Social Inflation: Increasing the Cost of Commercial Auto Insurance in the United States

Social Inflation: Increasing the Cost of Commercial Auto Insurance in the United States

Litigation cost has been on the rise and has a significant impact on insurer claim payouts, loss ratios, and the amount policyholders pay for coverage; this impact is known as ‘social inflation.’ According to a recent study conducted by Triple-I in collaboration with the Casualty Actuarial Society (CAS), between 2010 and 2019, social inflation boosted claims for commercial auto liability alone by more than $20 billion. The same pattern goes to other sectors like claims on medical malpractice and other liability incidences.

“If plaintiffs continue to win their actions against insurance companies, the amount of money insurance firms will continue to pay for claims will undoubtedly increase,” says Ronald F. Wittmeyer, Jr. In simple terms, social inflation means that juries are awarding considerable sums to plaintiffs, causing insurance firms to pay much more for claims. However, this needs serious attention to avoid crippling the entire state economy.

Contributing Factors to Social Inflation

Social inflation happens as a result of many reasons. The following are the key contributors to social inflation:

1. Negative Public Perception Towards Larger Corporations

Since the financial crisis, the American people have had a high skepticism towards large organizations and businesses. The news and media have occasionally aided this perception by broadcasting one-sided stories exposing corporate and business wrongdoings.

Such reports have led to a predisposition among juries and judges to sympathize with plaintiffs and support their claims since there are assumptions that the firm or insurance company can afford to pay the damages. They offer this support frequently regardless of the defendant’s level of fault, resulting in “shock” verdicts. These monetary damage awards are substantially larger than predicted based on the facts produced at trial, typically exceeding $10 million.

Furthermore, as several studies have shown, jury rulings can be unpredictable since jury members rarely have the professional competence to evaluate the case. Also, Jurors occasionally seek to penalize corporations and smear their reputations; juries frequently believe that only a massive award can “send a message.”

2. Litigation Funding

Plaintiff’s attorneys’ emotional pleas to juries are nothing new, nor are class action lawsuits. However, the plaintiff’s bar has taken things to a new level with third-party litigation fundraising and litigation lending methods. Litigation funding, banned in the past, is the act of funding lawsuits in exchange for a portion of any monies received by the plaintiffs. The practice is increasing and has become a contributor to social inflation as these bans have become weak in recent decades.

This trend continues to grow and the reason is because of the rise of a strong litigation industry capable of financing even illegal and costly cases. Litigation financiers cover all or part of the costs of litigation or arbitration, including attorney’s fees, making up a large part of the total cost of a trial. The financiers receive a predetermined proportion of the verdict or settlement money, as high as 40 percent.

It is essential to note that legal codes of ethics do not apply to financiers in the same way they do to lawyers who work on a contingency fee basis. As the litigation industry keeps growing, plaintiffs have become more willing to settle cases, as defendants may likely face higher defense expenses due to prolonged litigation. With this, plaintiffs can hire qualified experts, investigators, and witnesses to establish a litigation strategy.

3. State Legislative Rollbacks on Tort Reform

Liability claims nearly brought the American insurance industry to its knees in the 1980s, with coverage costs skyrocketing across all sectors. To reduce the harshness of unexpected jury awards, many states implemented tort reform laws. As a result of this tort reform passed around the country, there was a decrease in loss ratios.

Also, some jurisdictions have enacted statutory restrictions on punitive and non-economic damages awards, which have proven to help contain increasing liability claim costs. However, there have been changes in these reform laws by legislation in some states in recent years.

As a result, the reform trend has reverted to pre-reform levels. According to studies, legislative efforts in several jurisdictions to reverse these measures have contributed to social inflation.

The Impact of Social Inflation

Social Inflation’s effect on commercial auto Liability, products liability, and medical malpractice is high. However, commercial transportation is one of the sectors with the highest increase in litigation rate, which has resulted in higher insurance claim payouts. In a 2020 study conducted by the American Transportation Research Institute, the magnitude of jury verdict awards increased by 33 percent yearly between 2010 and 2018, while the total inflation increase rate was 1.7 percent and healthcare costs increased by 2.9 percent.

More frequent litigation and more expensive jury decisions may result in higher insurance costs and might force insurers to quit writing certain types of insurance. Higher claim expenses are also transferred down to policyholders as higher premiums. In severe circumstances, rising claim costs can spread across the economy, generating conditions similar to the 1980s liability crisis, when liability claims wreaked havoc on the insurance business in the United States, causing several insurers to go bankrupt.

Battling the Social Inflation Trend

There are steps insurers can take to curb social inflation. One of the steps is to participate in public policy debates to support legislative reforms that aim at leveling the playing field between plaintiffs and defendants. Additionally, an improvement in the ability to defend against aggressive plaintiffs’ lawyers; will have a significant impact on combating the social inflation trend.

Insurers can also improve their underwriting to limit the chances of claims shocks. They require better early-warning systems that incorporate data from across their businesses, liability cases, and data from social and digital media.

Furthermore, insurers should create policies to reduce social inflation. Co-participation agreements amongst reinsurers to share risks could help keep and even broaden the limits of insurability. Parametric insurance might play a part as well.

Final Thought

When a private citizen wins a case against a corporation, the financial consequences can be devastating, especially in the United States. Thus, it is advisable for business leaders and insurers to learn more about the social inflation trend, the drivers, and the potential influence on future financial outcomes.

Having a good grasp of social inflation, the reasons that contribute to the trend, and the potential consequences will enable Corporations and insurers to foresee future risks and losses from various claims and litigation. As the plaintiff bar has created new clever courtroom strategies to push for higher awards, the defense bar should also respond with its plan to stop the ongoing inflation of awards.

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