Social Inflation’s Devastating Effects on Commercial Auto Claim Costs

Social inflation describes the rising cost of insurance claims resulting from events, such as increasing litigation, broader definitions of liability, more plaintiff-friendly courts and larger compensatory jury awards. Recent data from the Insurance Information Institute and the Casualty Actuary Society attributed $20.7 billion in commercial auto losses from 2010 – 2019 to loss-development factors that general inflation cannot explain. That equals 14% of the total $148 billion in claims paid during that time.

“Inflationary pressure is being felt everywhere and the claims/litigation environment is no exception. There are many variables to the concept of social inflation, and the pandemic can be considered one of them,” said Todd McMillan, Vice President – Liability Claims at Safety National. “While the pandemic lowered miles driven, it also agitated the judicial process. Courts are working diligently to address pending matters and, as the miles driven steadily increases, it is reasonable to anticipate an associated increase in auto claim and litigation activity. Consequently, insureds should continue to partner with their carriers to mitigate exposures through collaborative risk management.”

Three major categories of causes are associated with social inflation’s impacts.

Nuclear Verdicts

In recent years, there has been a paradigm shift in how cases are tried due to changes in jury demographics, income inequalities, social pessimism and defense strategies. As a result, nuclear verdicts, those exceeding $10 million or awards greater than the expected payout, are becoming more frequent. The shock value of a million-dollar verdict no longer has the impact it used to with the public’s desensitization to large numbers. Combine that with sympathetic jurors and an anti-corporation sentiment, verdicts are now reaching $1 billion.

Additionally, a common defense strategy, known as reptile theory, is used to influence a jury outcome by stating that if the defendant’s action or inaction were to continue that they could endanger the community and even the jury itself. If used successfully, the plaintiff’s attorney then could convince the jury to return a large verdict against the defendant.

Litigation Funding

According to Bloomberg, litigation funding is a $39 billion industry worldwide. Third-party litigation funding allows financiers, or “silent investors,” to invest in lawsuits in exchange for a portion of the settlement. Since investors assume all responsibility for litigation costs, plaintiffs can employ expensive, expert help, which would otherwise be unattainable. Litigation funding has faced worldwide criticism due to its lack of transparency and the associated potential ethical risks.

Insurers often struggle to know who they are up against but are fighting to reveal who is behind the funds, with groups like the American Property Casualty Insurance Association (APCIA) working to ensure that all parties involved in litigation are disclosed.

Tort Reform Rollbacks

Throughout the 1980s and 90s, the insurance industry was on the brink of collapse due to rising liability claims. The cost of coverage in the US rose dramatically across all sectors. Tort reforms were then enacted across the country, with loss ratios generally declining. These reforms placed limits on attorney contingency fees, modifications of joint and several liability rules, modifications of collateral source rules, limits on liability, and limits on non-economic and punitive damages. While much of this was to reduce medical malpractice costs, the statutory limits on non-economic damages have effectively controlled rising liability claim costs. However, supreme courts in eight states, including Ohio, Alabama, Illinois, New Mexico, New Hampshire, Wisconsin, Oklahoma and Kansas, have overturned these limits. Without a cap on non-economic damages, a large payout could bankrupt an organization.