A recent study by the Geneva Association on the topic of “social inflation” addresses the challenges of defining and quantifying the phenomenon. More important, it takes on the question of what insurers and reinsurers can actually do about it.
“Social inflation is a term that is widely cited in insurance debates but it is often ill-defined or at best only loosely explained,” the report begins. Broadly speaking, it “refers to all ways in which insurers’ claims costs rise over and above general economic inflation.”
Actuaries typically label such growth in claims costs “superimposed inflation,” the study says, but their measures “may not adequately account for advances in medical technology, which create new therapies, change the costs of treatment, and increase the lifespan of seriously injured claimants,” as well as other considerations.
More narrowly, the report says, “social inflation refers to legislative and litigation developments which impact insurers’ legal liabilities and claims costs.”
The definitional difficulties are well illustrated in the rendering below, from the study.
Understanding what drives these costs – and whether they are temporary phenomena or a long-term trend – is essential to adequately pricing insurers’ exposures and enabling them to pay claims.
Major drivers, possible solutions
Rollbacks in tort reforms stemming from past insurance availability and affordable crises have been implicated by some for driving social inflation. The report finds that any such correlations are “weak at best.”
More significant, the study found, are shifting judge and jury attitudes in ways favorable to plaintiffs; growing anti-corporate bias; and aggressive tactics used by plaintiff attorneys, including third-party litigation funding.
What can insurers do to battle social inflation? The report suggests four areas of focus:
Engage in the public-policy debate to promote legislative changes that further level the playing field between plaintiffs and defendants;
Get better at defending against aggressive and increasingly well-armed plaintiffs’ attorneys;
Upgrade underwriting to reduce opportunities for claims surprises. “Insurers need better early-warning systems,” the report says, drawing on information from across their organizations, their own and competitor liability cases, and data from social and digital media;
Develop products with an eye toward mitigating social inflation. Given the scale of potential liability exposures, the report says, “co-participation arrangements” to share risks among reinsurers could help maintain and even expand the boundaries of insurability. Parametric insurance also might have a role to play.
Litigation funding – the practice of third parties financing lawsuits in exchange for a share of any funds the plaintiffs might receive – was once widely prohibited. As these bans have been eroded in recent decades, the practice has grown, spread, and become a contributor to social inflation: increased insurance payouts and loss ratios beyond what can be explained by economic inflation alone.
Social inflation is a broad term that insurers use to describe these rising expenses. Litigation funding is just one factor driving it.
The relevant legal doctrine – called “champerty” or “maintenance” – originated in France and arrived in the United States by way of British common law. The original purpose of champerty prohibitions, according to an analysis by Steptoe, an international law firm, was to prevent financial speculation in lawsuits, and it was rooted in a general mistrust of litigation and money lending.
The erosion of champerty prohibitions can be traced to the early 1990s in the United Kingdom and Australia.
“By the mid-1990s, a handful of Australian states had already done away with Maintenance and Champerty offenses such that they were no longer crimes or torts,” according to an article published by Harvard Law School’s Center on the Legal Profession. “Whether this rendered litigation finance permissible, however, remained doubtful. One jurisdiction [New South Wales] notably abolished Maintenance and Champerty offenses through formal legislation.”
These moves, the article goes on to say, “produced ambiguity around the use of litigation finance arrangements, where before they were more clearly prohibited.”
England, Canada, and Australia have since largely abandoned their laws against champerty, Steptoe writes, but Ireland, New Zealand, and Hong Kong continue to prohibit certain transactions as “champertous.”
Slow to take hold in U.S.
Despite the size of the potential market, litigation funding took time to gain traction in the United States because prohibitions on champerty are left to state legislatures and courts. Some states have abandoned their anti-champerty laws over the past two decades. Others still prohibit champerty, either by statute or common law. Some, like New York, have adopted “safe harbors” that exempt transactions above a certain dollar amount from the reach of the champerty laws.
Minnesota recently became the latest state to abandon its champerty prohibition. In Maslowski v. Prospect Funding Partners LLC, the Minnesota Supreme Court held that the litigation funding agreement under consideration was champertous; however, it also held that champertous contracts no longer contravene “public policy as we understand it today.”
The court explained that the common-law prohibition against champerty was originally based on a desire to prevent abuse of the court system by individuals wealthy enough to finance lawsuits. It held that the doctrine against champerty is no longer the only or best tool for achieving that goal – and, in fact, may “increase access to justice” by enabling individuals who might not otherwise have the financial means to pursue their claims in court.
Courts drive decline of anti-champerty laws
The Minnesota Supreme Court was able to abolish the doctrine, Steptoe writes, because Minnesota’s prohibition was based on common law, rather than statute. This is in contrast to New York, where the prohibition is statutory. Re-examining it is the responsibility of the state legislature, not the courts.
As the popularity of litigation funding – along with awareness of its impact on insurers and policyholders – grows, the practice has come under increased scrutiny. The policymaking arm of the American Bar Association (ABA) recently approved a set of best practices for such arrangements.
The resolution – adopted by the ABA’s House of Delegates by a vote of 366 to 10 – lists the issues lawyers should consider before entering into agreements with outside funders. While it avoids taking a position on the use of such funding, it recommends that lawyers detail all arrangements in writing and advises them to ensure that the client retains control.
The resolution also cautions attorneys against giving funders advice about the merits of a case, warning that this could raise concerns about the waiver of attorney-client privilege and expose lawyers to claims that they have an obligation to update this guidance as the litigation develops.
The charts below are based on 4,283 complaints that – while not comprehensive – provide a useful snapshot of the types of litigation and their relative frequency. They were updated on November 8.
Contract-related cases accounted for 1,255 suits and the largest percentage. Not far behind are insurance cases – mainly involving business interruption – at 1,054 and employment cases at 910. Employment cases, Silverman said, allege wrongful termination or failure to pay employees properly during the pandemic.
Taken together, the three broad categories – contract, insurance, and employment – account for more than 75 percent of COVID-related litigation to date.
Among contract cases, the largest share is in the Miscellaneous category (278 cases), which Silverman said are general contractual disputes where performance was affected by the pandemic. The second-largest group (262) consisted of lawsuits against schools (primarily higher education), seeking refunds of tuition and fees. Next come litigation involving leases (225) and event, ticket, or other refunds (224).
Cases involving actual exposure to the coronavirus come in relatively low, at 343 (8 percent), a fact that Silverman attributes to the economic lockdown.
“As more businesses reopen, exposure cases are likely to increase,” he said.
Perhaps unsurprisingly, nearly half of those cases (164) have involved nursing homes. Cruise ship passengers account for 64 exposure claims, and suits related to exposure risk have totaled 58. At least 44 cases to date have involved employee injury or death.
By James Ballot, Senior Advisor, Strategic Communications, Triple-I
It’s been more than eight months since COVID-19 first struck the U.S., and millions of small business owners are still hurting. All the while, a few plaintiffs’ attorneys are treating the pandemic as another opportunity to profit from costly insurance litigation.
At a time when businessowners are looking for leadership to bring much needed financial support, these same attorneys are hoping legislators and judges will help them retroactively rewrite business income (interruption) (BI) insurance contracts. One key figure in this effort is John Houghtaling, a New Orleans-based plaintiffs’ lawyer who was featured in a recent Bloomberg Businessweek profile.
Adds Michael Barry, Head of Media and Public Affairs, at the Insurance Information Institute, “Not one business interruption insurance policy in the U.S. was written on the assumption nearly every business would be interrupted at the same time.” Barry adds, “This is why regulators and judges are consistently siding with insurers who argue direct physical damage to property is needed to trigger a business interruption policy.”
Irrespective of insurers’ and trial attorneys’ competing points of view, the authors of the Bloomberg Businessweek article cite the need for timely and decisive action: “A yearslong legal battle might not be much help to struggling businesses,” the article states. As the end of 2020 approaches, litigation seeking to compel insurers to cover pandemic-related income losses appears likelier to further the lawyers’ interests as opposed to those of businessowners seeking financial support.
Other potential solutions are on the table, most of which are taking shape around the idea that the federal government is the only entity with the reach and financial resources to help businesses recover from an event the magnitude of a global pandemic. On this point, a growing consensus of legal scholars and insurance industry experts concur, with Stefan Holzberger, AM Best chief rating officer, concluding in commentary to a recent report, that “pandemic risk does not afford insurance companies any geographic diversification due to its global nature … Only a governmental program, or perhaps a public-private partnership, could provide the backstop sufficient to compensate for lost revenue to businesses.”
As a counterpoint to statements made by Houghtaling and other plaintiffs’ attorneys, Sherman Joyce, President of the American Tort Reform Association presents a competing vision for how American businesses can unite to recover economically from the COVID-19 pandemic: “Americans’ elected representatives — not the trial bar — should have the authority to regulate business within the U.S.” Joyce continues, “The courts must restore that balance of power by rejecting the dreaded return of regulation through litigation.”
A North Carolina court has ruled that Cincinnati Insurance Co. must pay 16 restaurants’ claims for business income (interruption) losses due to government-ordered COVID-19 shutdowns – a decision that runs counter to those of most judges who’ve ruled on similar cases.
As hundreds of COVID-19-related lawsuits regarding business interruption coverage make their way through U.S. courts, judge after judge has found in favor of insurer defendants. The central point has been that coverage depends – as specified in the insurance policies – on the policyholder suffering a “direct physical loss.”
“Business income (interruption) policies generally reimburse a business owner for lost profits and continuing fixed expenses when its facilities are closed due to direct physical damage from a covered loss, such as a fire, a riot, or a windstorm,” said Triple-I CEO Sean Kevelighan. “Insurers have been prevailing nationwide in nearly all of the litigated COVID-19 BI lawsuits because, as North Carolina’s Insurance Commissioner has noted, ‘Standard business interruption policies are not designed to provide coverage for viruses, diseases, or pandemic-related losses because of the magnitude of the potential losses.’ ”
“Policy language controls whether COVID-19 interruptions are covered,” said Michael Menapace, a professor of insurance law at Quinnipiac University School of Law and a Triple-I Non-Resident Scholar. “The threshold issue will be whether the insureds can prove their business losses are caused by ‘physical damage to property’.”
Cincinnati Insurance has said it plans to appeal the ruling.
Recent advisories from two U.S. Treasury agencies – the Financial Crimes Enforcement Network (FinCEN) and the Office of Foreign Assets Control (OFAC) – indicating that companies paying ransom or facilitating such payments to cyber extortionists could be subject to federal penalties are a reminder of the importance of good cyber hygiene.
The notices also underscore businesses’ need to consult with knowledgeable, reputable professionals long before a ransomware attack occurs and before making any payments.
Ransomware on the rise
In a ransomware attack, hackers use software to block access to the victim’s own data and demand payment (usually in Bitcoin or another cryptocurrency) to regain access. It has been a growing problem in recent years, and such attacks have intensified since the COVID-19 pandemic has led to many people working from home for the first time.
The FBI warns against paying ransoms, but studies have shown that business leaders today pay a lot in the hope of getting their data back. An IBM survey of 600 U.S. business leaders found that 70% had paid a ransom to regain access to their business files. Of the companies responding, nearly half have paid more than $10,000, and 20% of them paid more than $40,000.
Sanctioned entities
The OFAC advisory specifically targets transactions benefiting individuals or entities on OFAC’s Specially Designated Nationals and Blocked Persons List, other blocked persons, and those covered by comprehensive country or region embargoes (e.g., Cuba, the Crimea region of Ukraine, Iran, North Korea, and Syria).
“Companies should rely on experts to assist with their due diligence and work with the FBI,” writes law firm BakerHostetler in a recent blog post. “Experience in incident response is key, and your counsel should be an informed, confident partner as you navigate this rapidly evolving area.”
“Before a payment is made,” the law firm writes, “a company generally retains a third party to conduct due diligence to ensure that the payment isn’t being made to a sanctioned organization or a group reasonably suspected of being tied to a sanctioned organization. Additionally, checks are in place to ensure that anti-money laundering laws are not being violated.”
Many insurers are working with their clients to put such practices in place and taking a variety of other steps to address the threat of ransomware attacks. Cyber-insurance premiums started rising 5% to 25% late last year, according to Robert Parisi, U.S. cyber product leader at insurance broker Marsh & McLennan. Parisi called the increases “dramatic” but said insurers have not scaled back coverage.
Marsh has issued a client advisory — What OFAC’s Ransomware Advisory Means for US Companies — explaining what U.S. businesses need to know about the OFAC advisory and the importance of completing an OFAC review before payment of ransom demands. Marsh’s advisory also makes recommendations for re-assessing ransom incident response plans, mitigating ransomware risk, and preparation for and recovery from ransomware and cyber extortion attacks.
Future of American Insurance and Reinsurance (FAIR) has released a new interactive tool to help showcase the need for a federal solution to pandemic relief. The Business Interruption Insurance “explainer” utilizes digital storytelling techniques to help clarify information about this complex topic.
The digital explainer complements the FAIR campaign’s other recently-released digital assets, including a video overview of BI and pandemics, and a primer deck that provides quantitative backing to the assertion that pandemics cannot be privately insured.
As trial attorneys attempt to retroactively force uninsurable pandemic coverage in business interruption insurance contracts, this tool is designed to show what business interruption insurance covers, how surplus helps pay for covered perils such as hurricanes and wildfires, how insurers have stepped up to help policyholders, and the need for a federal solution to the pandemic.
ABOUT FAIR FAIR is an initiative of the Insurance Information Institute and its member companies whose mission is to ensure fairness for all customers and safeguard the industry’s longstanding role as a pillar of economic growth and stability.
While ridiculous sounding lawsuits are common in our litigious society, some stand out because they sound so preposterous they could have been the plot of a “Seinfeld” episode.
For example, in 2019 an infamous Long Island attorney nicknamed the “Vanilla Vigilante,” sued Whole Foods for $5 million, claiming the store’s vanilla soy milk is flavored with ingredients in addition to vanilla. The American Tort Reform Association (ATRA) highlights this case and others as part of Lawsuit Abuse Awareness Week (October 5-9).
Food disappointments appear to be a common theme among these suits:
A December 2019 complaint filed in federal court alleged a Panera blueberry bagel purchased in Manhattan didn’t contain blueberries but “dyed lumps.” The complaint argues that the bagel’s advertising breached the New York Deceptive and Unfair Trade Practices law, among others.
A May 2020 lawsuit contends that Haagen-Dasz milk chocolate coated ice cream bars should be labeled as milk chocolate and vegetable oil coated chocolate bars. The company says vegetable oil is used as an ingredient to help overcome the difficulties of applying a coating of chocolate to ice cream; the oil is not otherwise included in milk chocolate.
A June 2020 lawsuit against a snack food manufacturer alleges the “potato skin snacks” do not contain potato skins but potato starch and potato flakes.
Such cases are fun to laugh about, but increasing willingness of plaintiffs to bring suits of all kinds – and of juries to pay out large settlements, known as “nuclear verdicts” – feeds the phenomenon of social inflation, which drives up claims costs for insurers and premiums for policyholders.
ATRA warns that a wave of such lawsuits is expected against businesses as they reopen during the ongoing COVID-19 pandemic.
The U.K. High Court last week issued a ruling involving business-interruption claims against policies issued by eight insurers. Jason Schupp of the Centers for Better Insurance says the ruling is a “mixed bag” for U.K. insurers and policyholders and has little relevance for their U.S. counterparts.
In the U.K. case, Schupp writes, “the fundamental theme running through the insurers’ defense was that the policies only covered localized outbreaks, not global pandemics.”
“More to the point for U.S. property/casualty insurers,” says Michael Menapace, a professor of insurance law at Quinnipiac University School of Law and a Triple-I non-resident scholar, the U.K. case involved disease coverage – “an affirmative coverage not included in most U.S. commercial property policies.”
U.S. business interruption disputes so far have turned on two key policy features:
U.S. business-interruption coverage almost always requires property damage to trigger a payout.
Nearly all U.S. COVID-19-related court cases have involved policies that specifically exclude viruses.
“The U.K. court did not address either the question of property damage or the applicability of a virus exclusion,” Schupp writes.
As Menapace put it in a recent blog post about U.S. business-interruption cases, “Policy language controls whether COVID-19 interruptions are covered…. The threshold issue [for U.S. insurers] will be whether the insureds can prove their business losses are caused by ‘physical damage to property’.”
Perhaps the most emotionally compelling data point invoked by those who would compel insurers – through litigation and legislation – to pay business-interruption claims explicitly excluded from the policies they wrote is the property/casualty insurance industry’s nearly $800 billion policyholder surplus.
Many Americans hear “surplus” and think of a bit of cash they have stashed away for emergencies. And when you consider that nearly 40 percent of Americans surveyed by the Federal Reserve said they would either have to borrow or sell something to cover an unexpected $400 expense – or couldn’t pay it at all – that number may sound like overkill.
Not as much as you think
But policyholder surplus isn’t a “rainy day fund.” It’s an essential part of the industry’s ability to keep the promises it makes to policyholders. And although a number like $800 billion may raise eyebrows, when we look more closely at its components, the amount available to cover claims turns out to be considerably less.
Insurers are regulated on a state-by-state basis. Regulators require them to hold a certain amount in reserve to pay claims based on each insurer’s own risk profile. The aggregation of these reserves – required by every state for every insurer doing business in those states – accounts for about half the oft-cited industry surplus.
Call it $400 billion, for simplicity’s sake.
Each company’s regulator-required surplus can be thought of as that company’s “running on empty” mark – the point at which alarms go off and regulators start talking about requiring it to set even more aside to make sure no policyholders are left in a lurch.
By extension, $400 billion is where alarms begin going off for the entire industry.
It gets worse – or better, depending on your perspective.
In addition to state regulators’ requirements, the private rating agencies that gauge insurers’ financial strength and claims-paying ability don’t want to see reserves get anywhere near “Empty.” To get a strong rating from A.M. Best, Fitch, S&P, or Moody’s, insurers have to keep even more in reserve.
Why do private agency ratings matter? Consumers and businesses use them to determine what insurer they’ll buy coverage from. Also, stronger ratings can contribute to lower borrowing expenses, which can help keep insurers’ operating costs – and, in turn, policyholders’ premiums – at reasonable levels.
So, let’s say these additional reserves amount to about $200 billion for the industry. The nearly $800 billion surplus we started with now falls to about $200 billion.
To cover claims by all personal and commercial policyholders in a given year without prompting regulatory and rating agency actions that could drive up insurers’ costs and policyholders’ premiums.
Which brings us to today.
Losses ordinary and extraordinary
In the first quarter of 2020, the industry experienced its largest-ever quarterly decline in surplus, to $771.9 billion. This decline was due, in large part, to declines in stock value related to the economic recession sparked by the coronavirus pandemic.
Nevertheless, the industry remains financially strong, in large part because the bulk of insurers’ investments are in investment-grade corporate and governmental bonds. And it’s a good thing, too, because the conditions underlying that surplus decline preceded an extremely active hurricane season, atypical wildfire activity, and damages related to civil unrest approaching levels not seen since 1992 – involving losses that are not yet reflected in the surplus.
Insured losses from this year’s Hurricane Isaias are estimated in the vicinity of $5 billion. Hurricane Laura’s losses could, by some estimates, be as “small” as $4 billion or as large as $13 billion.
And the Atlantic hurricane season has not yet peaked.
The 2020 wildfire season is off to a horrific start. From January 1 to September 8, 2020, there were 41,051 wildfires, compared with 35,386 in the same period in 2019, according to the National Interagency Fire Center. About 4.7 million acres were burned in the 2020 period, compared with 4.2 million acres in 2019.
In California alone, wildfires have already burned 2.2 million acres in 2020 — more than any year on record. For context, insured losses for California’s November 2018 fires were estimated at more than $11 billion.
And the 2020 wildfire season still has a way to go.
All this is on top of routine claims for property and casualty losses.
Four billion here, 11 billion there – pretty soon we’re talking about “real money,” against available reserves that are far smaller than they at first appear.
No end in sight
Oh, yeah – and the pandemic-fueled recession isn’t expected to reverse any time soon. Economic growth worldwide remains depressed, with nearly every country experiencing declines in gross domestic product (GDP) – the total value of goods and services produced. GDP growth for the world’s 10 largest insurance markets is expected to decrease by 6.99 percent in 2020, compared to Triple-I’s previous estimate of a 4.9 percent decrease.
If insurers were required to pay business-interruption claims they never agreed to cover – and, therefore, didn’t reserve for – the cost to the industry related to small businesses alone could be as high as $383 billion per month.
This would bankrupt the industry, leaving many policyholders uninsured and insurance itself an untenable business proposition.
Fortunately, Americans seem to be beginning to get this. A recent poll by Future of American Insurance and Reinsurance (FAIR) found the majority of Americans believe the federal government should bear the financial responsibility for helping businesses stay afloat during the coronavirus pandemic. Only 16 percent of respondents said insurers should bear the responsibility, and only 8 percent said they believe lawsuits against insurers are the best path for businesses to secure financial relief.
