Social inflation – unpredictable, costly and on the rise

From the cost of our weekly shop to the pinch at the gas pump, we are all feeling the impact of inflation right now.

But while the fallout from economic inflation is all over our news feeds, I want to talk about a different type of inflation. One that is getting far less attention.

Behind the scenes, social inflation is taking hold of the insurance industry. Often harder to predict and quantify than economic inflation, it is driven by a range of socioeconomic, legislative and litigation trends: for example, juries’ negative sentiments against corporations and the increased propensity to litigate.

Shifting loss ratios for insurers are a major challenge and are creating a riskier and more costly environment for corporates. Here are some factors underpinning the trend and how we see them evolving.

Blame culture

Litigation culture was born in the US, but there is plenty of evidence to show underlying drivers of social inflation are spreading worldwide. There was some hope that the pandemic would mark a shift in this negative paradigm as case numbers dipped. There were a greater number of claims paid without going down the route of litigation, and a higher inclination to settle claims pre-trial to avoid delays and uncertainty.

In the US, civil filings in state courts decreased 28% and criminal filings fell 19% between 2019 and 2021 according to the Court Statistic Project and Thomas Reuters Westlaw data analysis by Swiss Re.

But as we continue to find our way while living with Covid-19, it appears litigation is resurging. Law firms are predicting an upwards trend in cases throughout 2022 and 2023.
These will hit the wall of cases caught in a pandemic backlog that courts are struggling to clear. Many more complex and high-severity claims from the past couple of years are still awaiting trial.

Again, looking at the US system, we estimate clearing this backlog could take 18 months to three years and possibly even longer.

With no meaningful reform on the horizon there is nothing to stem this trend, which could come to bite any company.

Third-party funding

The ever-expanding, third-party litigation funding market is having a sizeable impact on case volumes. No-win, no-fee offers make seeking court retribution more accessible for many people. Supported by these funds, law firms are using data and psychological techniques to drive settlements and verdicts to new heights.

But this is certainly not a US phenomenon alone. As an example, the number of filed securities class actions grew 2% annually between 2015 and 2019 in the US, whereas outside the US the annual growth rate has been 15%. And, according to Swiss Re’s own research, it is no coincidence that more than 65% of the securities class actions in the EU and UK are backed by litigation funders.

In fact, third-party litigation funding has even become an alternative asset class, with average return rates higher than real estate and private equity. The global litigation funding market is predicted to reach $18bn by 2025.

But on an individual case basis, juries remain largely unaware these funding models are supporting plaintiffs. They assume the awards given will be solely used to compensate for the wrongs suffered. The awards plaintiffs receive after third-party funders take their share are around 12 percentage points less, on average, than they would have received through traditional routes once legal costs are covered, according to Swiss Re calculations.

Going nuclear

The proportion of cases with huge – or nuclear – verdicts is increasing.

The rise of the share of large verdicts has been a constant since 2014. We observed a reduction in 2020, which has been immediately reversed in 2021. Swiss Re analysis shows that between 2014 and 2021 the number of awards of more than $5m in US courts grew 54%.

This includes large class-action cases, often supported by third-party funding. And as new areas of litigation open, this risk is expanding. The Netherlands, for example, is emerging as an innovative and attractive jurisdiction for many high-profile actions such as climate change litigation.

One notable driver for the increase in nuclear awards is a growing anti-corporate backlash, particularly among younger generations.

The bubbling risk of social inflation is spilling over into insurance pricing and corporate risk profiles. It is fanning the flames of the most challenging risk environment of the century. 

For corporates, the combination of social inflation picking up and the current inflationary economic environment make for an explosive mix. Risks are now harder to evaluate and more costly to insure.

Societal trends will continue to generate more legal proceedings than ever before. And court backlogs will delay resolution and prolong uncertainty.

While economic inflation may be comparatively short term, there is no sign social inflation will wane. There is no way to entirely shield yourself from this changing risk dynamic and companies must open their eyes to what it means for them. 

Julie Stephenson is global head of casualty reinsurance at Swiss Re