Social Inflation and the Potential Impact of COVID-19
By: Michael S. Olsan
Much has been written about social inflation and the enormity of its impact on the insurance industry. There is little debate that many industry insiders blame social inflation for nuclear verdicts, the increased number of class actions and the adverse financial impact on many insurance companies. What is less clear, now, however, is whether the shut-downs during the COVID-19 pandemic and the resulting economic consequences will exacerbate or temper social inflation. In this article, we will first discuss some of the basics of social inflation and its effect on the industry generally and then comment on the possible impact of the pandemic.
I. An Introduction to Social Inflation
In his 1977 Chairman’s letter to stockholders, Berkshire Hathaway CEO Warren Buffett advised that costs in the insurance sector were expected to rise. One reason he offered was “social inflation,” which he described as “a broadening definition by society and juries of what is covered by insurance policies.” Then, in the mid-1980s, as asbestos suits proliferated, a top insurance executive bemoaned the then current climate and commented: “The underlying and most dramatic cause of this insurance crisis is the wave of social inflation that has all but engulfed our system of jurisprudence… The mood of society is to seek a culprit for all of life’s mishaps, and to look to the insurance companies with the deep pockets to reward victims.”
Today the term “social inflation” has re-emerged in the lexicon of insurance executives. The increase in the number of class actions, “nuclear” verdicts and new concepts in tort law is contributing to the current round of social inflation. Some blame has been placed on various issues, including reviver statutes, increasing income inequality and litigation funding. In addition to the rise in losses in the medical malpractice space, the industry is also witnessing adverse impacts to directors’ and officers’ (D&O) liability, excess liability and commercial auto. As to D&O specifically, there has been a doubling in the number of shareholder class actions in less than three years while the median settlement value of $13 million has remained relatively constant.
II. Nuclear Jury Verdicts at the Root of Social Inflation
Some in the insurance industry and the defense bar use the term “nuclear verdict” to refer to jury verdicts that are substantially higher than expected, generally more than $10 million. Some nuclear verdicts include (1) an $8 billion verdict against Johnson & Johnson for Risperdal, a schizophrenia drug; (2) a $2 billion verdict against Monsanto for its herbicide Roundup which the court subsequently reduced; (3) a $1 billion verdict related to workplace negligence against HACC Pointe South, Inc.; and (4) another verdict against Johnson & Johnson for $4.7 billion (recently reduced to about $2 billion by the appellate court) related to its talcum powder products.
There are several reasons for these large verdicts, including reptile brain, corporate distrust, a changing concept of money and social media. Moreover, the increasing use of litigation funding may create an environment in which plaintiffs are more willing to take their cases to the jury.
A. The Reptile Brain
One reason for these large verdicts is the so-called “reptile” brain. This approach is a “strategy” some plaintiffs’ attorneys use to get jurors to access their “fight or flight” response. Utilizing this approach, a lawyer will make jurors feel so threatened by the defendant’s behavior that they will lash out at the defendant, the predator. The goal is to make the jury feel angry toward the defendant, as opposed to sympathetic to the plaintiff, so they want to change the world and make things right.
B. Distrust of Corporate America
Today, there is a prevailing distrust of corporate America, particularly the pharmaceutical industry, contributing to a jury’s desire to punish the defendant and reward the plaintiffs. Some have said that jurors no longer feel that large corporations are the “backbone of the economy” but rather they need to be punished for their wrongdoing. According to Kristin McMahon, chief claims officer, North American Specialty, Global Risk Solutions, Liberty Mutual Insurance, “[j]urors are endorsing a political philosophy of ‘populism,’ supporting the rights and power of the people in their struggle against a privileged elite, which is how the defendants are often viewed.”
C. The Changing Concept of Money
Jurors’ concept of money has changed, leading them to feel relatively unrestrained in the awards they deliver although as set forth below. However, this view could change in the wake of the COVID-19 pandemic. The public is frequently exposed to large dollar figures, whether in the form of box office hits, lottery jackpots or athlete salaries. If a corporation is a “bad actor” in the minds of the jury, as may be the case with catastrophic illness or injury, jurors do not hesitate to award sums of money that are often larger than expected. This phenomenon is exacerbated by the fact that plaintiffs’ lawyers frequently use those large figures during the trial, when permitted. Even in those jurisdictions like Pennsylvania, where a plaintiff cannot request a specific damages figure, attorneys use large numbers during the trial, citing for example a company’s net worth or the profits from a particular product. By using stratospheric numbers, a plaintiff’s lawyer de-sensitizes the jury to the point that it gains comfort in issuing a nuclear verdict. Further, there is some sentiment that jurors are increasing awards because they want to “be sure the injured are taken care of” to avoid simply over-compensating the plaintiffs’ bar through contingent fees.
D. Social Media and the Millennial Generation
Social media and shorter attention spans may also play a role in larger jury verdicts. The “millennial” generation has a general mistrust of corporate America and the government. While there are 82 million millennials in the United States, Ms. McMahon cited one poll that suggested “only 19 percent agree that most people can be trusted.” Through social media, the millennials “know how to leverage all of this information for a purpose . . . [which] can turn a small movement into a considerable force.” Attention spans have also gotten shorter and are not conducive to lengthy medical and technical testimony and documentary evidence.
III. Impact of Social Inflation on the Insurance Industry
The insurance industry has cited social inflation as a reason for recent financial difficulties it was facing even before the onset of the COVID-19 pandemic. For example, AXA XL reduced its earnings projections and stated, “claims have since come in higher and faster than anticipated.” In late October 2019, Travelers increased its reserves by hundreds of millions of dollars in its quarterly earnings report. Explaining the reason, Alan Schnitzer, Chief Executive Officer, referenced a “challenging level of social inflation.” Concurring in this sentiment is fellow executive, W. Robert Berkley Jr., chief executive of W.R. Berkley Corp., who told analysts “[s]ocial inflation is real. It is here, and the industry is beginning to pay attention.”
The insurance industry is in a hardening market. 2019 saw a 4.7% growth in net premiums over 2018 in the U.S. property and casualty market according to A.M. Best. Offsetting the rise in rates, however, is an increase in losses, including those resulting from social inflation. Investors’ anxiety about the industry, as a result of social inflation’s impact, became evident in 2019. According to the Wall Street Journal, for the fourth quarter of 2019, S&P 500 multi-line insurers were down 3% compared with a gain of 12% overall in the financial sector.
While the industry has faced societal factors in the past, Mike Hudzik, Swiss Re’s head of casualty underwriting for the U.S. and Canada, “believes the industry may be quicker to react than in past tough cycles with better risk assessment and information availability.” He continued, however, that there would need to be several years of improved pricing “just to fill the hole that exists from under-reserving, as well as the additional impact of social inflation.” According to Mr. Hudzik, rates have risen anywhere from the high teens for excess liability policies to as much as 75% on “certain loss-impacted accounts.” In addition to the higher pricing, some insurers have reduced or eliminated their exposure in certain sectors like truck fleets where there have been an increased number of nuclear verdicts.
IV. How will the COVID-19 Pandemic Likely Affect Social Inflation?
While it is too early to tell exactly how, if at all, COVID-19 will impact social inflation, there are two diametrically opposed schools of thought emerging.
A. COVID-19 May Ease Social Inflation
As the country shut down in March, courts closed, jury trials were put on hold, discovery slowed and some mediations were conducted virtually while others were postponed. When, and if, litigation returns to “normal” is anyone’s guess at this point. But some have opined that this uncertainty may help stem the tide of social inflation. Along those lines, some defense lawyers have reported that they have received more calls from plaintiffs’ lawyers to settle their cases than took place pre-COVID-19. Could it be that some plaintiffs would rather settle now rather than continue to be left in limbo as a result of the pandemic even if it means getting paid less than what they believe they deserve? Could it be that some plaintiffs are facing financial difficulties because of the pandemic related economic downturn and need the immediate cash infusion from a settlement to help them through the difficult financial times? Could it be that plaintiffs are concerned that jurors, who similarly have suffered financial (and perhaps personal) loss throughout the pandemic, may start to temper the award of nuclear verdicts? If these questions are answered in the affirmative, then the insurance industry may begin to experience an unexpected reduction in social inflation.
B. The Pandemic May Cause Social Inflation to Spike
Newspapers and legal journals are replete with updates on litigation against insurers that have denied coverage for COVID-19-related business interruption and civil authority claims. A.M. Best reported that this litigation, and the attendant costs, could cause social inflation to rise. Even if courts begin to find that business interruption claims are not covered, the court of public opinion may feel otherwise. To the extent the jurors of the future feel the insurance industry wronged those who suffered COVID-related losses, they may seek to punish the industry in other matters, leading to an increased number of nuclear verdicts and a rising tide of social inflation.
V. Concluding Thoughts
To do its part in reducing the impact of social inflation, the insurance industry should undertake several measures, such as the following:
- make sure that it stays on top of trends affecting underlying litigation (regardless of the sector or industry);
- collect data to facilitate its decision making on individual losses or portfolios of cases;
- partner with policyholders and defense counsel to change the views of, and further educate, jurors and claimants; and
- recruit the next generation of talent, which is more representative of the growing, diverse population like the jury pools that policyholders are facing, to provide strategic input.
With respect to COVID-19, there is little to do but watch and wait. For its part, the defense bar needs to examine new strategies for settlement and trial, when the latter is necessary. For example, plaintiffs are no longer averse to putting stratospheric numbers before the jury. However, the defense bar continues to avoid placing some alternative figures for the jury to consider. If the jury wants to punish the defendant, but all it has is the plaintiff’s damages figure, it may be more apt to award an amount in that range. Further, greater use of mock juries and the presentation of evidence in a way the millennial generation prefers may help move the needle.
In an ironic twist, the consumer — some of whom may very well be jurors — may become the victim as a result of the nuclear verdicts some juries are awarding. As insurers are required to pay higher and higher jury verdicts, they will raise their pricing accordingly. To the extent corporate policyholders, like product manufacturers, have to pay higher premiums, will those costs be passed on to the consumer? If so, perhaps the jurors will begin to see the light and bring their awards back to reality.
Michael S. Olsan is a partner at White and Williams LLP and chair of the Commercial Litigation Department and represents clients in the insurance industry in insurance coverage and reinsurance matters.