Actuaries: Social Inflation Increased Commercial Auto Claim Costs by $20B Over 10 Years

The insurance industry is ringing alarm bells about the cost of social inflation again, this time with the help of an actuarial analysis that concludes the phenomenon added more than $20 billion to the cost of commercial auto claims over a decade.

The Insurance Information Institute teamed up with the Casualty Actuarial Society to measure excess losses that can not be explained by regular increases in the Consumer Price Index. The analysis attributes $20.7 billion in commercial auto losses from 2010 to 2019 to loss-development factors that cannot be explained by general inflation. The amount is equal to 14% of the total $148 billion in claims paid during that time.

The report says even though commercial auto rates have been increasing year after year, they haven’t kept pace with even more rapidly increasing claim costs. Traditional actuarial methods that look at historical loss patterns have failed to detect the trend.

“In an environment of increasing inflation, these methods, without adjustment, will tend to underestimate future loss emergence,” said actuary David Moore, co-author of the report. “There are different methods and/or adjustments actuaries can use to explicitly anticipate increasing inflation in their projections. But first you need to be aware that you are experiencing increasing inflation and lengthening development patterns and not just random fluctuation in development.”

Moore and his co-author, actuary Jim Lynch, said they found evidence of social inflation in two other insurance lines: other liability-occurrence and malpractice-claims made. The actuaries did not provide a measurement.

The analysis examined loss estimates as they developed over time as reported to regulators in insurers’ annual reports. Specifically, the report examined the growth in “link ratios,” which is the difference in the reported cost beginning at 12 months and ending at 60 months after a claim is reported. Those are known as loss triangles.

The actuaries used changes in the national gross domestic product to “normalize” the numbers so it reflects the general inflation rate because losses tend to grow over time to reflect changes in the overall economy. The authors attributed the difference between the inflation rate and the even faster-growing link ratios to social inflation.

The paper did not provide a single definition of that term, but noted various white papers and news articles that describe social inflation as increasing claim costs caused by out-sized verdicts and increased litigation.

Moore said social inflation can be easily missed by actuaries who use the traditional loss-development method. He said that can impact claims management, in addition to rate filings.

“Claims adjustors establish case reserves that are intended to reflect the future cost to settle a given claim,” he said in an email. “For longer tail liability claims, there can be a considerable lag between the time the claim is initially reported and a case reserve is established until when the claim is finally paid and closed. If an adjustor is not explicitly including the impact of an increasing rate of inflation in the case reserve estimates, then their case reserves, on average, might be too low to cover the future costs of the claim.”

Because the analysis was funded with a grant from the Casualty Actuarial Society, it concludes with advice to working actuaries. The report recommends that actuaries “take care” when choosing which link ratios or methods to use. For example, they might use the most recent link ratio instead of a multi-year average.

Moore said “actuaries can still use methods that incorporate historic loss patterns and observable trends, but in an environment of increasing inflation, they should consider making adjustments to reflect that.

The III reported on Tuesday that underwriting losses for the commercial line are expected to continue through 2023, but improve year over year. “We continue to observe a significant rebound in premium growth due to the economic recovery and the hard market,” Moore said.