By Tim McCarthy
Social inflation, loosely defined by some as an increase in insurance claims costs due to increased litigation and larger jury awards, can be tricky to pin down. A catastrophe typically leaves a discrete and unambiguous mark on insurer losses, allowing observers to draw a clear line between cause and effect. The evidence for social inflation is usually inferred. Rather than one unambiguous causal link, there may be multiple indicators that point to social inflation. That said, we see several indications that suggest that social inflation is indeed more significant today than it had been in some time.
To understand why, let's break our headline question into a few chunks.
Yes. According to ISO statistical data and data from insurers’ annual statements, some coverages within general liability, commercial auto, and commercial umbrella/excess have experienced growing loss ratios since around 2015—or earlier.
For instance, according to an analysis of ISO statistical data containing general liability and commercial umbrella/excess experience, overall calendar year loss ratios (compared to charged premium) stood at 52.9 percent in 2015. They've climbed nearly every year since, landing at 61 percent in 2019. The trend has been even sharper for the commercial umbrella/excess loss ratio, which started deteriorating after 2012 (39.1 percent) to finish 2019 at 57.9 percent.
This is also during a period of generally rising rates for general liability and commercial auto based on the ISO MarketWatch® renewal indices for risks of all premium sizes. This generally indicates that lower rates aren’t driving the increasing loss ratios.
It doesn't appear to be. In fact, across several coverages experiencing higher losses, claims frequency has been relatively flat or trending down. This would appear to support the view that there has not been an increasing propensity to sue.
Take the premises/operations coverage inside general liability—from 2015-2018, ISO data shows calendar year loss ratios increasing from 63.2 percent to 72.3 percent. Yet claims frequency for this coverage fell for every year except 2018, where it notched a modest increase.
When we look at severity trends during this same period for premises/operations, we see increases in both property damage and bodily injury claims severity.
Unlikely. For one thing, insurer pricing models and loss reserves generally account for inflation, as does the loss development and trend processes that Verisk undertakes to produce our prospective loss costs. Indicators of macro-economic inflation aren't showing a sharp uptick, either.1 Loss ratios are significantly deteriorating in commercial umbrella/excess, which suggests that insurers aren't necessarily experiencing the cumulative effects of rising prices but the impact of very large claims.
There are several steps insurers could consider, including leveraging legal analytical tools, their own internal legal data, and making plans for possible "nuclear" verdicts so they're not caught off-guard should one materialize. Regularly reviewing and updating rating information, especially in times where social inflation may be significant, would also be a best practice.
Since it is generally understood that the most purchased attachment point for commercial umbrella/excess has not changed in over 30 years, a greater percentage of commercial auto and general liability losses are being responded to by those policies and may be an area to monitor closely.
Verisk routinely reviews our methodologies, actuarial rating information and exposure bases to help maintain consistency with current trends. For instance, in response to rising losses, Verisk has raised the increased limit factors in its general liability program for each of the past three years and will do so again in 2021.
Thanks to our work in response to past bouts of social inflation, we developed responsive actuarial methodologies that can help us derive more accurate rating-related information to help insurers mitigate the potential impact of social inflation.
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Litigation funding may incentivize the pursuit of more suits and larger jury payouts, which could lead to higher insurer losses and claims expenses.