Legal System Exploitation Drives Up Costs for US Casualty Insurers, AM Best Reports

AM Best has highlighted an increasing challenge in the U.S. casualty insurance sector: legal system abuse and social inflation significantly drive up loss costs. This trend, particularly evident in product liability, general liability, commercial auto, and medical professional liability, has seen loss severity rates outpace economic inflation, often doubling it. Over the past decade, the average loss severity in product liability increased by 20.4%, starkly higher than the 2.7% average annual economic inflation.

The phenomenon of social inflation, which reflects a cultural shift in attitudes towards risk allocation between insurers and plaintiffs, complicates the predictability and management of these costs. Jurors’ declining trust in corporations, believing they prioritize profits over safety, fuels larger verdicts and settlements, often manipulated by legal strategies such as the "reptile theory" and "juror anchoring." Furthermore, class action defense spending has risen, with companies reporting larger claims and an increase in class actions.

Nuclear verdicts, or extremely large compensatory and punitive awards, exacerbate this issue, affecting not just individual claims but also influencing other open claims and future settlements. This domino effect challenges insurers’ reserve adequacy and pricing strategies. The growth of third-party litigation funding, a $17 billion industry globally, adds another layer of complexity, often prolonging legal battles and inflating settlement amounts.

To navigate these challenges, insurers must refine their understanding of portfolio risks and improve actuarial practices. Additionally, advocating for tort reform and enhanced transparency in litigation funding could help mitigate the impacts of social inflation. However, as cultural attitudes continue to evolve, addressing these issues will remain a formidable task for the insurance industry.