Social inflation: litigation costs drive claims inflation

On average social inflation in the US rose by 5.4% annually during 2017-2022; economic inflation was 3.7%. Where the latter has fed into claims costs in property and motor insurance, social inflation has fuelled liability claims costs.

We define social inflation as the increased severity of insurance claims beyond that which can be explained by economic drivers. Prior episodes of social inflation in the US in the 1980s and 2000s were driven by material changes to tort law and an expansion of access to mass tort. The current episode starting in the mid-2010s has been characterised by a rising frequency of large single-claimant events, with associated outsized court verdicts centred around personal injury cases.

Figure 1: Social inflation index US: periods when claims severity growth has exceeded economic inflation

This sigma constructs (for the first time) a Social Inflation Index to disentangle the growth in liability claims due to such non-economic factors from that resulting from economic inflation. Non-economic drivers include factors like use of psychology-based strategies by the trial bar, third-party litigation funding, data analytics, digital media advertising and attitudes to social injustice.

Our Social Inflation Index for the US shows values greater than zero since 2014, rising to around 7% by 2023. In other words, we estimate that social inflation contributed 7 ppt to liability claims growth in the US last year.

Figure 2: Social Inflation Index in the US and select countries

There have been signs of social inflation in other countries also. Over the five years to 2022, countries like the UK and Australia have seen double-digit growth in liability claims, also in excess of economic inflation. Based on our index analysis, we estimate that in the UK, social inflation contributed more than 10 ppts of liability claims growth in 2022. For Australia and Canada, the contribution was 7 ppts. To date, social inflation pressures in Germany and Japan have been minimal.

We expect social inflation in the US to continue for the foreseeable future, and that it will remain mostly a US phenomenon. While economic inflation is abating, there are no signs of a let up in social inflation pressures. And in our view, the current rate of increase is unsustainable: we estimate the impact on casualty business in the US will outweigh the earnings benefit of higher interest rates within one to two years.

Other countries are exposed to many of the driving forces of social inflation as in the US, but not all. They are also exposed to spillover effects from the US social inflation risks emanating from international insurance programs. Even so, while social inflation will likely spread internationally, it will not reach the same heights as in the US. That social inflation is predominantly a US phenomenon is largely due to mega awards delivered by juries there. With different tort liability systems, other jurisdictions are not similarly exposed.

After the US, of our sample countries Canada, the UK and Australia, which also have common-law systems, will likely be most exposed to social inflation. We see Japan as least exposed due to specifics of its legal system, with an emphasis on alternative dispute resolution and less adversarial legal proceedings. In Europe, a broadening scope of product liability risks and expansion of collective redress will be the main drivers pushing social inflation higher. Within the region, the Netherlands is likely to be most exposed given the existence of a well-established third-party litigation funding market and class action system.  

Table 1:  International comparison of drivers for social inflation in the future
 

Another consideration for the future is the emergence of new areas of litigation risk potential such as the use of "forever chemicals", obesity and algorithmic liability. These could broaden the origin of liability claims in the years to come, adding fuel to social inflation pressures in all jurisdictions.