The past three years have been challenging, to say the least, for everyone buying insurance. Individuals, families, and corporations have been hit with significant increases in premium, reductions in the amount of insurance offered by insurers on a particular risk or community, and more restrictive coverage terms.
What’s behind these changes?
The answer can be found in a confluence of factors, including: Unprecedented natural catastrophes, which have cost insurers and reinsurers dearly. Supply chain problems caused by the pandemic, which have led to higher construction costs and more expensive auto parts. Tight labor markets, which have further increased the cost of rebuilding and repairing anything and everything.
And then there’s “social inflation.”
While the effect of factors like natural disasters and price inflation on insurance costs is clear and direct, the impact of social inflation is not so easily recognized—or as well understood.
So, what is social inflation? What causes it? And how can it be brought under control?
A recurring cycle.
Social inflation arises from the cost of legal judgments that insurance companies must pay and can be defined as insurance companies’ increased costs beyond general economic inflation. It tends to run in cycles, from conditions that favor plaintiffs at one time to those that favor defendants—and the companies that insure them—at another. When the litigation pendulum swings to the plaintiffs’ side, insurers bear the brunt of the cost.
Contrary to what is being hyped by some, social inflation is nothing new. In the past, conditions like the ones we find ourselves in would have been labeled a “liability crisis” or “insurance crisis,” but the fundamentals haven’t significantly changed.
Underpinned by changes in jury attitudes, rollbacks in tort reform, and other factors, we are now in an environment in which the pendulum has swung in favor of plaintiffs—which means that insurers are paying bigger settlements more frequently. How do they absorb these increased expenses? By increasing the premiums they charge for liability insurance.
And two new twists.
While the social inflation cycle is a well-established pattern, two new factors have arisen that threaten a return to reason anytime soon: Litigation funding and the failure of insurers to index their pricing and exposures to loss.
First, litigation funding. Litigation funding is a relatively new (and outrageous) practice through which a hedge fund, specialized litigation funding firm, or other financing source provides capital to a plaintiff involved in litigation in return for a portion of the settlement.
With this funding, plaintiffs and their attorneys have more time and money on their side than ever before, allowing them to hold out for jury trials and potentially higher settlements—without having to suffer any loss or damages of their own. Only time will tell if the cure for the litigation funding problem is curtailing or even eliminating litigation funding altogether, or something as simple as requiring that courts disclose to juries that the actual plaintiffs are not only those who have suffered the loss in question, but also include a group of investors who are unrelated to the claim and have suffered no harm or damages. Until then, so long as such third parties are allowed to join in, settlements will continue to rise and, along with them, insurance premiums.
Including a self-inflicted wound.
The other new problem is the failure of the insurance industry to index itself.
One of the least discussed causes of current social inflation conditions is insurers themselves and the role they play in almost encouraging social inflation.
For over 40 years, the primary limit of liability insurance offered by insurers—whether commercial general liability insurance, auto insurance, medical malpractice, or other form of professional liability coverage—has been set at $1 million. Over those same 40 years, however, the value of money has nearly tripled (e.g., $500,000 in 1984 is now worth about $1,500,000).
Insurance pricing for umbrella coverages has not nearly kept pace, so insurance buyers are, in effect, spending 1984 dollars for 1984 limits of coverage in 2024. For example, personal and small business umbrella liability pricing continues to hover between $500 to $1,000 per million of coverage, which is close to, if not the same, as it cost in the mid-80s. We see the same thing happening with deductibles. Many individuals and families have carried $500 personal automobile deductibles for decades when it’s now not uncommon for something as small as a damaged side-view mirror to easily cost $1,000 to replace—twice as much as the deductible.
Insurers may squawk about how they are paying more losses in their excess or umbrella layers, but they must acknowledge their share of blame or responsibility by neglecting to adjust their pricing over the past four decades.
How can the problem of social inflation be solved? There are a number of ways. State legislatures must enact tort reforms that bring more reason to the litigation process. They also need to address the problems that come with litigation funding by either eliminating it or at least requiring it to be disclosed. Corporate and personal consumers need to better understand the increased cost of risk and be prepared to take more risk if they are going to own properties. And insurers need to index all aspects of their business (deductibles, limits, and pricing) so that every time their clients renew their policies, they will be reminded that everyone, insurers and clients alike, must be prepared to take on new and greater risks as they arise.
Why Altus Partners is uniquely prepared to help.
As the nation’s only 100% commission-free corporate insurance broker, Altus Partners has always measured success not by how much we can sell our clients but by how well we can serve them. This can be especially valuable in helping you navigate the complexities of risk management in an environment as challenging and volatile as we face today. Whenever you need objective advice or guidance, please don’t hesitate to call on us.