59 Pages Posted: 3 Sep 2020 Last revised: 2 Nov 2021
Date Written: September 2, 2020
In traditional theories of insurance supply, idiosyncratic shocks are diversifiable and should not matter for insurers beyond a change in expected losses. In this study, I quantify the risk and economic consequences of social inflation – shifts in the loss distribution due to social and behavioral factors such as large jury awards and broader definitions of liability – which challenges this standard narrative and poses a source of aggregate risk for the insurance sector. Using commercial auto liability insurance as a stylized setting, I assemble a novel dataset that spans jury awards, financial statements, and insurance rate filings. Exploiting geographical variation in jury awards, temporal variation surrounding a widely publicized verdict, and personal auto liability insurance as control, I show that the potential shifts in loss distribution due to jury awards have resulted in significantly higher insurance prices above and beyond the impact of traditional economic factors. I also document an uptick in the number of insurance frauds in more affected states, while insurer exits have been rare. A theoretical model of social inflation shows that a shock to the insurer's loss distribution has a “double kick” effect on insurance supply through increased effective marginal cost and interaction with the capital requirement.
Keywords: social inflation, social norms, nuclear verdicts, insurance regulation, financial stability, jury awards, property and casualty insurance
JEL Classification: G10, G20, G22, G41
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