The main business for primary insurance companies is to diversify their underwriting risks. To effectively achieve this, insurers buy reinsurance contracts to improve their financial stability. However, when insurance companies use reinsurance in excess, this may signal financial difficulties for the primary insurer. In this regard, a less solvent insurer is likely to use more reinsurance to raise capital.
Understanding Social Inflation
Social inflation involves a rising cost of insurance claims, resulting from increased litigation, fueled by societal trends. Despite the causes of social inflation, the underwriters demand higher pricing on business accounts.
Other drivers of social inflation include plaintiff-friendly legal decisions, wherever there is righting of wrongs, nuclear verdicts, distrust of the corporate world, media influence, third-party financing litigation, the changing concept of money, and tort reformations.
1. Nuclear Verdicts
A primary driver of social inflation in the insurance marketplace is Nuclear Verdicts, which involves juries asking for an amount more significant than what is anticipated, based on the injuries caused and the situational facts. These large verdicts are a result of the reptile brain used by plaintiffs attorneys to get jurors to access their flight or fight response. Most jurors are motivated by compensatory jury awards and settlements with a shifting focus only on the professionals and rich people, thereby reaping several benefits.
A lawyer uses this approach, making jurors feel threatened by the behavior of the defendant. The main goal of the lawyer is to make the jury angry towards the defendant and not sympathetic to the plaintiff.
2. Distrust of the Corporate World
Distrust of the corporate world has also contributed to social inflation, particularly in the pharmaceutical industry, the jury has a desire to reward the plaintiff, and punish the defendant. The defendants act as supporters of the rights and powers of the people against the privileged elite.
3. The Concept of Money
The jurors have become unrestricted in their delivery of awards, changing the concept of money. As a result, they award more substantial sums of money than expected when they feel that a corporation is a bad actor. Plaintiff lawyers use these large sums of money during the trial to desensitize the jury to issue a nuclear verdict. Jurors are also increasing awards to take care of the injured party, and avoid charging contingent fees by over-compensating the plaintiff bar.
4. Media Influence
Media plays a significant role in shaping the perception of the awards and high verdicts by juries. Abuse of class action, social media coupled with a shorter attention span and Salesforce Consulting Partner also play a role in the jury’s decisions, turning a small movement in use, to the detriment of the defendants. Little or no attention period is allowed for documentary evidence and lengthy technical testimony, resulting in a higher settlement cost for any life insurances, such as John Hancock final expense life insurance. This contributes to the normalization of litigation and entitlement to compensation.
With increasing social media use and television advertising for legal services, many attorneys have engaged in increased liability claims. Many businesses, including corporations and law firms, spend large sums of money on online platforms to display advertisements. Once someone clicks on the advert, the pay goes to the website publisher based on the market value.
Enhanced advertising and the use of online services by the attorneys contribute towards the general perception of the consumer attitudes on personal injury litigation. Such advertising, aimed at making the public angry about income inequalities, and a feeling for entitlement to compensation, make the audience obtain those opportunities for filing a lawsuit or insurance claims. Post events feedback also contributes to the insurance industry suffering from social inflation blow after headline news events that potentially change the thoughts, attitudes, legal environment, and motivations.
5. Third-Party Litigation Funding
Funding from third party litigation has also fueled an increased cost of insurance claims. In settling a lawsuit, both the defendant and the plaintiff face strong incentives. The defendant, who may include businesses, corporations, individuals may work towards minimizing the risk associated with the lawsuit cost. On the other hand, the plaintiffs want to increase it to maximize what they receive as compensation or damages. Eliminating a potential liability of any amount may be an incentive for the defendants. The plaintiffs are motivated by receiving a jury award as soon as a lawsuit becomes filed.
Companies that fund litigation give a lot of resources to the plaintiff attorneys, thus expecting a share in the recovery. The plaintiff lawyer can use litigation funding to access trial technology, mock juries, and focus groups. Still, the plaintiff is not under obligation to refund the money if the lawsuit is unsuccessful. The effect is that the plaintiff attorney has to seek other financial means to get money to retain experts, develop sophisticated trial presentations, and find witnesses.
With litigation financing, many claims can occur and continue to have a long-lasting effect. Backed by litigation funding, defendants have continued to win over plaintiffs by supporting legal teams, making some cases costly to defend. However, with well-funded plaintiff lawyers, and sophisticated technology, defendants have leveled both sides, increasing the claims.
Third-party litigation financing increases the period in which a particular lawsuit can take before resolutions are reached, thus neutralizing the plaintiff’s efforts to settle a claim. To this extent, the defendants face an increased cost of resolving a lawsuit. Moreover, the increased use of litigation financing may support plaintiffs to take their cases to the jury.
6. Tort Reforms
Enactment of tort reforms and punitive damages leads to the filing of few claims, causing insurance companies to experience lower costs resulting in lower premiums. Legislative actions may cause social inflation, with the plaintiff barred after the expiry of the lawsuit period from filing personal injury lawsuits.
The retroactive extensions of the lawsuit period create an additional cost that initially factored in when the insurance policy was priced and issued. For the insurers, there is a lot of pressure on low costs, resulting from longer litigation cycles, higher jury awards, and defense costs. Personal injury claimants and trial lawyers add incentives for more lawsuits, increasing the potential damages on the trial and claims. In turn, the claimants and the plaintiffs seek for higher settlements from the defendants as well as the insurers.
The Effects of Social Inflation on Insurance
The insurance industry faces social inflation increase in many ways, with such financial difficulties becoming a reality in the recent past. The following are some of how social inflation has impacted the insurance industry.
1. High Insurance Claims cause High Insurance Premiums
When the insurance premiums increase, this leads to higher reinsurance premiums, what insurers see in business lines. Such business insurance lines include medical malpractice, commercial, general liability, commercial automobile, directors, and officers.
A primary insurer can recede premiums to others, commonly known as reinsurers. Through this, a primary insurer improves the solvency while diversifying the underwriting risks. However, with social inflation, the primary insurer is responsible for all the claim payments, whether the reinsurance contracts become reinforced or not.
2. Fierce Competition Among Insurance Companies
An unexpected higher claim cost coupled with significant jury verdicts can make insurance companies shut down their business lines, or worse, go out of business. Business competition becomes stiff among insurance companies when the premiums go high. Other companies which are new in the insurance marketplace, may undercut the already increasing premiums to gain market share. A review of defense counselors shows an increase in the plaintiff’s bar, with the captives trying to do so, resulting in higher legal costs. The poor performers in the business get removed from the industry.
3. Increased Insurance Insolvencies
Reinsurance can lead to the solvency of the primary insurer when they fail to recover a reinsurance contract. The higher the risk, the more the potential burdens to the primary insurer, thus, less solvency.
Increased competition for business among insurance companies leads to a downward premium trend in the face of social inflation. Many insurance companies, especially ceding insurers, find it difficult when it comes to predicting and measuring social inflation, due to societal behavioral and attitudinal changes related to righting wrongs and fair compensation.
Reinsurance has an indirect effect on the solvency of the primary insurer. Many primary insurers underwrite less without reinsurance or shift to underwriting policies that are too risky. With the presence of the reinsurance insurers, primary insurers may engage in risky business, raising the risk of insolvency of these insurers.
4. Negative Impact on Insurance Reserves
Social inflation poses a challenge to insurance companies, making it difficult for them to predict trends in social life. An insurer may take years before the adequacy of the original policy pricing. A spike in social inflation impacts both current reserves for the open years, causing the depletion of the reserves, escalating problems for the insurer, or the captive.
When an insurer suffers capital loss and experiences difficulties to recover, this leads to reduced direct writing while raising the use of reinsurance. It is more costly to an insurer to boost an external investment than the internal one already in use. When an insurer experiences a high default risk, outside investors become reluctant to invest in the business. Moreover, the existing business owner may not supply the needed capital, leading to the default in all new investment by the owners.
Social inflation is gaining popularity in modern times because of a shift in societal trends and behavioral changes. It is a concern in the insurance industry because it is difficult to predict trends in social inflation. However, broader definitions of liability by court decisions, changes in laws and regulations, and longer agreement terms increase insurance losses, leading to social inflation.