A group of general insurance actuaries working as part of the IFoA Covid-19 Action Task Force have been studying the impact of Covid-19. This blog discusses the changes in social inflation caused by pandemic.
Social inflation has no rigid or uniform worldwide definition, but it refers to the unexpected rise in claims because of jury awards and changing views towards litigation. It is largely a jury-driven phenomenon which has been witnessed primarily in the US but which is now catching on globally.
In insurance, social inflation includes the rising costs of claims fuelled by trends in society like increased jury awards against corporate policyholders partly due to behavioural patterns of the plaintiffs’ bars that strategize and act in a way to trigger jury awards.
These behavioural or societal trends could be a more liberal treatment of claims, populism, changing views of social responsibility or a lack of sensitivity to large court settlements. Some changes in the legal environment may also be contributors, for example, third-party litigation funding and eroding tort reforms in the recent past. The compensation awarded by juries often reflects public sentiment more than the actual loss to the claimant.
Social inflation was a major contributor to the insurance and reinsurance industry’s worsening results in the US pre-Covid-19. Both insurers and reinsurers face similar issues dealing with social inflation, higher claim costs lead to higher insurance premiums which in turn lead to greater reinsurance premiums.
Industries such as retailers, healthcare, insurance, banking and financial services that have direct customer interactions at their core have borne the brunt of rising court awards in recent years. Among insurance classes, understandably medical malpractice, commercial auto and directors and officer’s liability (D&O) are most affected by social inflation. Particular examples include truck accidents, sexual assaults and opioid exposures in auto, product, umbrella and excess liability, especially for large corporate risks where the largest limits are offered.
Social inflation can cause long-tail claims to resolve at much more expensive settlements or jury awards than in the past, pushing the overall loss ratio for insurance and reinsurance contracts to 100% or more. Speeding up the settlement process could mitigate social inflation. Countries such as the US or the UK, which operate a common law legal system, are more affected by social inflation than those that operate a civil law system. The top 50 verdicts in US from 2014 to 2018 have nearly doubled from $28 million to $ 54 million, with some even being settled at $1 billion.
Before the pandemic, social inflation has been caused by higher frequency of litigation, a broader definition of what constitutes a liability and juries that enact more plaintiff-friendly legal decisions. It is now unclear if the pandemic and resulting economic and societal chaos is likely to increase or dampen social inflation.
Some believe that Covid-19 may soften the impact of social inflation since court closure and lack of a return to normal dates are impacting the legal environment. Attorneys working remotely make the legal process more complex and slower. Plaintiffs realize that, even if their case makes it to court, it could be a full two years or more before it is tried before a jury. Others worry that jury trials won’t be feasible due to social-distancing rules and outcomes from virtual trials will not result in the same financial verdicts.
It is possible that claimants who find themselves in financial distress may accept an out-of-court settlement to ease their immediate stress. As a result, plaintiffs might be much more willing than before to settle out of court because of impatience or cash-flow issues.
There is also the counterargument that Covid-19 may lead to increase in social inflation. There have been a number of cases against company directors for not having been prepared for a catastrophic event such as this, although the risk of spreading infectious diseases hitting operations was not unknown. There have also been court cases over business interruption claims that insurers have denied. In Europe, there have been some awards in favour of the insureds. This is more a pressing problem in the UK and Europe than in the US where BI is generally triggered by physical damage to property.
Social inflation is similar to any emerging risk except that it is not an actual risk but a driver of the increased costs associated with these risks. Like emerging risks, the effects of social inflation may make reinsurance unaffordable and cause some insurance companies to shut down lines of business or, in extreme situations, go out of business. It can also directly affect reinsurers because those changes alter the economic dynamics of the reinsurance business.
The insurance and reinsurance industry will be cautious and try to clarify the terms and conditions of future policies to either exclude pandemic-related coverage with clear policy wordings or include it with the appropriate added premium. Since a global pandemic similar to the coronavirus is systemic and, therefore, not insurable in principle, the solution may lie in a public-private partnership that may be able to provide insurance coverage against pandemics without overburdening the insurance sector.
In conclusion, although it is unclear whether social inflation will increase or decrease as a result of Covid-19, actuaries should pay particular attention to the trends in liability court awards and factor these into pricing and reserving decisions.
