Social inflation is a term that has gained significant attention in the insurance industry due to its profound impact on claims costs. It refers to the rising expenses of insurance claims driven by societal trends and shifts, rather than purely economic factors. This article explores the development and quantification of a social inflation index by the Swiss Re Institute (SRI) and examines its implications on insurers, reinsurers, and their customers.
Understanding Social Inflation
Defining Social Inflation
Social inflation is distinctively defined as the discrepancy between claims severity growth and claims inflation propelled strictly by economic factors. Claims severity describes the average size of claims, and thus, social inflation can be quantified using a straightforward formula. By determining this difference, insurers can better understand the non-economic factors influencing the costs of their claims.
Social inflation = claims severity growth – economic inflation
Calculating Claims Severity Growth
Claims severity growth was critically determined by stripping away influences such as growing economic activity, labeled as exposure growth, and variations in claims frequency. The Swiss Re Institute calculated claims severity using the following formula, which isolates the influence of pure economic growth and changes in claims occurrence rates.
Claims severity = claims growth – exposure growth – frequency changes
Exposure growth reflects the expansion of economic activities, which inevitably leads to more businesses, employees, vehicles, and, consequently, more accidents or other harmful actions. To account for this, the institute deducted real GDP growth from overall claims growth. Claims frequency, which they define as the number of claims relative to the number of policies, also affects claims growth independently of claims severity. This thorough distinction ensures that the growth attributed purely to severity is isolated from the broader economic situations.
Economic Inflation Components
Analyzing Economic Inflation
SRI employed an analysis combining three Consumer Price Index (CPI) measures from the U.S. Bureau of Labor Statistics, targeting healthcare, wages, and core CPI inflation. These components were strategically chosen due to their significant correlation with liability claims severity. Core inflation, notably, excludes volatile items such as food and energy prices due to their limited relevance in tort liability claims.
By focusing on these particular indexes, SRI could hone in on the most relevant economic inflation metrics, enhancing the accuracy of the social inflation calculation. The exclusion of food and energy prices ensures a more stable and representative measure. This laser-focused approach underscores the precision needed to differentiate between economic and non-economic factors impacting claims severity.
Weighting Economic Inflation Components
In their detailed process, SRI assigned weights of approximately one-third each to healthcare, wage, and core CPI inflation. However, they gave a slightly higher weight (37%) to core CPI. This calculated approach involved assessing claims severity growth and subtracting the weighted average of the identified economic inflation components to zero in on the social inflation value.
Utilizing three-year moving averages for all variables allowed SRI to smooth out random data noise, providing a clearer trend analysis. The use of averaging also acknowledges the typical delays between economic activity and claims settlements, offering a more accurate picture of the true growth in claims severity. This methodical process allowed for the precise calculation of social inflation, illuminating the often obscured impacts of societal trends on insurance costs.
Trends and Findings
Long-Term Trends in Claims Frequency
The report illuminated a significant long-term declining trend in claims frequency for general liability and medical malpractice. Conversely, it noted a rising trend for commercial auto claims since 2021. This dual trend analysis is crucial for comprehending how different types of claims are variably affected by social inflation.
The distinction in trends indicates that while some areas are seeing fewer claims, others are experiencing increases, informed by various underlying societal trends and behaviors. This multifaceted understanding helps insurers navigate the complex landscape of claims and adjust their strategies accordingly. Recognizing these different trends is pivotal for assessing the broader impact of social inflation on overall claims costs.
Social Inflation’s Impact Since 2014
Since 2014, the findings consistently indicated that three-year average growth in claims severity had surpassed economic inflation. This highlights that non-economic factors are significantly driving up liability claims severity, thus termed as social inflation. SRI’s analysis demonstrated that by 2023, social inflation alone contributed approximately 7% to claims costs, marking a substantial rise driven by societal trends rather than economic growth alone.
This persistent growth underscores the necessity for insurers to understand and predict social inflation’s impacts accurately. The continuous presence of non-zero values for social inflation from 2014 onward suggests a steadily growing influence on claims costs. This data refines insurers’ capacity to forecast future claims expenses, leading to more precise pricing and risk management strategies.
Implications for the Insurance Industry
Growing Impact on Claims Costs
The continuous non-zero values of social inflation since 2014 have significant implications for claims costs. It indicates a growing impact of societal and legal trends on insurance claims beyond what would typically be attributed to economic conditions alone. This underscores the need for insurers to consider these broader social factors in their risk assessments and pricing strategies.
Recognizing the influence of social inflation helps insurers better prepare for future claims, allowing for more robust risk management and adaptable policy frameworks. It also prompts a deeper engagement with social trends, encouraging insurers to identify and mitigate the underlying factors contributing to these rising claims costs. This awareness and adaptation are crucial for maintaining financial stability and competitiveness in the insurance market.
Strategic Adjustments for Insurers
Social inflation has garnered notable attention in the insurance sector because of its marked impact on claim costs. Essentially, it pertains to the increasing expenses associated with insurance claims driven by social dynamics and changing societal attitudes rather than by purely economic factors. The Swiss Re Institute (SRI) has been at the forefront of this issue, developing and quantifying a social inflation index to better understand these rising costs. This article delves into the creation of this index by SRI and discusses its consequences for insurers, reinsurers, and their clients. Social inflation not only affects the premiums that customers pay but also influences the overall financial stability of insurance providers. By quantifying these social trends, SRI aims to equip the industry with the means to predict and manage future claim costs more accurately. Through this exploration, both insurers and customers can gain a comprehensive understanding of the broader social influences at play and better prepare for their financial impact.
