Demystifying social inflation

Inflation has a profound impact on consumer behavior. As the cost of living goes up, people have less purchasing power. This makes them rethink their spending and often cut back on expenses to make ends meet. This means many people look for cheaper insurance plans in the insurance industry. They might reduce their coverage to only the most important and closely examine insurance costs. This results in underinsurance, which leads to an increasing number of underinsured clients. Inflation makes it more expensive for insurance companies to handle claims, so they often must raise premiums.

Besides this, the impact of traditional inflation is compounded by the rise of social inflation.

What is social inflation?

Social inflation refers to the phenomenon of claim settlements outpacing traditional economic inflation. This escalation stems from a shift in societal perspectives on legal culpability and appropriate compensation, leading to a heightened financial burden on insurance carriers. The result is an increasingly litigious culture that results in significant legal awards.

Social inflation is reshaping the legal landscape. It favors plaintiffs with larger verdicts, creating heightened liability risks for insurers. The insurance industry is facing these challenges in all areas, even with personal insurance policies. Legal firms are amplifying the issue by providing services where clients don’t pay unless they win, which encourages more lawsuits by removing the financial obstacles for plaintiffs.

Whether an incident occurs on the street, in a store, or at home, insurers bear the brunt of claims, highlighting the extensive impact of social inflation. It underscores the deep connection between consumer actions and insurance dynamics, forcing insurers to mitigate risk by continuously adapting their strategies.

The impact of social inflation on insurance carriers

Social inflation’s impact on the insurance landscape is particularly evident in the rising costs and litigation pressures carriers face. From 2010 to 2019, commercial auto insurance liability claims payouts surged by over $20 billion. This trend was exacerbated by the booming Third Party Litigation Funding market, expected to reach $31 billion by 2028, with the U.S. accounting for 52% of this growth. Such funding increases litigation frequency and intensity, pushing insurers into tougher financial positions.

The litigation landscape has also seen a dramatic increase in severity and duration. The average trucking verdict size, for instance, rose substantially over the last few years. Median jury awards from the largest U.S. verdicts spiked from $27.7 million to $54.3 million between 2014 and 2018. These trends indicate a shift toward higher compensation demands and more plaintiff-friendly judgments, with nearly half (47%) of claims moving to litigation between 2017 and 2021.

These conditions have contributed to a surge in nuclear verdicts — awards exceeding $10 million — and disproportionately high settlements surpassing policy limits. Such outcomes reflect an increasingly contentious legal environment and pressure insurance providers significantly. Insurers are now challenged with managing riskier portfolios, aligning pricing with increased exposure, and addressing adverse reserve developments. Moreover, the focus on acquiring and retaining high-risk clients further complicates insurers’ sales and distribution strategies.

Left unchecked, social inflation poses a significant threat, especially to property and casualty insurers who operate across all business lines and markets. It contributes to rising rates, claim costs, and the potential for substantial legal awards. This phenomenon manifests itself as an increase in the average severity of litigated cases and a rise in processing time for commercial claims.

Strategies to curb the effects of social inflation

To combat social inflation, insurers must deploy a suite of strategic approaches designed to anticipate, manage, and mitigate its impacts:

Insurers need to prioritize a deep understanding of social inflation’s dynamics to predict its impacts better. Using data analytics, they can develop predictive models for claim severity that identify high-risk claims early, allowing for proactive management.

Insurers should implement risk-based pricing using AI and analytics. This strategy aligns insurance costs with the customer’s risk profile, ensuring that higher-risk customers pay more, which helps balance financial equity and coverage adequacy.

Technological tools like in-car devices and apps can, for example, be used to monitor and improve driving behaviors, reducing claims frequency and severity. Such tools can also educate customers on safe practices, further minimizing risk.

Streamlining the claims process and enhancing post-accident customer service are crucial. Automated systems and efficient management strategies reduce claim resolution times and costs, boosting customer satisfaction.

Insurers should leverage augmented litigation decision systems that provide reliable data on plaintiffs and juries. These systems are crucial for determining the most strategic approach to settling claims or proceeding with litigation based on the likelihood of success and associated costs.

Proactive engagement strategies, including timely notifications and safety tips, keep customers informed and connected. This enhances their safety while deepening their trust in the insurer’s commitment to their well-being.

Insurers must refine their litigation tactics to align more closely with the challenges of claim disputes. By matching plaintiffs with suitable defense strategies through data analytics, insurers can handle legal challenges more effectively.

Adapting pricing models to incorporate trends related to social inflation and implementing detailed exposure-level reserving are essential for precise risk assessment and financial planning.

Through comprehensive analyses, such as book risk assessments and umbrella limits analysis, insurers can protect against potential vulnerabilities and ensure that policies are adequately priced and sufficiently protective.

Getting ahead of the trend

Social inflation and its effects can’t be negated but can be curtailed. Insurers can effectively address this rising trend by concentrating on strategic areas such as risk management, financial stability, and customer education. Enhancing their understanding of social inflation’s specific impacts on their business and leveraging analytics and AI is essential for refining risk assessment and optimizing responses.

This approach helps manage the complexities introduced by social inflation and ensures the insurer’s stability and relevance in a rapidly evolving market. Educating consumers about the importance of comprehensive coverage and preventive measures further mitigates the broader impacts of social inflation, maintaining high levels of customer satisfaction. These strategies should form part of a broader, long-term approach designed to fortify insurers against evolving challenges in the industry.