Stephen Applebaum (stephen.applebaum@gmail.com) is managing partner of Insurance Solutions Group. Alan Demers (alan@insurtechconsult.com) is president of InsurTech Consulting, LLC.

This article is published with permission from the authors and may not be reproduced. Opinions expressed here are the authors’ own.

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