What should we make of insurers who blame Social Inflation for recent woes?

Every insurance story these days includes a, usually unnamed, underwriter bemoaning the ills of social inflation and how it is causing havoc with their portfolio.

Gee, Officer Krupke – so many insurance portfolios all got a social disease!!!*

Let’s unpack what social inflation is; and is not.

Broadly speaking (no doubt the genius of small differences will permit a variety of definitions) social inflation is the amount by which escalation in claims costs exceeds price inflation.  Essentially, it’s the combination of a whole heap of factors, plaintiff bar ingenuity, evolving attitudes to claims, and (who’d a thought it?) that people insure their more valuable stuff.  You get the idea.

Funnily enough, since I started working in the industry, insurance claims costs have somehow always grown faster than price inflation over the medium term.  We should, in the industry be happy about this, it has been a major engine for premium growth.  Sure, there have been periods when things settled down, or claims costs grew more slowly than CPI, but over time, claims inflation has been an irresistible force.

This inexorable growth is characterised by “jumpy” behaviour – extended periods of benign claims inflation punctuated by intermittent step-changes in claims costs.  These jumps are often caused by large, possibly landmark, court awards or by the introduction of significant legislative changes.  The increasing use of litigation finance may also have accelerated this effect recently.  This jumpy behaviour explains why some, but certainly not all, (re)insurers are pointing to Social Inflation as the cause for their prior year reserve deteriorations.  Social Inflation is just a new(ish) name for this effect, formerly known (more boringly perhaps) as “Excess Claims Inflation” or “Superimposed Inflation”.

Hence the West Side Story song reference: Social Inflation seems to have the wonderful ability to deflect blame for past actions onto unnamed others.

What’s really going on?

For perfectly understandable reasons, claims handlers can’t really allow for future scenarios in their case estimates.  As a result, prospective jumps in claims costs, whether known or unknown, will not appear in the actuarial claims data used for estimating IBNR before the major court award or legislative change happens.  In fact, it may take some time for case estimates to be fully adjusted.  And even longer for a reliable change to work through claim payment data.  So it is easy to see how optimism/naivety can mean it doesn’t appear in the IBNR booked by firms.

Let’s be clear, Social Inflation, or whatever you want to call it, has existed for a long time, and will continue to do so.  As such, IBNR estimates (whether for pricing or reserving purposes) need to make a judicious allowance for it, even when claims inflation appears to be benign.  And attempts to use Social Inflation to explain prior year reserve deteriorations, whether framed as such by actuaries, underwriters or insurance CEOs, should be probed very carefully.

Essentially, blaming reserve deterioration on Social Inflation is often simply an admission that reserves were previously set at an inadequate level.  Those responsible at that time did not make sufficient allowance for a well-known and well-understood effect.

So the next time someone tries to explain away prior year losses as a result of Social Inflation, you know the right response. Gee, Officer Krupke – Krup You!

*  For non-West Side Story fans, this is a comedy song where members of the Jets street gang tease Policy Sergeant Krupke by shamelessly blaming their gang membership on a variety of societal forces. Both they, and Officer Krupke, know that this is just an excuse to dodge personal responsibility.

Alex Marcuson, 26 March 2024.