Insurance rates continue to rise, and it is not just due to the televised inflation we see on the news. Another factor increasing rates is driven by legal systems with nuclear verdicts and, often, what many refer to as ‘litigation abuse’ which increases the costs and time to settle a claim. Attorneys stand to reap huge rewards by inserting themselves into the claims process. Last year, Lex Machina reported a 30% YoY increase in insurance cases litigated in federal district courts: frequency. Increasing payout totals have a snowball effect with no end in sight: severity. 

Louisiana, an extreme example

Many believe that Louisiana is a cheap place to live. In December, 2023, the Insurance Research Council found that it is the least affordable state for personal insurance. Auto insurance accounted for 2.93% of median household income, plus another 3.84% for homeowners. Compared with totals in other states, Lousianans pay 55% more for these policies. The American Tort Reform Association designates Louisiana as the #7 judicial hellhole and estimates, “Lawsuit abuse and excessive tort costs wreak havoc on Louisiana’s economy, extracting a “tort tax” of more than $1,100 per resident annually. Due to these exorbitant tort costs, nearly 50,000 jobs vanish each year…”

When it comes to responsible claims, there are only two true options: settle or litigate. In today’s market, this may be a difficult decision to make:

• Settling:
  Settling is quicker, easier, and far less expensive from a legal standpoint. Speediness to settle can drive down overall costs significantly. Plus, the amount is defined and agreed upon. However, power has shifted to the plaintiff based on the prevalence of nuclear verdicts. Claimants develop high expectations for potential payments after hearing other awards. Both sides have an interest in settling quickly. However, a plaintiff’s attorney will always first ask “what is the policy limit?” Oftentimes settlements are private. Keeping this privacy is advantageous to the entire insurance industry.
• Litigating:
  The buzz term over the last few years has been “social inflation.” Travelers does an excellent job of breaking down social inflation for a layman, and shares some drivers:
  • Desensitization to large numbers and media impact – root causes of this may be inferred from lottery payouts to poor mathematics education and an over-indulgence in social media
  • Negative thoughts about corporations – similar to the above, a broad swath of the population despises corporate profits and believes corporations should do more than generate profits and abide by the law, not to mention the prevalent CEO pay scrutiny coupled with animosity toward the ultra wealthy
  • Legal system drivers – Taking a case to trial now runs the risk of an ornery jury awarding the plaintiff much more than the pursued, yet already inflated, settlement offer. The Insurance Journal found a 27% YoY increase in nuclear verdicts in 2023, as defined by $10M+, a 15-year high. Many do not understand that costs rise across the board due to these nuclear verdicts, similar to how shrinkage at grocery stores increases all consumers’ cost of food. Zurich’s CEO, Kristof Terryn, in a recent interview with AMBest stated, “there seems to be no end to these nuclear verdicts… ultimately, it is the consumer who pays for it.” Social inflation leads many insurers to pursue the second option of settling. 

Drivers in the Legal System

• Backstepping tort reform: removal of caps on payouts, most of which were focused on limiting the amount awarded due to pain and suffering, and lengthening of the window in which a case may be filed.
• Bad faith laws: while these are warranted for insured protection, cases are often filed using bad faith laws as a basis under which little evidence is present. Once filed, insurers have a dogfight ahead of them.
• One-way attorney fees: these clauses allow the winner of the case to receive legal fees from the counterparty, thus increasing the overall cost.
• Litigation funding (third-party): investors provide funding for a plaintiff’s legal expenses in exchange for an expected economic payoff. Growing payouts make this niche financing industry increasingly attractive.
• Marketing: plaintiff attorneys spend billions of dollars on advertising to claimants, promising life-changing payouts, and standing to collect 25-40% of any settlement or jury award.
• Anchoring: a psychological move where plaintiff attorneys dangle excessively high numbers in front of plaintiffs, and jurors, which then becomes the baseline.

Mitigating These Costs

Combat Fraud

• The FBI estimates non-health fraud increases overall premiums for the average family about $400 and $700 per year (I must disclose this estimate includes insurance companies and distribution partners…).
• Investigation and identification of claims fraud is increasingly important. The Coalition Against Insurance Fraud states that fraud occurs in 10% of P&C losses!  Insurers need more robust investigation teams and tactics, whether in-house or outsourced. There are also a multitude of tools available. Companies like PageVault allow for legally admissible online capture of injured claimants engaging in activities such as kayaking. 
• Combating fraud at the underwriting stage through more rigorous analysis of applications should be paramount. Firms are using social network analysis to identify that smoker who checked “I do not smoke” on their life insurance application. AI is also leveraged to identify application “gaming,” where an applicant plugs different numbers into online quote engines to receive lower rates.
• Technology & data-driven software should be used for risk identification. Identifying patterns and trends in claims data that may be related to social inflation may allow firms to adjust strategy. On the tech side, the trucking industry is installing multiple cameras for defensive purposes. As a data example, identifying cross-referrals between certain doctors’ groups and law firms can lead insurers to require multiple medical opinions.
• Subrogation should be pursued more often, where applicable. The NAIC published a piece estimating that “missed subrogation opportunities cost the insurance industry $15 billion annually.” 
• Settle claims quickly, before the claimant has a chance to engage an opportunistic lawyer who helps seek a ridiculous payout. 

Fight Back

The CEO of Prime Insurance told Best’s Review that insurers should fight back. Stating insurance companies should pay out claims, “When you’re at fault, you pay. You don’t make people sue you.” However he knows when to fight back in court, “if you’re not liable you have coverage at any limit.”

Legislation

Legislators are far from insurance experts. Only recently are they looking to understand the mechanics of insurance due to public outcry. States may change their insurance laws in an effort to protect the insurers, indirectly shielding consumers from continuing rate increases. Similar to Louisiana, Florida was another extreme example, at one point accounting for 76% of all litigation against insurers nationwide. Insurers began exiting the market, leaving the state with outsized balance sheet risk due to backing the insurer of last resort, Citizens. In fact, Citizens states that 12% rate increases are still 30-40% below the rest of the market.

Florida took action. Desantis signed legislation prohibiting Assignment of Benefits, elimination of bad faith claims filed solely on appraisal awards, elimination of one-way attorney fees, and permitting mandatory arbitration clauses. In April, 2024, eight new insurers entered the market. This is a clear sign that efforts to mitigate pressure on insurers and stabilize the market may be working. 

California wants to prevent itself from being the next Florida. In the face of some homeowners exodus, Newsom stated he is working on a bill  to expedite the rate filing and approval process. The current long-drawn out timeline leaves insurers behind as they continuously reassess exposures and file rate changes. Currently, a subsequent rate filing may occur before the previous filing was even approved. 

Zurich holds a yearly consortium looking at litigation abuse and what type legislation may address it. One push is to make sources of litigation funding clear to jurors. If social inflation is driving nuclear verdicts, jurors may think twice if they are aware that a jury award may be eaten up by opportunistic financial backers. In fact, there was a Litigation Funding Transparency bill introduced in both US Congressional chambers in 2021 which would require disclosure of who is financing these cases and shed light on any conflict of interest. Who knows how long this bill will be sidelined.

Conclusion

As insurance rates continue to climb, it becomes imperative to address the underlying factors driving these increases. By understanding the roles of litigation abuse, social inflation, and legal system drivers, insurers and policymakers can take informed actions to mitigate these costs. Through combating fraud, settling claims swiftly, fighting back when necessary, and enacting thoughtful legislation, we can work towards a more balanced and fair insurance landscape. Ultimately, these efforts will help stabilize the market, benefiting consumers and insurers alike.