Is social inflation to blame for your high insurance rates?
The escalating rates of auto and home insurance have left some policyholders reeling and looking for answers. Like a relentless game of hot potato, insurance industry stakeholders have pointed their fingers in several directions, shifting blame to rising reinsurance costs, climate change and price gouging on vehicle repairs and home rebuilding costs. However, others claim social inflation is the culprit.
Confused yet? You’re not alone. If you’re unsure what social inflation is and why insurance companies are finding it increasingly challenging to balance profits and affordability, Bankrate insurance experts are here to explain.
What is social inflation?
Warren Buffett, former chairman and CEO of Berkshire Hathaway, is credited with coining the term social inflation in 1978. In a letter to Berkshire Hathaway stockholders, Buffett justified rate increases due to “a broadening definition by society and juries of what is covered by insurance policies.” Fundamentally, this definition still holds true.
Social inflation refers to the increasing costs of insurance claims expanding beyond the rate of general economic inflation. Director of the Insurance Journal’s Academy of Insurance Patrick Wraight states this phenomenon is “one of the reasons that liability claims continue to get larger and a reason why more people should consider raising their limits of insurance on their liability policies.”
Several economic mechanisms and societal factors are forcing more auto and home insurance claims — and larger jury awards if these claims end up in court. Increases in litigation contribute to higher insurance rates and can result in policyholders paying out of pocket for liability losses that exceed the limits of their policies.
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Powered by Coverage.com (NPN: 19966249)
Coverage.com, LLC is a licensed insurance producer (NPN: 19966249). Coverage.com services are only available in states where it is licensed. Coverage.com may not offer insurance coverage in all states or scenarios. All insurance products are governed by the terms in the applicable insurance policy, and all related decisions (such as approval for coverage, premiums, commissions and fees) and policy obligations are the sole responsibility of the underwriting insurer. The information on this site does not modify any insurance policy terms in any way.
What factors contribute to social inflation in insurance?
Social inflation is reshaping the landscape of the industry in significant ways. The Center for Insurance Policy and Research states that there are 10 trends that drive social inflation in the commercial insurance industry, and many insurance insiders say the same may apply to personal lines of auto and home insurance. Some of these trends are:
- Changes in jury demographics
- Evolving definition of what “liability” means
- Increase in marketing to consumers
- Increase in third-party litigation funding
- Increased reach of social media
- Jury emotions impacting rulings
- Media attention on large settlements
- Public distrust of insurance companies
- Rollbacks in tort reforms
- Rollbacks in caps on punitive damages
The role of insurance is to indemnify policyholders, meaning to help make them no better or worse financially than they were before they experienced a loss. However, if a policyholder feels their claim payout is inadequate, they may choose to take their claim to court. Some say marketing is increasingly impacting what policyholders perceive to be adequate.
“As legal advertising has evolved over the last 50 years, so have client expectations,” says Wraight. “Billboards and buses that read ‘My lawyer got me $100 million’ work. Potential clients begin to hope and expect ever larger judgments.”
When claimants are awarded large sums of money — called nuclear verdicts — the media is quick to report the story but less likely to follow up on how much the claimant walked away with in the end.
Wraight says, “When a jury or a judge awards a huge judgment, that’s the story. The final payout may not happen for months or years, depending on the negotiations and appeals. Sometimes, a jury makes an award and the judge has discretion to reduce that award. In the end, many of those huge judgments ended up paying out considerably less than the originally reported number.”
Even when the final payout is a high dollar amount, a large portion goes back to the claimant’s lawyer. “On top of that,” says Wraight, “lawyers receive one-third of the final settlement amount. Going back to those clients whose smiling faces are on the billboard, maybe the lawyer got them $100 million, but the law firm got the first $33 million.”
The U.S. functions on a tort system. This system is what allows citizens to sue parties that wronged them, whether intentionally or through negligence. While each state has its own laws surrounding tort and damage payouts, national tort costs for personal liability associated with auto and home policies are increasing annually by 4 percent, according to a 2022 report from the U.S. Chamber of Commerce Institute for Legal Reform. As of 2020, national tort costs were $443 billion, with $148.7 billion attributed to personal automobile liability alone. But according to the research, only 53 percent of tort costs go to compensating claimants.
The American Tort Reform Association compiled the following list of states that passed tort reforms in 2023. The tort reforms aim to reduce frivolous lawsuits and ease the burden on the legal system:
- Florida
- Georgia
- Indiana
- Iowa
- Kansas
- Montana
- Texas
- Utah
- West Virginia
Social inflation naysayers: Is it all just a smoke screen?
In many ways, the concept of social inflation feels less tangible than economic inflation and is hard to pin down. While widely discussed within the insurance industry, it is a subject of debate and controversy.
Our society has only become more diverse and informed since 1978. In theory, changes in jury demographics that more accurately represent society should be a good thing, but this factor is repeatedly mentioned with negative implications. When we spoke with Douglas Heller, director of insurance with the Consumer Federation of America, about the validity of social inflation, he said, “Generally, I think social inflation is a very malleable concept that the insurance industry has made in order to justify steep rate hikes and to argue to restrict consumers’ legal rights.”
Many in the insurance industry say that changes in societal attitudes toward insurance companies have caused younger and more diverse jurors to want to punish large corporations by awarding disproportionate sums to claimants. However, according to research by Kenneth S. Klein, a civil litigator who is currently president of the advisory council of the Community Law Project and a consumer representative for the National Association of Insurance Commissioners, the facts don’t support this line of thought.
In his paper “The Case for Pausing Any Immediate Embrace of the Social Inflation Argument for Legal System Reforms,” Klein argues that societal attitudes constantly evolve. Studies on generational shifts indicate that Millennials and Gen Xers may have a heightened sense of entitlement but not an increased tendency toward litigation.
Social inflation is a political term, not an actuarial term. It used to push lawmakers to restrict consumer rights rather than getting lawmakers and regulators to scrutinize insurance company practices and rates.— Douglas Heller, Director of Insurance with the Consumer Federation of America
When we asked Wraight about the concerns regarding the validity of social inflation, he said: “Here’s where we get into a tough space between public perception, advertising and reality. To start with, insurance companies do need to make a profit because businesses that don’t make a profit don’t operate very long. It’s also true that social inflation is making a real impact in the insurance market.”
How do attorney tactics and litigation funding contribute to social inflation?
Todd Kozikowski, CEO and co-founder of 4WARN, agrees that certain marketing techniques fueled by advances in AI and funded by third-party litigators are the driving force behind rising insurance rates. Kozikowski says, “Tech-enabled claim instigation can drive social inflation even if claims are closed without payment.”
4WARN is a data analytics and risk assessment firm designed to discover and track opportunists who use SEO and other AI-driven platforms to misdirect policyholders away from insurance companies and toward law firms.
“The development of AI has allowed more scammers that may not have had the skills or knowledge to use advanced hacking schemes and techniques,” stated Kozikowski. “AI provides individuals with no coding knowledge the tools to target people, companies and, of course, websites. This leads to the scalability of numerous cyberattacks, as well as the ability to publish large volumes of targeted SEO content.”
Law firms and third-party litigators use targeted SEO in hopes of finding cases with a nuclear verdict — those where punitive and compensatory awards exceed $10 million.
How does social inflation impact insurance costs?
Social inflation contributes to rising insurance premiums by increasing the cost of insurance claims beyond what is anticipated. Auto and home insurance companies base rates on the likelihood of risk and the company’s ability to price said risk. Carriers anticipate a certain amount of litigation each year, which is factored into their modeling. However, with AI and litigation funding supercharging a law firm’s ability to seek out claimants, carriers are having trouble pinning down this moving target.
Just the cost of managing the influx of claims spurred by legal abuse practices can cause policyholders to pay higher insurance rates. “Carriers must uniformly address claims that are denied,” said Kozikowski. The cost of denying claims is “relatively fixed and the answers are specific to the claim that is reviewed and denied.”
With insurance carriers handling more frivolous claims, internal employee costs are increased when outside counsel and litigation interrupt the standard process. “While opportunists can leverage litigation platforms and AI to file suits that become cheaper and cheaper due to automation, carriers must address each claim based upon its merits and specifics,” says Kozikowski. “Therefore, a low-cost litigation can result in a high-cost defense expense even if there is no payment.”
Facing the challenge of social inflation: What can be done?
Social inflation is a multi-layered issue that requires solutions from all angles. To start, three states — Indiana, West Virginia and Louisiana — have passed legislation that limits third-party litigation funding to varying degrees. Several other states tried and failed to pass similar laws this year.
Many suggest that media and advertisers should be held more accountable for how they discuss large claimant payouts. Transparency in how much the claimant will really receive and how much their lawyers are paid may help adjust the public’s perception of overblown settlements.
“On top of all that, the insurance industry has historically done a poor job of telling their story,” says Wraight.
It makes the news when insurance companies fail to do what’s right, but the majority of the time, for the majority of insurance companies, the company does right by the customer, putting them back in the place they were before the loss happened. As an industry, we need to do a better job telling people how we help out.— Patrick Wraight, Director of the Insurance Journal's Academy of Insurance
Some insurance companies seek help from companies like 4WARN to preemptively combat tech-enabled claim instigation. According to Kozikowski, this helps limit frivolous lawsuits and can allow insurance companies to lower their premiums. Kozikowski shared that one of their clients reported an 80 percent decrease in new monthly lawsuits filed over the past eight months while using 4WARN’s services.
Regardless of how or what service insurance carriers use to monitor the online threat posed by opportunists, mitigating the risk of escalating lawsuits is vital. Carriers’ ability to accurately predict and rate claims and litigation may be key to the affordability of auto and home insurance.
When speaking about what policyholders can do to fight social inflation, Wraight said, “I would love to say here are three simple tips an insurance consumer can do to reduce social inflation, lower their insurance rates and be a happier, more fulfilled insurance customer. I just can’t do that.”
However, he did have some sound advice for policyholders looking to keep their individual insurance costs down. Wraight stated, “The best thing that an insurance consumer can do to mitigate their own insurance costs is to contact a local, licensed, independent insurance agent who understands insurance coverages to help them to understand their own risks, help them to get the insurance they need and meet their budget goals as well.”
Frequently asked questions
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While the terms are sometimes used interchangeably, they are different. Social inflation refers to the rising cost of insurance rates due to an increase in insurance claims and litigation payouts. Legal system abuse refers to practices in the court system that drive up costs, such as aggressive attorney advertising and large jury awards. While legal system abuse contributes to social inflation, not all instances of social inflation stem from abusive legal practices.
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Yes, economic inflation impacts the cost of auto insurance because it directly leads to higher prices for vehicle parts, labor and medical expenses associated with auto accidents. The cost of home insurance is also impacted by economic inflation in terms of housing materials and labor connected to rebuilding costs. Social inflation leads to higher rates for several types of insurance, including commercial and medical insurance. More frequent and higher claims and litigation payouts are significant factors in higher insurance rates from social inflation.
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The term social inflation was coined in 1978 by Warren Buffett. Originally, it was used in reference to asbestos litigation for commercial insurance, but it has since grown in meaning and scope.
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