What is Social Inflation, and how is it impacting insurance?
‘Social Inflation’ is becoming more relevant to businesses and their cost of insurance in advanced economies. It refers to claims costs rising at a greater rate than general inflation due to societal influence on the absorption of liability.
Amid a social environment of heightened distrust for the corporate world, there is a trend towards broader obligations and liability on corporations. Corporations transfer the risk of this widened liability via their insurance programmes. Where the trending continues, we will likely see insurers become more reluctant to absorb risk of such losses.
What is meant by ‘Social Inflation’?
Insurers use the term to describe the rising costs of insurance claims resulting from increasing litigation, broader definitions of liability, more claimant-friendly legal decisions, and larger jury/court awards. Social inflation fundamentally refers to factors that cause insurance claims to be more expensive and cannot be attributed to regular inflationary measures. The increased costs driving social inflation are not new but their effect on insurers has only started to come to be adequately measured in recent years.
How does it impact insurance?
There are distinct areas within the insurance industry that are directly impacted by social inflation. These areas include commercial auto, general liability, and medical malpractice, all of which have seen significant underwriting losses and higher insurance claim returns as a result of shifting societal perspectives on who should absorb risk. The general idea of social inflation stems from the notion that when any form of damage or injury occurs, some form of payment needs to be made to the plaintiff; in many circumstances irrespective of negligence, and usually from the deepest pockets.
What factors can influence social inflation?
A prime example of how Insurers can find themselves paying for claims that were not envisaged for payment at the time of pricing the risk are the COVID 19 Business Interruption claims.
Given the complexities that arise in relation to business interruption policies in the context of COVID-19 impacts, it has been necessary to obtain clear guidance from the courts as to how business interruption policy wordings are to be interpreted and applied so that decisions can be made by insurers and the Australian Financial Complaints Authority (AFCA) in an efficient, fair and consistent way.
There have been two test cases heard in the Courts to assist with determining key aspects of business interruption cover. These test cases are important in providing clarity to the broader insurance industry as to how business interruption policies are to be interpreted.
It is important to note that guidance was only sought in relation to business interruption policies and not any other type of insurance policy.
Insurers, including those not directly involved in the court proceedings, have committed to applying the reasoning of the final judgments of the test cases in an efficient, transparent, and consistent way when assessing claims. The insurance industry has also met the legal costs of the policyholders in both test cases. See our article here for further details.
Many business interruption policies sought to exclude cover for pandemics through a reference to the Quarantine Act, however, the Quarantine Act was repealed in 2016 and replaced by the Biosecurity Act. A test case on this issue was heard in 2020 in the NSW Court of Appeal, which ruled in favour of policyholders. This judgment was upheld in June 2021 when the High Court denied insurers’ application for special leave to appeal.
The High Court’s decision in June 2021 means insurers cannot rely on references to the Quarantine Act to deny liability in policies written in the same terms as the policies considered in the first test case.
Although this test case was decided by the NSW Court of Appeal the decision is relevant to all Australian claims regardless of location. In cases where the policy has a disease clause, theses clauses would cover loss that arises from the presence or outbreak of infectious disease at the Insured premises or within a specified radius of the Insured premises. This has meant that a pool of policyholders thought not to have insurance cover by Insurers for a specified risk, the Courts have deemed may now have claims.
Environmental, Social and Governance (ESG) responsibilities have become increasing onerous to Companies and Corporations in recent years. They bring a new raft of societal expectations and liabilities for flagrant or irresponsible breach and for behaviour that was once acceptable.
Breaches of carbon emission, pollution, deforestation, water usage and various other green energy initiatives and waste management practices are now not only unacceptable (and in many cases illegal) but failures to properly consider the social and environmental impacts of your business and your business partners are being prosecuted by shareholders. These are costs that were previously not incurred by Insurers or not with the same frequency.
The impact of societal expectations regarding ESG are considerable and as such the costs for failing to meet these expectations is rising fast. See our article here for further information on ESG obligations for directors.
The introduction of the Design and Building Practitioners (DBP) Act is a Government response to protect consumers ostensibly as a result of what happened from the cladding and other building defect class actions (Opal and Mascot Towers). This new Act imposes a broader duty of care on builders, developers, and consultants, and in essence extends liability to persons (in addition to companies) with a broader limitations period. This was all driven by consumer sentiment, reflected in election promises and mandates. The problem being that insurers have been meeting costs of these past claims and now they are being asked to underwrite the risk of further claims to the extent of the broader legal liability as a result of “social ideology”. The issue is that the industry needs to revise its own quality control, governance and the like: it cannot always be up to insurers to “pay for the sins” of what has happened. If that remains to be the norm then insurance will not exist. See our article here for further information on updates to the DBP Act.
Recent floods in Queensland and NSW in 2020 and 2021 are another prime example of how Social Inflation can affect Insurers and have a knock on effect on the costs of claims and thus policy pricing.
Courts and lobbyists effectively managed to redefine the difference between a flood and a storm. Storm cover is relatively standard in most property policies and is there to cover against the damage caused by weather events. Flood cover is normally an additional cover that must be purchased and is there to cover damage caused to property when there is an overflow of water onto land that is usually dry from another body of water.
Insurers found themselves in a position where they were forced to settle flood claims on storm cover only policies due to lobbying and adverse court findings, essentially because there was an expectation from consumers that their policy should respond. Policies that were inexpensive because they did not have flood cover ended up having claims settled.
This pushes Insurers into redefining the terms of policies that are issued. Most storm policies now exclude “pluvial flooding”, rain flooding.
These examples are by no means limited to one type of insurance policy. The effects are being felt Industry wide.
Overall, the trend of social inflation affecting the cost of insurance shows no real downward curve and companies should try and insulate themselves from the costs involved.