This post is part of a series sponsored by AgentSync.
Social inflation is a term specific to the insurance industry and describes the rising costs of insurance claims beyond what can be explained by the overall rate of inflation.
We recently did a deeper dive into inflation and how it affects the insurance industry. In this piece, we will focus specifically on the idea of social inflation and how it relates to the insurance industry.
What is social inflation?
The insurance industry uses the term “social inflation”
; to describe the rising costs of insurance claims when these costs cannot be accounted for by overall inflation. While insurance claim costs are affected by the prices of pretty much everything—material and labor prices affect the cost of a car claim, for example—social inflation refers specifically to the forces acting to make insurance claims more expensive that are not part of the normal measure of inflation like the consumer price index (KPI).Social inflation can be defined both narrowly and broadly. In the strict sense, social inflation occurs when lawsuits and litigation costs increase for insurers. This can happen for a variety of reasons which we will touch on below. More broadly, anything from new medical advances to changing social attitudes about businesses can drive the cost of insurance claims higher.
Ultimately, social inflation is a concept often referred to in insurance industry discourse, but not always clearly defined or understood, according to a 2020 report by The Geneva Association. The report goes on to say that social inflation is on the rise and poses a threat to insurers as its unpredictable nature means premium increases may not be sufficient to offset rising claims costs.
Another concern: Because liability insurance is “long tail”—meaning the true cost of a claim isn’t known for a period, sometimes years, after the loss occurs—it can be difficult or impossible for an insurer to price policies on appropriate way. These factors make social inflation a risk for insurance companies’ future solvency and profitability.
What causes social inflation?
Social inflation occurs due to factors that contribute to the total cost of injuries when these factors are not tied to general inflation, i.e. the CPI. Depending on your definition, these factors may be limited to increased legal costs or broadly include a variety of social and financial factors.
The point is that “social inflation” is not when prices go up because of supply chain problems or an excess of demand for a product. Social inflation is when (for example) changes in societal attitudes lead juries to award larger settlements to injured parties than they have in the past.
Social inflation can be caused by any, or a combination of, the following:
Advances in medical technology: Modern medicine is expensive! When someone is injured and files a claim against the responsible party’s insurance, their treatment is likely to cost more today than it did in the past. That’s thanks to new drugs and therapies that cost more than the good old “ice it and rest for a few days” method. In addition, new medical technology is helping severely injured people live longer. This is good if you are the injured party, but costly to the insurance companies. If an injured person lives longer, an insurance company can cover many years or decades of treatment, rehabilitation and lost earnings. It is possible that an insurance claim for a seriously injured person could be more expensive if that person lives another 50 years than it would have been to compensate the injured person’s family if the person had died.
More, and bigger, jury awards to plaintiffs: A $301 billion legal settlement is likely unprecedented. In fact, it is unlikely to happen even in the present. But it happened. Cases like this one, where a jury awarded this astronomical sum to the family of a woman killed in a drunk driving accident who claimed a bar willingly served far too much alcohol to the patron causing the death, are becoming more common. From the infamous McDonald’s coffee case to a recent and strange human papillomavirus case that could potentially cost insurer GEICO $5.2 million, judges’ and juries’ opinions about what companies are responsible for and how much they should pay have gotten more expensive over the years. .
How much more expensive? The aforementioned Geneva Association report states: “A review of US cases shows that the number of verdicts of $20 million or more in 2019 has increased by more than 300 percent from the annual average between 2001 and 2010.” Any way you slice it, that’s a lot of huge payouts from insurance companies!
Long and protracted legal processes: As legal cases surrounding liability claims become more complex and take longer to resolve, legal costs increase. This is a contributing factor to social inflation that is very clearly not tied to general economy-wide inflation, but rather is due to more lawyers spending more time trying to reach an agreement between insurers and claimants.
Change in laws, including caps on settlements, or lack thereof: Some states set limits on how much monetary damages can be awarded to claimants. But these laws are (you guessed it!) complex, varied, and ever-changing. As legislation evolves, it may become more consumer-friendly and less business-friendly. New laws may encourage juries to award these large settlements, or at least place no limit on their ability to do so.
New and emerging risks: A pandemic probably wasn’t an event insurers were basing their policy pricing on in 2018. But in 2022? You can bet they’re seriously considering how to build another pandemic into everything from health insurance premiums to business interruption policies.
And pandemics are not the only new risk. With every innovation comes new risks that we could not have imagined before. For example, cyber security risks were not even a twinkle in the eyes of insurance companies in the 1980s. Today, they cost billions of dollars worldwide every year. Unless they have a crystal ball, insurance companies can’t anticipate these brand new risks, so they can’t factor them into their rates. It leaves them open to the risk of having to pay out for a larger, costly and unforeseen event in the future.
There are many other causes and contributing factors to social inflation. To repeat, broadly defined, social inflation is caused by all the spending that results from higher claims costs that cannot be attributed to your normal, everyday inflation.
However, it is important to note here that each of the above factors do not necessarily cause social inflation if they are limited to a short period of time. If we see a wave or explosion of a certain type of activity, it may cause insurance claim costs to be higher for a few years, but things soon return to normal and there is no long-term damage to the financial health of insurance companies. The real question arises when these factors continue to trend upwards over the long term. An even greater risk is that these trends will go unnoticed for years at a time. If social inflation occurs, and it is persistent over time, and insurance companies do not see it and make adjustments to their rates and other financial strategies, it may be too late to right the ship.
What can insurance companies do about social inflation?
While insurance companies cannot simply stop social inflation in its tracks, they can take steps to counteract its effects and to protect themselves against the biggest effects.
The Geneva Association’s report concludes that insurers and the insurance industry as a whole can:
- Lobby for legislation that places limits on liability and limits potential damages awarded to claimants.
- Improve their legal defenses to get better results when claims are settled in the legal system.
- Get better at predicting the unpredictable and consider tomorrow’s surprise claims in today’s underwriting decisions.
- Create new insurance products that intentionally protect insurers from the effects of social inflation by design.
Counter social inflation with risk management strategies
Another way insurers can counter social inflation is with proactive risk management. There are certainly times when accidents and disasters cannot be avoided, but corporate liability can affect the frequency and severity of insurance claims if companies invest in measures and policies that reduce the risk.
If companies see insurance as a “get out of jail free” card, where just having a policy and paying premiums means you don’t have to worry about a thing, they invest less in preventing incidents that lead to large claims.
The insurers can demand that the insured take responsibility for a larger part of the risk, a higher deductible in a sense, both through expectations in insurance contracts and through stricter insurance policies.
For example:
- If a company can only get flood insurance by agreeing to cover the damage associated with the first flood foot before their insurance begins, the company is less likely to build its facilities in a flood plain.
- If a cyber liability policy limits coverage to damage that occurred within the first 12 hours after a credit card skimmer was placed, this motivates retailers to thoroughly train employees to prevent and quickly detect skimmers to prevent major losses.
- To go back to an earlier anecdote, a bar might invest in training staff to recognize the signs of an overly intoxicated person so they can stop serving them
In cases like these, preventive measures can reduce the risk of a catastrophic large loss occurring. If fewer of these claims need to be paid, especially in liability cases that may involve large jury settlements, then social inflation is not as big of a problem.
Whether it’s from general inflation, social inflation or some other cause, insurance companies can’t deny the truth that prices are going up everywhere. Running an insurance company comes with a lot of overhead, including the cost of hiring and retaining the best people. One way to save costs without cutting costs is to adopt a modern compliance management solution. AgentSync can streamline your back office operations, get your downstream distribution partners to sell faster, and do it all without risking your compliance status. See what AgentSync can do for you today.
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