Social Inflation: Why Insurers Are Losing the Analytics Race

Social Inflation: Why Insurers Are Losing the Analytics Race

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“Social inflation” has become somewhat of a buzzword on insurers’ earnings calls in recent years – especially over the past 18 months. The phenomenon is responsible for driving up the cost of claims across a range of lines, ultimately affecting insurers’ profitability.

But for all the talk, very little is being done about it. Insurers know it’s there – they can see it in their results – but as an industry we struggle to define it, measure it, and come up with a credible response.

And this matters because the legal system is doing quite the opposite: committing significant resources (including investment in data analytics) to understanding and exploiting this very issue. The result? The insurance industry is losing a battle it didn’t even realize it was in.

But first, let’s take a quick look at what social inflation is and why it’s a growing problem today.

At its core, social inflation is an industry-wide rise in insurers’ claims costs over and above economic inflation. More specifically, it’s caused by shifts in societal views about increased litigation, broader contract interpretations, plaintiff-friendly legal decisions, and larger jury awards.

It’s not a new phenomenon – the US has seen waves of social inflation in the 1980s and 1990s. Now it’s back, with the US litigation rate rising for the seventh consecutive year in 2019 to 8.9% compared with an average of 3% for the previous two decades. And the level of compensation awarded has also increased, especially in large cases. The number of verdicts of $20M+ in 2019 was 300% more than the annual average between 2001 and 2010.

If unaccounted for, social inflation pushes up the cost of claims to such an extent that pricing does not accurately reflect risk, which puts pressure on insurers’ profitability. If social inflation persists, it can ultimately impact capacity and even availability across whole lines of business.

The Rise of the Claims Culture

There are two answers to the question of why social inflation is on the rise today.

The first answer is rooted in societal shifts that stem back to the 2008 financial crisis, which left a deeply felt sense of anger and distrust toward large businesses. This has contributed to a tendency among juries and judges to sympathize with plaintiffs. This is especially visible among members of the millennial generation who now occupy positions of influence and sit on juries.

The second answer requires a look at the legal system and related third parties, which are deploying proactive and sophisticated tactics to monetize the trend for higher payouts.

For example, lawyers are investing in powerful data, analytics, and technology to identify and exploit liability opportunities. Increased marketing spend, aggressive plaintiff attorney practices, social media tracking, and the adoption of behavioral science are just some examples of the tactics being used.

Indeed, a whole sub-industry of consultants and lawyers has evolved to cultivate a “claims culture” and improve trial outcomes.

Where does this leave the insurance industry? To put it bluntly: playing catch-up. As an industry, we’re masters in understanding other types of claims trends, but when it comes to litigation-related claims we rely on high-level data and guesswork.

This imbalance between the insurance and legal industries must be addressed. We as an industry must become experts in social and legal trends, just as we are masters in other types of claims trends.

Societal shifts should be respected and managed sensitively. But losing the analytics arms race against the legal system serves only to undermine a healthy functioning insurance market that is vital for society.

Social Inflation: A Human Risk

At the heart of our work is the notion that social inflation is a human risk. Human behavior can be analyzed and even predicted in much the same way that traditional perils such as natural catastrophe can. But – and here’s the key point – it requires a different set of tools.

This is where nontraditional data comes in. Unlike traditional data, it is not based on past records but is gathered from “live” activities such as internet activity, social media, and smart technology. These data points provide “clues” about human behavior which, with the support of advanced analytics, can be analyzed at scale to create a powerful predictive model.

Guidewire engineers are working with our clients and partners to analyze claims and policy experience together with quality analytics; behavioral data and other nontraditional data. Additionally, we’re already starting to build a detailed understanding of the link between behavioral indicators and liability.

Our aim is to build a predictive social inflation model that can measure levels of social inflation and help insurers price risk appropriately and take remedial action where necessary.

The alternative is to leave social inflation unchecked. But burying our heads in the sand is the biggest risk of all, and not just to insurers’ balance sheets. Persistent and severe social inflation can lead to the withdrawal of entire classes of insurance altogether – as we saw in the 1980s and 1990s – which is highly damaging for society because it drives a dangerous wedge in the protection gap.

We’re not at that point yet. But let’s not wait until it’s too late to take action.

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