Policyholders Are Not to Blame for “Social Inflation”

But when consumers of insurance wonder why premium increases for some products are wildly outpacing economic inflation, they may well be told by their insurers or brokers that so-called social inflation is at least partially to blame.

A quick internet search reveals that social inflation is primarily a creature of publications and studies associated with property and casualty insurance companies, their trade groups and, increasingly, their law firms.⁵ Consumers can also easily learn that these rate increases are being imposed amid record profitability for some of the largest P&C insurers.⁶

Social inflation is the controversial assertion that insurers are facing an unprecedented increase in claims costs—and therefore must increase premiums—due to, inter alia:

• The rise of litigation funding;
• Attorney advertising;
• Legislation incentivizing litigation;
• "Reptile tactics" employed by plaintiffs attorneys;
• The normalization of "nuclear" jury verdicts;
• Pervasive anti-corporate and anti-insurer sentiment, as well as a punitive mindset, among jurors;
• Proliferation of class actions and multidistrict litigation;
• Rollbacks of tort reforms;
• Judicial expansions of the bases for liability; and
• "Changes in underlying beliefs about the appropriateness of filing lawsuits and expectations of higher compensation," according to The Institutes.⁷

Consumer advocates and experts have sharply criticized this theory, finding that there is little or no evidence that these factors are causing premiums and loss ratios to improperly or unjustifiably rise.⁸

But a recent Law360 guest article makes a pernicious addition to the insurance industry's oeuvre of misinformation on this subject: It suggests that policyholders themselves contribute to social inflation by "submit[ting] inflated claims," taking coverage positions "comparatively more extreme than that of the insurer," and seeking extracontractual damages—and that policyholders are therefore also responsible for remedying social inflation.⁹ These accusations are unsupported by empirical data, and should not be accepted by the policyholder community.

A Theory in Search of Evidence
The term "social inflation" is often traced back to Warren Buffett's 1978 letter to the stockholders of Berkshire Hathaway, in which he described "a broadening definition by society and juries of what is covered by insurance policies" and advocated for rate increases.¹⁰ The insurance industry constantly, and almost affectionately, reminds us of this provenance, as if the term's origin magically imbues it with infallible truth.¹¹

Of course it will not be lost on consumers of insurance that the originator of the concept has made a fortune from the float—investment income from collected premium—and underwriting profit of his insurance companies.¹²

In reality, the supposed existence and impact of social inflation has never been supported by credible evidence. Focusing on research by independent academics, in addition to insurance industry-affiliated sources, a consumer liaison to the National Association of Insurance Commissioners recently debunked many of social inflation's foundational assumptions.¹³

Ken Klein found that even within the P&C insurance industry, there is no agreed-upon definition of "social inflation"; industry sources concede that social inflation is difficult to measure and it is hard to find evidence that supports or disproves it; and that there is disagreement about the primary contributing factors to possible social inflation. Additionally, proponents of social inflation theories overlook the following points:

• A general increase in civil litigation cannot automatically be equated with frivolous litigation or incorrect verdicts—generally, there is no evidence that most large awards are not real and proper.
• Verdict data is sparse or poor, but in any event, over 90% of civil cases do not go to trial or verdict, and there is no evidence supporting an assertion that plaintiffs win more often than defendants or that the rules of evidence or procedure are biased toward plaintiffs.
• The U.S. legal system is designed to weed out frivolous cases and reverse verdicts that are unsupported by evidence.
• A rise in gross dollar amounts of verdicts may also be consistent with poor insurer claims handling, and "if [coverage] litigation is driving premiums and loss ratios, then the reason is that insurers are doing business in a way that increasingly is making suing the best and perhaps only option for full recovery."

Klein was unable to find any compelling data showing an increase in frivolous lawsuits brought by plaintiffs or quantifying the effect of alleged frivolous litigation on premiums or insurer loss ratios. Nor could he find compelling data showing that there is an overall increase in insurance litigation (challenging claims denial; insurer bad faith; subrogation).

Ultimately:

[I]f one looks for data supporting essentially any aspect of the claim that Social Inflation is an "increasingly dangerous phenomen[on]" "spreading at an alarming rate" "with devastating consequences for consumers and insurers alike," then either there is no data, or the data is far from conclusive, or the data actually supports the opposite conclusion. ... There is no evidence of any alleged social inflation factor causing insurers to incur new, unusual, and materially higher, improper costs.¹⁴

• At the time of publication, the P&C insurance industry was sitting on over $800 billion in surplus (assets in excess of liabilities), more than at any time in history, representing quadrupled profits since 1994 and a 5,000% increase over the past 60 years. The authors characterized the current surplus as "obscenely excessive."
• "Social inflation" is an industry-created marketing term referencing supposedly spiking litigation, jury verdicts and insurance claims trends that are not actually supported by credible data.
• After accounting for reasonable adjustments based on the Consumer Price Index and population growth, losses across all lines of P&C insurance cumulatively stayed essentially flat between 1999 and 2018 while premiums have gone up and down in sync with the insurance industry's economic cycle.
• D&O insurance was a major target for rate increases in 2020, despite the fact that shareholder class action filings remained flat from 2017 – 2019, the average settlement value in 2019 was the lowest in a decade, alleged investor losses in filed cases decreased by 45% from 2019 to 2018, and 2019 saw the fewest shareholder litigation settlements of the decade.
• Generally, the P&C industry inflates its reported losses by manipulating its claim reserves at key moments to justify rate hikes, while also lowering tax liabilities. The reserves are later released into profits by insurers.
• In short, the social inflation factors cited by the industry have not put it in any kind of financial peril.
• In general, the P&C industry operates according to a "little recognized economic cycle, created by anti-competitive—yet legal—underwriting practices, unique and opaque accounting policies, and virtually unchecked power because of the generally weak regulation of insurance rates."¹⁶

It is beyond the scope of this article, and beyond the expertise of its author, to delve into whether the above findings are correct. Suffice it to say, however, that the existence of social inflation should not be posited or accepted as scientific truth, and in any case it should not be blamed on the policyholders who already pay lucrative premiums in exchange for protection against the very litigation risks cited by proponents of social inflation theories.

No Basis to Blame Policyholders
The recent Law360 guest article discussing social inflation is correct insofar as it correlates unfair insurer claims handling practices with potential exposure to greater liability for both the policyholder and insurer. But it presents no evidence that policyholders are somehow contributing to a cycle of social inflation through the improper submission of claims and pursuit of coverage.

The article imports the concept of social inflation to the first-party property insurance context, which does not normally involve litigation risk, but rather the risk of damage to insured property and resulting financial losses.

But third-party claimants, i.e., tort plaintiffs and their lawyers, are not even relevant to first-party claims. Rather, the article implies, it is policyholders' own supposedly "inflated" claims, "extreme" positions, and "bloated" coverage expectations that create undue loss exposure for insurers and result in premium increases for all. But there is simply no empirical data to support such generalized assertions.

The article's sole illustration of this alleged phenomenon involves homeowners' insurance litigation in Florida. According to the Florida Office of Insurance Regulation, in 2019, Florida accounted for about three quarters of homeowners' suits against insurance companies in the U.S.¹⁷

On some level, it is not surprising that one of the most populous states in the country, that is also hit by far more destructive hurricanes than any other state¹⁸ should be home to a lot of homeowners' insurance litigation.

The OIR suggested other "possibilities to explain the disparity" between Florida and other states, including a proliferation of roof claim solicitations. But the OIR was clear that it "does not have a readily available explanation for Florida's outlier status"—and that Florida's ratio of suits filed to claims closed without payment is eight times higher than the next highest state, Connecticut.¹⁹

The takeaway from the foregoing discussion is that the homeowners' insurance litigation situation in Florida, whatever its causes may be, may not be projected upon any market outside of Florida or upon any other line of insurance.

Property insurers have also protected themselves against litigation costs associated with what they may view as inflated claims. For example, first-party policies—and many state insurance statutes—call for submission of quantum-of-loss disputes to a binding out-of-court appraisal process.

As for supposed extreme positions, we are living in a world in which the property insurance industry effectuated a wholesale denial of most COVID-19-related insurance claims under all-risk policies lacking standard virus exclusions and without conducting meaningful loss investigations.

In short, policyholders should be extremely skeptical of social inflation arguments put forward by the insurance industry.

¹ E.g., C. Oner, Inflation: Prices on the Rise, International Monetary Fund, https://www.imf.org/en/Publications/fandd/issues/Series/Back-to-Basics/Inflation#:~:text=Long%2Dlasting%20episodes%20of%20high,power%20falls%20and%20prices%20rise. (last visited Nov. 12, 2022).

² E.g., P. Harker, Inflation: What Caused It and What to Do About It, National Bureau of Economic Research (Sept. 1984), available at https://www.nber.org/system/files/working_papers/w1453/w1453.pdf (last visited Nov. 12, 2022).

³ E.g., F. Mishkin, The Causes of Inflation, Federal Reserve Bank of Philadelphia (Oct. 20, 2022), https://www.philadelphiafed.org/the-economy/monetary-policy/221020-greater-vineland-chamber-of-commerce (last visited Nov. 12, 2022).

⁴ E.g., L. Ball, et al., Understanding US inflation during the COVID era, Brookings Papers on Economic Activity (Sept. 7, 2022), https://www.brookings.edu/bpea-articles/understanding-u-s-inflation-during-the-covid-era/ (last visited Nov. 12, 2022).

⁵ E.g., J. Dunsavage. What is Social Inflation?  What Can Insurers Do About It?, Insurance Information Institute (Jan. 25, 2021), https://www.iii.org/insuranceindustryblog/what-is-social-inflation-what-can-insurersdo-about-it/ (last visited Nov. 12, 2022); D. Pain, Social Inflation: Navigating the evolving claims environment (December 2020), The Geneva Association,  https://www.genevaassociation.org/sites/default/files/research-topics-document-type/pdf_public/social_inflation_brief_web.pdf (last visited Nov. 12, 2022); 4 Factors Causing Social Inflation, Travelers, https://www.travelers.com/business-insurance/general-liability/4-factors-causing-social-inflation (last visited Nov. 12, 2022); J. Stephenson, Social inflation – unpredictable, costly and on the rise, Swiss Re Group (Sept. 8, 2022), https://www.swissre.com/risk-knowledge/risk-perspectives-blog/social-inflation-blog-julie-stephenson.html (last visited Nov. 12, 2022); Hinshaw & Culbertson LLP, Insurers are Confronting the Combined Forces of Social Inflation, Price Level Inflation, and Greenflation (July 28, 2022), https://www.hinshawlaw.com/newsroom-updates-insights-for-insurers-insurers-are-confronting-social-inflation-price-level-inflation-and-greenflation.html (last visited Nov. 12, 2022).

⁶ E.g., B. Moorcraft, Chubb breaks records in Q2 earnings, Insurance Business America (July 26, 2022), https://www.insurancebusinessmag.com/us/news/breaking-news/chubb-breaks-records-in-q2-earnings-414558.aspx (last visited Nov. 12, 2022); Zurich delivers one of the best results in its history; expect to meet or exceed all 2022 targets, Zurich Insurance Group (Feb. 10, 2022), https://www.zurich.com/media/news-releases/2022/2022-0210-01 (last visited Nov. 12, 2022).

⁷ See, e.g., B. Green, Policyholders should also want to fight social inflation, Law360 (Nov. 8, 2022), https://www.law360.com/insurance-authority/articles/1544390/policyholders-should-also-want-to-fight-social-inflation (last visited Nov. 13, 2022); Social Inflation: Evidence and Impact on Property-Casualty Insurance, The Institutes Risk & Insurance Knowledge Group (June 2020), https://www.insurance-research.org/sites/default/files/news_releases/IRCSocialInflation2020.pdf (last visited Nov. 13, 2022); S. Seaman, et al., The legal trends behind 'social inflation' in insurance, Law360 (Feb. 21, 2020), https://www.law360.com/articles/1245725?scroll=1&related=1 (last visited Nov. 13, 2022).

⁸ E.g., K. Klein, Unpacking "Social Inflation," NAIC Summer 2022 National Meeting (Aug. 12, 2022), https://content.naic.org/sites/default/files/national_meeting/AttmtFive_Consumer_Social%20Inflation_kenklein.pdf (last visited Nov. 12, 2022); J.R. Hunter, et al., How the Cash-Rich Insurance Industry Fakes Crises and Invents Social Inflation, Consumer Federation of America (March 9, 2020), https://consumerfed.org/wp-content/uploads/2021/04/How-the-Cash-Rich-Insurance-Industry-Fakes-Crises-and-Invents-Social-Inflation.pdf (last visited Nov. 12, 2022).  See also D. Nye, et al., The Myth of the Liability Insurance Claims Explosion: An Empirical Rebuttal, 41 Vanderbilt L. Rev. 909 (1988), https://scholarship.law.vanderbilt.edu/vlr/vol41/iss5/2/ (last visited Nov. 12, 2022).

⁹ B. Green, Policyholders should also want to fight social inflation, Law360 (Nov. 8, 2022), https://www.law360.com/insurance-authority/articles/1544390/policyholders-should-also-want-to-fight-social-inflation (last visited Nov. 13, 2022).

¹⁰ W. Buffett, Chairman's Letter to the Stockholders of Berkshire Hathaway Inc. (March 14, 1978), https://www.berkshirehathaway.com/letters/1977.html (last visited Nov. 13, 2022).

¹¹ E.g., Triple-I, CAS Quantify Social Inflation's Impact on Commercial Auto (Feb. 8, 2022), https://www.iii.org/insuranceindustryblog/triple-i-cas-quantify-social-inflations-impact-on-commercial-auto/ (last visited Nov. 13, 2022).

¹² E.g., J. Goldstein, Warrant Buffett Explains the Genius of the Float, NPR Planet Money (March 1, 2010), https://www.npr.org/sections/money/2010/03/warren_buffett_explains_the_ge.html (last visited Nov. 13, 2022); C. Carlsen, 147 Billion Reasons Why Warren Buffett Loves the Insurance Industry, The Motley Fool (March 4, 2022), https://www.fool.com/investing/2022/03/04/147-billion-reasons-why-warren-buffett-loves-the-i/ (last visited Nov. 13, 2022).

¹³ K. Klein, Unpacking "Social Inflation," NAIC Summer 2022 National Meeting (Aug. 12, 2022), https://content.naic.org/sites/default/files/national_meeting/AttmtFive_Consumer_Social%20Inflation_kenklein.pdf (last visited Nov. 12, 2022).

¹⁴ Id.

¹⁵ J.R. Hunter, et al., How the Cash-Rich Insurance Industry Fakes Crises and Invents Social Inflation, Consumer Federation of America (March 9, 2020), https://consumerfed.org/wp-content/uploads/2021/04/How-the-Cash-Rich-Insurance-Industry-Fakes-Crises-and-Invents-Social-Inflation.pdf (last visited Nov. 12, 2022).

¹⁶ Id.

¹⁷ OIR Commissioner D. Altmaier Letter (Apr. 2, 2021), https://floir.com/siteDocuments/ChairIngoglia04022021.pdf (last visited Nov. 13, 2022).

¹⁸ B. Griggs, No other state gets hit by hurricanes as often as Florida, CNN (Sept. 11, 2017), https://www.cnn.com/2017/09/11/us/hurricanes-landfall-by-state-trnd (last visited Nov. 13, 2022).

¹⁹ OIR Commissioner D. Altmaier Letter (Apr. 2, 2021), https://floir.com/siteDocuments/ChairIngoglia04022021.pdf (last visited Nov. 13, 2022).