68 Pages Posted: 3 Sep 2020 Last revised: 11 Jun 2021
Date Written: September 2, 2020
I study the risk and economic consequences of social inflation – rising insurance rates due to social factors such as large jury awards and broader definitions of liability – which challenges a core assumption in models of insurance supply. Using a novel dataset that spans jury verdicts, financial statements, and rate filings for commercial auto liability insurance, I document that the number of verdicts and settlements exceeding $50 million has increased almost threefold from 2011 to 2019. To highlight the role of these developments in insurance pricing, I build a model of social inflation and show that social inflation risk has a “double kick” effect on insurance price through increased effective marginal cost and interaction with the capital requirement. Consistent with the model prediction, I find a statistically and economically significant impact of social inflation risk on insurance rates, estimated through a triple-difference framework. I also show that insurance frauds have increased due to social inflation risk, while insurer exits have been rare. Ultimately, I uncover an important new source of aggregate risk that affects the stability of the insurance sector and the economic activities that depend on it.
Keywords: social inflation, litigation, nuclear verdicts, insurance regulation, financial stability, jury awards, property and casualty insurance
JEL Classification: G10, G20, G22, G41
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