Blog

The insurance sector can no longer defend itself against these risks using the same old tactics.

Legal misuse in the insurance business is a long-standing problem that has been slowly spreading throughout the sector for many years. It is neither new nor particularly recent. Currently known as social inflation, the consequences are worse and the concept of “tort reform” appears illusive.

As per a study carried out by Munich Reinsurance America, Inc. (Munich Re U.S.) and the American Property Casualty Insurance Association (APCIA), approximately 86% of Americans concur that state and federal lawmakers ought to tackle the malpractices in the legislation. The insurance sector can no longer afford to ignore this issue and pass on the accompanying costs to policyholders, nor can it continue to rely on present methods and solutions.

A look back at the evolution of ‘social inflation’

In a 1977 letter to Berkshire Hathaway stockholders, Warren Buffett utilized the term “social inflation” for the first time, defining it as “a broad definition by society and juries of what is covered by insurance policies.” In a 2010 whitepaper, reinsurer PartnerRe clarified the definition, explaining that social inflation is the rise in insurance losses brought on by:

The following factors have been observed: higher jury awards; wider mistrust of large corporations; more liberal treatment of workers’ compensation boards; increased use of social media; growing attorney involvement in claims; social developments that impact jury members and result in very high jury awards; and widening income disparities.

Today’s operating climate has gotten much tougher for carriers, on top of the abuses that have all continued to get worse. Consumers and regulators are starting to fight back after record rate rises in 2022 and 2023. To reduce costs and boost growth, an increasing number of insurers have stopped renewing property and vehicle policies in unprofitable states and, in certain situations, have pulled out of the market altogether until rates drop.

The longer tail of liability claims hangs over multi-line carriers like a dark cloud as they brave the anticipated more active hurricane season of 2024 and step out from under the shadow of general cost inflation. Considering the long-tail effect casts doubt on reserve accuracy.

One of the many effects of social inflation is pressure on settlements to increase, such as fear of unfavorable trial verdicts. Higher plaintiff awards generally and jury verdicts of $10 million or more, dubbed “nuclear verdicts,” can force insurers to settle disputes more frequently and for larger sums than they have historically, which can alter both reserving and loss payment trends.

According to AM Best, the insurance industries most impacted by social inflation include commercial auto, directors’ and officers’ liability, professional liability, and product liability.

Challenges posed by litigation funding

Around 2015, lawsuit funding emerged, adding to the financial difficulties already posed by the aforementioned. By using a third-party funding organization, litigants can pay their litigation or other legal fees in exchange for a sizable share of any award or settlement. This technique is sometimes referred to as litigation funding or legal financing.

Funding for litigation has the impact of promoting cases and higher settlements that might not have been possible otherwise. A recent RAND Research Report lists the following as some outcomes of this trend:

• A rise of 10% in 19 states’ yearly new court filings per capita between 2012 and 2019.

• In 2019, a significant proportion of cases (64%) resulted in a verdict in the plaintiff’s favor, an increase from 53% in 2010.

The funding for lawsuits has grown dramatically in the last few years. There have been an estimated $15.2 billion invested in commercial litigation in the United States alone, making it a multibillion-dollar sector globally.

Numerous finance companies, some supported by private equity investors, are active worldwide. They can be classified as public or private. At a compound annual growth rate (CAGR) of 13.2% through 2028, the global litigation funding market is projected to reach a valuation of $18.2 billion in 2022. By 2032, the market is expected to have grown to $24.7 million from $13.7 million in 2023, according to some estimates.

Wisconsin, West Virginia, Indiana, and Montana are the only four states with legislation pertaining to litigation financing.

According to survey results released in March 2024 by Munich Reinsurance America, Inc. (Munich Re US) and the American Property Casualty Insurance Association (APCIA), most Americans are unaware of the detrimental effects plaintiff lawyers’ strategies—such as deceptive advertising and the use of third-party litigation funding—have on their household expenses through the “tort tax,” regardless of whether the household is involved in civil litigation. Over 2,000 American individuals were interviewed for the poll, which was carried out by The Harris Poll.

Many Americans are also unaware, according to this research, that the plaintiff lawyer keeps a sizable portion of settlement or judgment awards, with a substantial portion going to investors who have no connection to the claimant and are only looking to benefit from their misery. After realizing this, most Americans (86%) concur that state and federal legislators ought to address the injustices inside the American judicial system.

Role of attorneys

Due to their large advertising budgets, plaintiff law firms that focus on personal injury lawsuits are growing across the country and bringing on new customers. With over a thousand attorneys and locations throughout all states, Morgan & Morgan is the biggest law practice of its kind in the nation.

Trial lawyers in the United States invested almost $2.4 billion on regional print, radio, billboard, and television advertisements last year. Not long after even a small accident, claimants are deluged with lawyer cold calls. Since they often receive between 30% and 50% of settlement funds, plaintiff attorneys have strong financial incentives.

One important indicator of changes in the average claim settlement value is the percentage of claims filed with an attorney. Increased legal fees contribute to higher claim costs in several ways, such as longer claim cycles, larger defense expenditures, and eventually higher settlement sums. These instances tend to inflame the situation by drawing attention to the benefits that consumers may receive from suing insurers in this way.

According to a research study conducted in 2023 by LexisNexis Risk Solution, of those who employed an attorney in connection with motor insurance claims, 57% decided to do so before filing the claim, and 71% stated the attorney pushed them to pursue further care.

According to a Sedgwick survey, 55% of commercial auto claims that are litigated had an attorney involved either prior to or on the same day as the report to carrier date. Just four years ago, this measure was 43%. In the meantime, lawyers become involved in 67% of disputed cases within the first 14 days of filing.

How the insurance industry is responding

When all these issues come together, carriers can no longer afford to watch helplessly as their profitability declines and the company becomes unviable. Increasing numbers of lawsuits, jury verdicts, and the intensity of claims all drive up liability expenses. Premiums are how consumers and businesses are made aware of all of this.

To distinguish social inflation from other contributing components, further research is necessary due to a complex interplay of forces. Any coordinated sector reaction against litigation misuse is still lopsided by a large margin, even though the insurance business has led the charge on tort reform laws in multiple states.

However, different business executives have different opinions about the best ways to counteract it. The chair and CEO of Chubb, Evan Greenberg, has stated that one of the main causes of the skyrocketing expenses of jury verdicts is societal attitudes that pit small businesses against large American enterprises.

At the S&P Global Ratings 40th Annual Insurance Conference, Greenberg told insurers, “We are not the sympathetic face to show” to change those sentiments. He noted that there will not be a federal solution to social inflation and stated that corporations are now driven to spearhead wars that will be fought state by state and county by county.

What’s next: A call for action

The insurance business can’t continue to absorb and pass on the associated costs to policyholders, nor can it rely just on present tactics and solutions to this challenge. Tort reform is a laborious, sluggish process that does not address the trends of today.

More carriers are anticipated to step up and start implementing fresh, all-encompassing short-term tactics to actively tackle societal inflation. These initiatives will probably involve taking steps to hinder the plaintiff bar in troublesome areas, preventing litigation from the start, strengthening legal defenses in their entirety, and possibly assuming greater risk via trials.

The APCIA and other insurance industry associations will be crucial in enabling carriers seeking to implement best practices to share information with one another and in broadly endorsing legal tort reform as a means of securing the industry’s long-term health and sustainability.

Now is the best time of all to get started.