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Social inflation is a term that has gained increasingly common currency among insurers as they seek to explain why claims costs often out-run general inflation.
In December 2024, Jim Kaniclides, Head of US Insurance, Insight Investment, told Insurance Investor that it “has been a significant driver of claims costs and is likely to persist”.
“In the broadest sense, social inflation is anything other than economic inflation, but it's largely driven by the judicial system and the higher claims severity due to litigation costs,” he said.
He added that by “some measures, social inflation has risen faster than economic inflation and is likely to continue that trend”.
It is driven by shifts in legal, cultural, and societal attitudes, leading to higher compensation demands, larger jury awards, and increased litigation. A major contribution to the growing threat this poses to insurers, the firms they insure and invest in, has been the huge growth of class actions, especially in the US.
Its risks are heavily prescient for investment teams at insurers in the current era and need to be taken into consideration more thoroughly.
It is not a new phenomenon. Motor insurers in particular have struggled for decades to contain rising personal injury costs, which have become one of the biggest factors in premium increases that have outstripped inflation and attracted the ire of policymakers and consumers in many countries.
They have also brought down some insurers across the globe. One of the most spectacular was the collapse into insolvency of the Irish motor insurance company, Private Motorists’ Protection Association (PMPA), in 1983.
PMPA was Ireland’s biggest motor insurance company, having a 70% share of the market. It had started as a policyholders’ co-operative in a challenge to the hold the British tariff insurance companies had over the Irish market but a combination of weak regulation, poor management and runaway awards for personal injury by the Irish courts caused its demise. 40 years later, the Irish government is still pressing ahead with further reforms of the court system to limit personal injury awards. It is not alone in this constant battle to find fair ways of limiting awards and, crucially, escalating legal bills.
Later in the 1980s, UK mutual insurer Iron Trades was forced into run-off as it was battered by sharp rises in industrial deafness claims, mainly from shipyards it insured.
These examples demonstrate the emergence of social inflation, as well as its persistence and corrosive impact. It was around that time that Warren Buffet is often credited with being the first to use the term when he defined the threat to insurers as “a broadening definition by society and juries of what is covered by insurance policies.”
The issue has broken out of claims departments as insurers around the world are forced – often by regulators – to take a much broader view of their financial resilience.
"Social inflation is predominantly a US tort liability issue. Some
countries beyond the US are also impacted by social inflation."
The fear for many is so-called “nuclear verdicts” – when juries award unexpectedly high awards to large numbers of claimants in the class actions gathering momentum, especially in the United States and that this will fuel enthusiasm for similar actions elsewhere.
“Social inflation may have been born in the US, but a number of jurisdictions globally are developing frameworks for both collective redress and litigation funding which could see social inflation become more of an international issue”, said Duncan Strachan, a partner at London law firm DAC Beachcroft.
The fear that US-style litigation and awards could spread internationally is a widespread concern, said Thomas Holzheu, Chief Economist Americas, Swiss Re. “Social inflation is predominantly a US tort liability issue. Some countries beyond the US are also impacted by social inflation, but the drivers vary because of jurisdictional differences. The US is unique in that it has large individual verdicts.
“Other common law countries such as Canada and the UK are exposed to an accumulation of mass torts but don't have runaway verdicts to the same degree,” said Holzheu. “In civil law systems in continental Europe, on the other hand, social inflation is less evident in the data currently, but it is likely on the horizon due to legislative changes. EU directives such as the Product Liability Directive, AI Directive and Representative Action Directive expand the scope of liability and provide new mechanisms for asserting claims.”
Lawyers see the trend towards class actions outside the USA as a significant trend that will impact insurers but are reassuring about the potential size of settlements.
“In the UK and Europe, quantum is based on putting the claimant back into the position that they would have been in prior to the injury. In the US, because the jury decides the award and punitive damages can be awarded too, anything goes. There’s less control over the level of compensation in US civil trials, although nuclear awards are frequently reduced by the trial court or on appeal”, said Strachan.
One of the features of social inflation is that it does not track general inflation, and its impacts move from sector to sector, not always in predictable ways. It can hit personal injury claims, healthcare costs, product liability claims or employee liability/workers compensation portfolios depending on the issues of the day.
"The hedging of such liabilities through index-linked sovereign bonds or
inflation swaps should prove totally ineffective with major basis risk."
This leaves very little scope for insurers to fully protect themselves against its impact, apart from more rigorous underwriting and premium hikes, said Erik Vynckier, Chair of the Investment Committee at Foresters Friendly Society.
“The hedging of such liabilities through index-linked sovereign bonds or inflation swaps should prove totally ineffective with major basis risk,” he said. “There is no reason why such social inflation would at all be effectively mimicked by broad indices covering inflation across all sectors and price drivers. Social inflation has shown itself persistently to be far higher than broad based indices such as CPI. Provisioning off the principle of CPI + x% does not mean that the x% will in any way prove constant.”
If the focus has to be on the underwriting portfolios then where are the major looming risks to insurers from social inflation? Across a broad spectrum of sectors, said Holzheu. “These include healthcare, transportation and logistics, and pharmaceutical and life sciences. There is also a risk of social inflation spreading to other lines and sectors such as personal auto and homeowners. For example, up until a few years ago, social inflation also affected homeowners insurance in Florida due to specific aspects of Florida's legal environment.”
To that list insurers should add the growing threats of legal action around climate change. These are gathering momentum around the world and are likely to be pushed even harder as major financial institutions – including insurers – back away from the commitments they made at COP26 in Glasgow a little over three years ago.
Identifying the potential pressure points is one thing; responding to them is not always easy, Holzheu added. “Although there is broad awareness within the industry of social inflation and its impacts, formulating an effective response is complicated. Data lags, lack of transparency around large verdicts, and measurement issues make it difficult to quantify cause and effect.
“It needs to be seen as a reality and find its way into underwriting."
“Insurers can adjust policy terms and enhance claims management practices to help address short-term profitability issues, but it is also important to raise awareness more broadly. This includes educating policyholders and communities about the costs of social inflation and advocating tort reforms such as limits on punitive damages and enhanced transparency around third-party litigation funding.”
Vynckier, too, looks to his underwriting colleagues to provide the frontline defences against social inflation.
“It needs to be seen as a reality and find its way into underwriting,” he said. “There is truly no ‘hedging’ for this in the financial capital markets and those who cannot risk manage the situation in the company need to reinsure all business they underwrite back-to-back, with the reinsurance costs being incorporated into the underwriting on a daily basis.”
He added that there is only so much one can do with terms and conditions given that the public opinion will not be on the side of the insurer.
“There is no reason to believe that the public attitude towards
insurance claims will become more favourable to insurers."
In the 40 years since Warren Buffett coined the term “social inflation”, insurers have grown more aware of its impact, says Holzheu, who offers some reassurance for investment managers about its limited direct impact on their portfolios: “Social inflation primarily affects underwriting rather than the investment portfolio. Asset risks are driven more by economic factors such as general inflation.”
This does not mean investment portfolios are immune. There can be unexpected negative – and positive – impacts.
There is no room for complacency about the wider impact of the societal and cultural changes that drive social inflation, warns Vynckier, as people might take out their anger at the rising costs of insurance and perceived unfairness in claims settlements in other ways.
“There is no reason to believe that the public attitude towards insurance claims will become more favourable to insurers. See the murder of a health care insurer CEO [Brian Thompson} in the USA just recently as an extreme example. People see the insurance industry as a free for all: once the premiums are paid a them-versus-us mentality dominates all negotiation.”
This may be an extreme response but insurers that do not acknowledge and manage social inflation in a balanced way that strengthens their resilience but still delivers the protection and service at a price policyholders expect risk jeopardy on a wide front.
The impact of favourable and unfavourable verdicts in the US courts on asset values is illustrated by the actions launched against Bayer over the use of glyphosate, the active ingredient in many herbicides such as Roundup.
Roundup was first developed by Monsanto in 1973. This company, based in Missouri, was acquired by German pharma giant Bayer for $63bn in 2018, a deal initially viewed very favourably by investors.
However, Bayer’s acquisition saw it become liable for lawsuits related to claims Monsanto had failed to properly warn customers that using Roundup might increase their risk of developing cancer. This has been a controversial issue. The International Agency for Research on Cancer classified glyphosate as “probably carcinogenic to humans” in 2015.
The US Environmental Protection Agency subsequently said glyphosate is unlikely to be a carcinogen.
In June 2020, Bayer agreed to settle over 100,000 lawsuits, allocating up to $9.6bn for current claims and $1.25bn for potential future claims.
Cases were also brought in Australia and in September 2023, environmental groups in Europe filed a criminal complaint against Bayer, alleging the concealment of studies indicating risks associated with glyphosate exposure, particularly concerning pregnant women.
The cumulative impact of these actions saw Bayer’s share price fall by 43% in the year to mid-August 2024.
When a court in Philadelphia ruled in Bayer’s favour in August last year in a case brought forward by a Pennsylvania landscaper who claimed he developed non-Hodgkin lymphoma after using Roundup, Bayer’s share price immediately jumped by 12%.
It was further boosted in the summer by a decision in the Federal Court of Australia that dismissed a class action lawsuit involving over 800 plaintiffs who claimed exposure to Roundup caused non-Hodgkin's lymphoma.
These cases illustrate the need for investment managers with larger equity holding to keep close to the issues driving social inflation. It is not just the potentially enormous damages that might have to be paid but the distraction of senior and operational management, reputational damage and the threat of increased regulatory scrutiny.
