November 8, 2022
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Insurers frequently bemoan the rise of social inflation, but why is the industry best equipped to insulate itself from the problem the only one sounding the alarm? Meanwhile, the real victims of social inflation are, at best, apathetic.
Effectively combating the ills of social inflation requires all stakeholders, not just insurers, to recognize the mutual interests between insurers and the risk pool of insureds, and how those transactions influence the economy more broadly. Indeed, insureds and insurers alike participate in a symbiotic relationship and are accountable to each other — we are all in this together.
Broadly defined, social inflation describes "an upward creep in perceptions by an injured party of what they are owed, their willingness to pursue that via the legal system, and what that means for insurance policies covering companies' liabilities."
To illustrate, between 2001 and 2010 there was a 300% rise in the frequency of jury verdicts over $20 million. Similarly, between 2014 and 2018 the average of the top 200 excess liability claims grew from $27 million to $54 million. Further, the median size of awards over $5 million rose by 26% in general liability cases and 32% for vehicle negligence cases between 2010 and 2019.
Commentators point to various explanations for this phenomenon, including, but not limited to: the rise of litigation funding; attorney advertising; legislation incentivizing litigation; reptile theory; the normalization of nuclear verdicts; and pervasive anti- corporate sentiment — among many other contributing factors, each worthy of its own scholarship.
While the effect of social inflation upon liability insurers in the third-party coverage context has been the primary focus of articles on this topic, the negative impact of social inflation upon first-party property insurers has been largely ignored. When policyholders litigate disputed property claims against their insurers, many of the same forces of social inflation that plague third-party carriers can be present. This article is focused primarily upon identifying and mitigating social inflation in first-party claims.
Whether in the first- or third-party context, insurers are harmed by social inflation, but they are not without recourse. The economics of insurance are that the premiums of many pay the claims of a few. Insurers have actuarial tools at their disposal to predict the aggregate losses they will pay and can adjust premiums accordingly.
Therefore, the threat of social inflation goes beyond the effect it has on the insurer — the insurer will correct for the disparity.
Rather, the primary problem is that members of the risk pool, to their own detriment, subsidize the inflated payouts to plaintiffs and pass those costs on to consumers. Moreover, litigation is expensive. And insurers' litigation costs, like indemnity costs, are passed on to consumers. In the first-party property context, the increased frequency and duration of litigation contribute to the overall costs that property insurers face.
Policyholders' litigation costs are also a factor in driving up the amounts insureds seek from their insurers in litigation. By the time a policyholder retains attorneys, public adjusters, remediation contractors, inspectors, litigation financers and various other consultants, the economics of the claim require an insured to consider and include these costs in their demands and estimates.
Public adjusters, attorneys, litigation financers and the like might accurately advertise that they increase gross recoveries. But, increased gross recoveries do not necessarily — and frequently do not — equate to an increased net recovery for the insured after accounting for expenses. The insureds and their vendors, then, are incentivized to maximize recovery.
Insurers, by contrast, are motivated by the Goldilocks principle — to adjust a claim accurately and get it just right. Both over- and undervaluation of claims can have negative outcomes for the insurer. Overpayments stress the system; underpayments create litigation risk. Thus, the claim adjustment process involves macroeconomic considerations.
So here, the limitations of the adversarial system are revealed. Rather than two adversaries litigating from symmetrical positions, the differing micro- and macroeconomic perspectives create asymmetry by encouraging policyholders to take positions comparatively more extreme than that of the insurer. Often, the disputed claim ends up being resolved somewhere between the insurer's sincere valuation and the claimant's inflated demand.
As this process repeats time and again, the macroeconomic effect of this phenomenon has the circular consequence of artificially placing perceptions of claim values on an upward trajectory, i.e., social inflation. The common thread running through each cause of social inflation, then, is a device that drives a wedge between the parties and creates asymmetry by encouraging one party to take positions comparatively more extreme than their opponent.
But social inflation is not just the insurer's problem. Combating social inflation requires all stakeholders to correct the erroneous notion that insurers are the enemy. All stakeholders must recognize that when policyholders submit inflated claims, they are hurting other members of the risk pool by forcing them to subsidize those claims in the form of increased premiums, which are passed on to consumers. Whether resulting from ignorance or apathy, social inflation will persist until not just insurers, but members of the risk pool and the culture more broadly put a stop to it.
The real victims of social inflation, then, are those subsidizing the extracontractual payments insurers make on inflated claims. What can be done about it?
First, insurers must use contractual mechanisms that align their interests with their insureds to the greatest extent possible. Admittedly, this is more feasible in the first-party context where the insurer and claimant are in contractual privity.
Insurers already have several tools at their disposal that attempt to mitigate the adverse effects of moral hazard and adverse selection, including: deductibles, copays, exclusions, sublimits, underwriting to screen high-propensity individuals, experience rating, loss controls, robust special investigations unit departments, and duties after loss provisions — just to name a few.
Many insurers already employ these contractual tools, as well as other means, including geographic information system analytics, Insurance Services Office checks, and correlating premiums and deductibles with claims history. The tools themselves are nothing new, but the ingenuity with which they are employed is becoming highly sophisticated.
With advanced data analytics and contractual mechanisms that reduce moral hazard and adverse selection, the invisible hand of the market shepherds low-risk policyholders to insurers willing to reward them proportionately to their risk and requires others to subsidize their comparatively higher risk.
By way of further example, property insurers are aligning their interests with their insureds more completely through managed repair programs. These programs have recently come into vogue in litigation-heavy jurisdictions and align the parties' interests by permitting the insurer to take a hands-on approach to repairs by selecting contractors to restore the insured's damaged property — a function insurers have traditionally eschewed — in exchange for premium discounts, financing, deductible credits or increased coverage.
Similar concepts have long existed across other insurance lines, such as preferred vendor programs in health insurance programs. In managed repair programs, rather than an insured retaining its own separate vendors, who may not be motivated to do the best work at the best price, the parties creatively and collaboratively conserve resources and work together to efficiently restore the insured to pre-loss condition. This, in turn benefits the entire risk pool by reducing claims expenses and taking upward pressure off premiums.
Of course, confronting social inflation requires more than big data, sophisticated contracts and savvy underwriters; it requires increased awareness of the shared interests among members of the risk pool. As U.S. Supreme Court Justice Louis Brandeis put it, "sunlight is the best of disinfectants."
Though there are many action items that would mitigate social inflation, chief among them is highlighting the mutual interests that insureds share among themselves along with their insurer to counteract the false narrative that insured and insurer must necessarily be adversaries.
For example, consider protection and indemnity clubs. A P&I club is an intimate form of mutual insurance where, like a premium, shipowners pay calls maintained in a pool by the club. The members' annual call is directly determined by the funds remaining in the pool. Each year members either enjoy a reduced call or refund, or they must chip in to replenish the pool depending on the group's claims.
Under this intimate model, the members are accountable to each other, and selective about membership. Under the P&I model, the insurance contract is not merely a contract between insurer and insured, it is a pact between the insured and all other insureds.
While implementing the intimate P&I model may not be feasible for large property and casualty insurers, carriers would do well to develop mechanisms that help their insureds understand their policies as pacts between themselves and other members of the risk pool — that social inflation is not just a bee in the insurer's bonnet, but that it is directly and primarily adverse to their own interest.
For example, consider Florida, whose courts are the venue for three-quarters of all property insurance litigation in the U.S. and where generous fee-shifting legislation permits attorneys to collect fees that often eclipse their clients' recoveries. For this special privilege, Floridians pay premiums nearly three times the national average, and their state-owned insurer of last resort is the biggest game in town that props up a market on the verge of collapse.
Whether due to apathy, bloated expectations of coverage or decreased barriers to litigation, the status of Florida's insurance market reflects a cultural willingness to use premium dollars to pay litigation expenses that often dwarf a claim's value. That tolerance will continue until the culture resolves to stop it.
To illustrate, insurers should not be the only ones outraged when a law firm files over 1,640 hurricane lawsuits of questionable validity in a day claiming 40% contingencies in what U.S. District Judge James D. Cain Jr. characterized as an attempt "to prey on people." Setting aside the ethical considerations of the case before Judge Cain, all members of the risk pool need to be aware that when a policyholder inflates a claim, the costs incurred in paying or litigating the claim are spread across the risk pool.
Additionally, the culture beyond the risk pool should be aware of the second- and third- order consequences those costs have in the form of increased perceptions of claim values generally. On a macro scale, this appreciation can be accomplished via legislation and publicity campaigns.
For instance, in both the property and casualty contexts, insurers should maximize the general deterrent value of criminal insurance fraud enforcement — publicizing convictions and the real-world effect of the crime. So too, the industry should counter the snowballing effect nuclear verdicts have on perceptions of claim values by similarly championing each defense verdict and the contributions they make to a stable economy.
More specifically, insurers should develop mechanisms that help their insureds understand how social inflation is contrary to their own interests.
Insurers need to adjust claims in a manner that makes the temptation to pay high contingencies and expenses unappealing and cost prohibitive. Primarily, this means giving insureds a fair, individualized and compassionate high-quality claims experience. If claimants knew that retaining adversarial vendors would not put any more money in their pocket, they would not do it.
In the first-party context, many jurisdictions have a version of an unfair claims settlement practices act that generally prohibits things like misrepresenting policy provisions, concealing coverages, failing to explain coverage positions, failing to make undisputed payments and making arbitrary coverage decisions, among other things.
Insurers should embrace these statutes as being entirely consistent with their desire to adjust claims with integrity and in accord with the Goldilocks principle. Very much like how poor communication, more than anything else, correlates to malpractice suits against doctors, adjusters should be hyper-cognizant that many conflicts can be avoided with communication and a positive claims experience.
And, conversely, insurers should be equally diligent about curbing the negative macroeconomic consequence of enabling bad actors pursuing illegitimate claims by paying them to save expenses. Insurers can minimize the effect of social inflation and dissuade inflated and extracontractual payments by taking very seriously their obligation to adjust and pay meritorious claims efficiently and in good faith and refusing to pay illegitimate ones.
There are, of course, specific policies and action items that would help curb social inflation, all of which should be explored: disclosure of third-party litigation finance, curbing exploitative attorney advertising, greater enforcement of disclosure requirements in public adjuster legislation, greater enforcement of criminal insurance fraud statutes — to name a few.
Primarily, however, effectively combating social inflation requires all stakeholders, not just insurers, to embrace the truism that they all participate in a symbiotic relationship and are accountable to each other — that we are all in this together.
 Telis Demos, The Specter of Social Inflation Haunts Insurers, Wall J. (Dec. 27, 2019), https://www.wsj.com/articles/the-specter-of-social-inflation-haunts-insurers-11577442780.
 Annemarie McPherson, The Jury's Out: Social Inflation Is on the Rise, IA Magazine (Mar. 2, 2020), available at https://www.iamagazine.com/magazine/issues/2020/march/the-jury- s-out-social-inflation-is-on-the-rise.
 Swiss Re Institute, US Litigation Funding and Social Inflation, The Rising Costs of Legal Liabiliy P. 3 (December, 2021), https://www.swissre.com/dam/jcr:7435a896-5f4b-463b- a1e6-7d4ec17db556/swiss-re-institute-expertise-publication-us-litigation-funding-and- social-inflation-december2021.pdf.
 The U.S. is the world's largest third-party litigation funding market, garnering a whopping 52% of a $17 billion industry. Id.
 Attorney advertising has increased rapidly since the 1977 Supreme Court ruling in Bates v. State Bar of Arizona, 433 U.S. 350 (1977). In a 2005 study, one researcher found that the return on advertising investment by law firms was four to six times the cost. H.R. Moser, "An Empirical Analysis of Consumers' Attitudes Toward Legal Services Advertising: A Longitudinal View," Services Marketing Quarterly, volume 26 (4), pp. 39-56.
 Case in point, Florida, which imposes extracontractual liability as a matter of course and has 7.03% of homeowners insurance claims nationwide, but 76.32% of homeowners insurance lawsuits. David Altmaier, Property Insurance Stability Report, Florida Office of Insurance Regulation (July 1, 2022), available at https://floir.com/docs-sf/default- source/property-and-casualty/stability-unit-reports/july-2022-isu- pdf?sfvrsn=34f77ed6_2.
 This is a tactic by which attorneys appeal to jurors' base instincts for safety and self- reservation by suggesting (implicitly and explicitly) that they are in danger due to defendant's conduct. See, Kenneth L. Shigley & John D. Hadden, Rules, Reptiles, and Betrayal, GA. LAW OF TORTS PREPARATION FOR TRIAL § 11:7 (2021 ed.) April 2021 Update.
 Louis Brandeis, What Publicity Can Do, in OTHER PEOPLE'S MONEY AND HOW THE BANKERS USE IT 92, 92 (1914).
 Weatherall Scottsdale Indemnity Co., Case No. 2:22-cv-3096 (W.D. La. October 20, 2022) (hearing transcript, p. 8); Andrew Strickler, La. Judge to Review Texas Firm's 1,640 Hurricane Suits, Law 360 (October 25, 2022), available at https://www.law360.com/insurance-authority/articles/1543213/la-judge-to-review- texas-firm-s-1-640-hurricane-suits.
 See, g, Elliot Weld, NY Doctor Cops To Role In Trip-And-Fall Litigation Scam, Law360 (Sep. 30, 2022) (reporting on doctors who performed over 200 needless medical procedures), available at https://www.law360.com/articles/1535725/ny-doctor-cops-to- role-in-trip-and-fall-litigation-scam-.
 See, g., Md. Code Ann., Ins. § 27-303 (West).
 Aaron Carroll, To be Sued Less, Doctors Should Consider talking to Patients More, New York Times (June 1, 2015), available at https://www.nytimes.com/2015/06/02/upshot/to-be-sued-less-doctors-should-talk-to- patients-more.html.
 At the federal level, the Litigation Funding Transparency Act has been introduced several times in Congress but has not yet become See H.R. 2025, 117th Cong. (2021- 2022); see also Mark Beckett, § 77:37 Discovery – Court required disclosure of funding, (updated Oct. 2021), in 2 N.Y. PRACTICE SERIES – COMMERCIAL LITIGATION IN N.Y. STATE COURTS, Chapter Seventy-Seven, (Robert L. Haig, 5th ed.), Westlaw; Jeffrey J. Grosholz, In the Shadows: Third-Party Litigation Funding Agreements And The Effect Their Nondisclosure Has on Civil Trials, 47 FLA. ST. U. L. REV. 481, 492-494, (2020). Some jurisdictions, however, including Wisconsin and West Virginia, have been proactive in combatting the rise in litigation funding by third parties and have imposed regulatory disclosures on such funding. See Jerry M. Custis, LITIGATION MANAGEMENT HANDBOOK, § 8:51 Litigation funding agreements, (updated Nov. 2021), Westlaw; see also John L. Ropiequet, Consumer Litigation Funding Developments, 35 NO. 6 BANKING & FINANCIAL SERVICES POLICY REPORT 11, (June 2016), Westlaw. Additionally, some jurisdictions have permitted discovery of evidence of litigation funding.