Part One – Understanding social inflation
It is difficult to listen to the quarterly earnings call of a publicly traded US insurer without hearing the CEO mention the impact of “social inflation” on the company’s casualty results. The term has only recently become widely used in the US insurance industry, but its first mention was over forty years ago in Warren Buffett’s annual letter to shareholders:
“The pendulum now is beginning to swing the other way. We estimate that costs involved in the insurance areas in which we operate rise at close to 1% per month. This is due to continuous monetary inflation affecting the cost of repairing humans and property, as well as “social inflation”, a broadening definition by society and juries of what is covered by insurance policies. Unless rates rise at a comparable 1% per month, underwriting profits must shrink.”
Warren Buffett, 1977 Letter to Berkshire Hathaway Shareholders
While the American justice system has many strengths, trial by jury frequently lends itself to broad interpretations of the law and outsized awards, often driven more by emotion than by facts, logic, and sound judgment. There are several drivers behind the recent dramatic increase in social inflation:
- General desensitization to large jury verdicts, settlements, and dollar amounts in general – examples include recent multi-billion-dollar jury awards, massive salaries of CEOs and professional athletes.
- More liberal treatment of claims and the expansion of coverage beyond the four corners of the policy – there has been a recent push for insurance policies to cover COVID-19 business interruption claims despite the fact that most policies specifically exclude this exposure.
- Erosion of tort reforms (such as limits on non-economic damages) enacted during the last century.
- Third-party litigation funding where investment groups fund the litigation costs of cases which have high monetary potential in return for a share of the award.
- Changing views of social responsibility and the righting of wrongs
Social inflation has led to a dramatic increase in the number of lawsuits filed and the damages awarded in many of these suits. This article is part of a three-part series scheduled to follow in the next two editions of IUMI Eye. Part Two will focus on the impacts of social inflation on the insurance industry.
