Social inflation arrived on the insurance scene in 2017 and is not going away. Captive International reports on a growing issue for insurers.
“All else being equal, jury awards are higher in geographic areas with greater levels of income inequality.”
Jeremy Pecora, WTW
In the wake of the COVID-19 pandemic, the issue of inflation is particularly relevant at the moment—and especially social inflation, including claims inflation.
The cause of inflation in the general US economy is complicated and is down to a wide range of factors, from the price of oil to the Russian invasion of the Ukraine and post-COVID 19 issues surrounding manufacturing and supply.
Social inflation is different from normal inflation, as the latter causes a steadier increase in values across all claims, whereas social inflation can cause a dramatic shift in the likelihood and size of large claims. And the likelihood of higher claims changes behaviours for both plaintiffs and defendants.
However, according to WTW, the reasons behind a recent jump in claims from legal cases are a number of societal and sociological issues.
In a presentation before the Insurance Managers Association of Cayman in December 2021, Jeremy Pecora, actuarial advisor & manager at WTW, said that social inflation arrived on the insurance scene in 2017 and was driving catastrophic liability. One thing he cited was increasing wealth disparity: the relationship between wealth disparity and loss ratios has shown that, all else being equal, jury awards are higher in geographic areas with greater levels of income inequality.
As a result, this had created a ‘haves’ vs ‘have-nots’ mentality, leading lawyers and juries to search for the deepest pockets.
In addition, a new generation is starting to enter the jury selection pool, changing the makeup of that pool. The Millennials are arriving, and WTW cited polling data that claimed that 71 percent of Millennials feel corporations put profits ahead of safety
This means that in some trials juries are increasingly anti-corporate. Jurors are becoming familiar with corporate wrongdoing—so when it comes to punitive damages, the idea is to punish a corporation and deter it from future wrongdoing.
With bigger awards being given by juries, WTW thinks that this is leading to more aggressive plaintiffs, while some defence lawyers are too complacent. As a result, insufficient preparation and financial incentives weaken a legal defence’s ability to counter aggressive trial bar efforts.
WTW also noted that law firms have increased marketing spend by a possible factor of 10 over the last decade, as litigious issues become more prominent.
Jurors for social justice
In a 2020 report, “Managing captive insurance in a social inflationary world” EY stated that jury interviews suggest that social inflation is based on a growing belief in the importance of social justice and that the desire for social justice is accompanied by individuals’ feelings regarding a reasonable level of compensation and that compensation for injured parties should be significantly higher than it previously was.
EY said that social media had influenced corporate behaviour by pressuring businesses to take morally defensible positions or positions that will not show up in a social media blog with multiple supporters.
Social inflation is impacted by the generational composition of juries. EY pointed out that a larger portion of juries now comprise Millennials and underlined that market research indicates that Millennials typically have higher distrust for corporations and a higher propensity to determine larger awards as jurors.
“These jurors tend to have a shorter attention span, as they have grown up in a rapid-fire, multitask, social media environment,” said the EY report. “Jurors with a shorter attention span may pay less attention to lengthy testimony and complex explanations and may ultimately make their award decisions based more on emotions.”
EY pointed out that a lot of modern corporations are integrating social missions into their business operations and recruiting strategies for Millennials and Generation Z talent. Since it has historically become more conventional for corporations to introduce ethical behaviour, there may be a greater inclination to punish companies when individuals have been significantly harmed. The days of companies doing cost-based analyses on settling severe claims based on product weaknesses appear to be long gone.
Another element identified by EY is the salary of many jurors. EY said that that higher-valued worker salaries have grown by a larger amount than average employee salaries, which may also influence claim values in jurors’ eyes. As a result, younger individuals may be more inclined to regard larger awards as more in line with damages.
EY said that from 1978 to 2018, average chief executive salaries grew by 940 percent to $17.2 million, while the average wage increase for high-valued workers grew by 339 percent. Wages for average-salaried employees have grown by just 11 percent in that same time frame.
According to EY these figures illustrate that Millennials have grown up in a time when higher-valued workers earn significantly more than they previously did. Similar increases can be seen for professional athletes and entertainers. These factors may impel younger individuals towards making larger jury awards.
EY stated that the current increases in social inflation are expected to have a permanent effect. The current issuance of higher awards may desensitise juries to these awards in the future as they become more commonplace. Insurance companies also have an increased propensity to settle at higher values, as the possibility of large awards under litigation changes company behaviour.
“Increasing social inflation should influence how captives handle both their claims and overall operations.”
An example of this behaviour was when an umbrella carrier settled a claim for several million dollars to avoid litigation and potentially higher costs. The primary insurance carrier was unwilling to settle the claim, and on trial, no liability was found. The umbrella carrier settling in what was described as a clear case of no liability as advised and proved by the primary carrier clearly illustrates an increased propensity to settle based on fears of increased costs in a social inflation environment.
Other non-societal trends that may impact increasing social inflation include the incidence of “nuclear” settlements and third-party litigation funding. Nuclear settlements are defined as devastatingly large claim settlements where liability has little correlation to economic loss or prior settlement precedent and are often characterised as settlements of $10 million or higher. Wrongful death settlements associated with trucking claims have been observed in the $20 million range, and other large automobile claims for amounts exceeding $50 million have been reported.
The concept of third-party funding of claims litigation relates to hedge funds and investment companies financing the plaintiff position of claims in exchange for a portion of the final settlement amount. This increasingly common funding mechanism enables a claimant and its legal counsel to obtain fees from an investment company to allow more time for them to pursue their claim and likely achieve a greater ultimate settlement value.
EY identified that a number of insurance lines of business are experiencing and will continue to experience the impacts of social inflation, including:
- Personal automobile and commercial automobile liability. Severe injuries and deaths are associated with automobile insurance, many involving driver error or the use of a vehicle in a state of disrepair.
- Commercial general liability. Claims under this line involve bodily injury and property damage to third parties. These include product liability, premises operations and contracting claims. Each of these lines can experience very large jury awards associated with the most severe claims.
- Professional liability. These claims include employment practices insurance (EPLI), directors and officers claims, and medical malpractice claims. Increases in severe matters are most notable in the EPLI and medical malpractice sectors.
- Excess and umbrella liability. Insurance coverages, including those listed above, are often provided with a primary limit of coverage, typically $1 million. Excess and umbrella insurance coverages are provided for limits over and above the aforementioned primary limits. Instances where major companies are involved and major excess and umbrella limits are provided raise the potential for significant awards and payment of such awards.
Captive insurance companies are usually established to manage risk efficiently, as EY points out. Captives achieve efficiencies by hiring company risk-management personnel to understand and control the exposures. Captives are also cost-efficient, as they eliminate the margin and expense levels associated with the purchase of insurance company risk transfer policies.
In today’s environment, excess-of-loss coverages and the associated price/risk trade-off should be explored as claims begin to reach levels much higher than in the recent past. A company should model scenarios of one or a few additional shock losses at industry levels to determine whether such losses are manageable or whether high excess coverages should be purchased.
Captive insurance companies should also invest in exploring claim defence and settlement strategies in the increasing social inflation environment. Captive management should try to actively defend certain claims on a risk-reward basis. A captive insurer should guard against developing a reputation as one willing to settle all high-valued claims regardless of merit.
In addition, captives have actuarial consultants or in-house actuaries to assist in the development of rate and reserve levels. EY thinks that captive management should discuss the impact of social inflation on the relevant lines of insurance with its actuarial team. During recent years, the insurance industry has generally exhibited favourable-to-stable run-off of reserves, and pricing levels have followed suit (decreasing or remaining stable) for many captive insurance companies.
However, this favourable environment may be changing. Captive insurers should monitor trends closely with their actuarial personnel to mitigate the downside potential in their rates and reserve levels. Inadequate loss reserve and rate levels can hinder management in managing, expensing and developing risk transfer mechanisms for captive programmes.
The insurance world often exhibits loss and premium cycles that are driven by market forces. Social inflation is an important factor in the current environment. It is vital for captive insurance management to become aware of the social inflation developments and establish a strategy to manage risk that may be significantly increasing in certain sectors.
“Increasing social inflation should influence how captives handle both their claims and overall operations,” EY warns. “First and foremost, risk managers and corporations should understand how attractive a target they may be. Litigation counsels will be knowledgeable of the company’s financial means, its potential for reputational risk and its insurance coverage. In developing a defence strategy, jurisdictional factors should be taken into consideration.
“The difference in outcome by state has always been a relevant consideration, but jurisdictional analysis is an even higher defence priority now because of social inflation. Until recently, high-valued claims had experienced relatively stable trends and were not a major risk-management concern. That situation has changed.”
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