Social Inflation

Abstract

I study the risk and economic consequences of social inflation – shifts in the insurer's loss distribution due to factors such as large jury awards and broader definitions of liability – which poses a novel source of aggregate risk to the insurance sector. Using a dataset spanning jury awards, financial statements, and insurance rate filings, I show that the price impact of social inflation is greater in regions with higher legal exposure, greater for insurers that are more financially constrained, and is economically significant even for insurers not directly affected by verdicts and settlements. Consistent with empirical patterns, 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 higher effective marginal cost and interaction of increased uncertainty with the capital requirement. I discuss factors that affect the future dynamics of social inflation and implications for the role of insurers.

Keywords: social inflation, social norms, nuclear verdicts, insurance regulation, financial stability, jury awards, property and casualty insurance

JEL Classification: G10, G20, G22, G41