Social Inflation - Measures of Wealth and Income Inequality Warrant Attention From Underwriters
Our friends at Assured Research, LLC are known for their insightful “Assured Briefing” publication, which emphasizes data-driven analysis and actionability for insurers. We found the following article - that explores U.S. social inflation by linking income inequality with liability insurance results - especially resonant as it supports many of the same findings that we published in my own recent blog.
Assured Research, LLC was kind enough to allow us to reprint their article in its entirety below. We hope you find it as compelling as we did.
Social Inflation: A Closer Look at Income Inequality
Measures of wealth and income inequality warrant attention from underwriters
- Assured Research, LLC
Some election issues will slowly fade into the background. Income inequality is not one of them. In fact, for P/C insurers we suspect the topic will come to be closely identified with the first word - social - in the term social inflation.
Regular readers will know that we have, for some time now, regularly included the topics of wealth and income inequality in our efforts to "find objective signals of social inflation in the economy" as we like to describe our research. In this note we bring all of our recent comments on the topic into one note and share new data using inequality indexes by state to look for relationships between inequality and liability loss ratios.
Liability writers should be wary of the intersection between societal and legal trends in New York and Missouri. Charts in this report will show that hellhole states (of which New York and Missouri are regular members) have wider measures of income inequality. Peering into the mid 2020s and using projections of household (HH) net income made available through S&P Global, it appears that both states will lag the national average by more than 25% in the years ahead.
If even directionally accurate, we’d guess that it won’t be difficult for plaintiff attorneys to find disgruntled jurors in those states.
- The trend toward widening gaps in wealth and income inequality began long ago, but they have accelerated since the Great Recession. Said another way, inequality worsened while the economy was steadily improving over the past decade.
- It seems every conceivable measure shows the pandemic recession worsening gaps between employment, wages, and wealth.
- We believe these societal trends influence both the propensity of claimants to sue and the size of verdicts for those cases that go to trial. In turn, large jury awards raise the bar and award value for the majority of claims that settle out of court.
- Using data from 1973, there seems to be a reasonably strong, inverse correlation between the national real wage index and the liability loss ratio. (Figure 3)
- And when we examine the Gini coefficient (that’s a measure of wealth inequality) by state and over the past ten years, we find that the ten worst Hellhole legal states have much higher inequality measures than the ten states with the best legal environments. That begs the question: Did politicians in those states pass plaintiff-friendly laws because of the large inequality gaps? That hypothesis might prove intriguing to those inclined to see our legal system as one with a role of redistributing income.
- Our analysis falls short of proving that income inequality is a principle driver of liability loss ratios. We think it clears, however, the lower bar of asserting that trends in past and projected future wealth and income inequality should be an underwriting (and liability pricing) consideration for insurers seeking to enter new states or grow existing liability products. (See our sidebar for an example.)
Having set the stage, we can tell much of the remaining story using graphs and sidebars. As we transition, keep this quote in mind from Boesen Litigation Consulting:
In the years that followed [the financial crisis of 2008], the market bounced back and progressed through its longest expansion in history. Meanwhile, employment rates and hourly wages remained stagnant. As the middle class shrank, we heard jurors talk more and more about the “Two Americas...One for the elite and one for the rest of us.”
Inequality Continues to Worsen
Figure 3 reveals an intuitive, inverse correlation between the liability loss ratio and the national real wage index dating back to 1979. We describe the relationship as being intuitive if you buy into the idea that household frustration levels will rise as wages stagnate. In turn, that might drive more claimants and angry juries into the legal system.
Examining Inequality and Liability Loss Ratio Trends by State
Only 3 states and Washington, D.C. showed slightly declining levels of income inequality over the years 2010 to 2019: Colorado, Rhode Island, and South Dakota.
The Gini index is described as a measure of income inequality ranging from 0 to 1, or perfect equality (0) to perfect inequality (1). For purposes of this work we’re taking the index at face value and offer our thanks to the U.S. Census Bureau which makes the index available by state over the past ten years. Consistent with data from the Federal Reserve, the Census Bureau’s index shows gradually rising levels of the index over that time (i.e., rising inequality).
We first examined the relationship between the 10-year average liability loss ratio (relative to the national average and including all liability lines) and the trend in the index across all states.
When we focused our attention on the ten states with the best and worst legal environments, interesting differences emerged from the soup shown in Figure 4. Not surprisingly, judicial "hellhole" states have appreciably higher loss ratios when compared to the states with the best legal environments (each benchmarked against the national average). But more interestingly, the states with the best legal environments tended to have much lower levels of inequality than the hellhole states (observe the sloping line in Figure 5).
We argue (1) income inequality affects legal outcomes and awards (i.e., social inflation) and (2) it warrants attention from underwriters and other insurance professionals contemplating where and what types of liability products to offer.
Coincidence? Maybe. But maybe the plaintiff friendly laws in the hellhole states are a reflection, through the political process, of a populace frustrated by gaps in income and wealth equality?
Looking Ahead: HH Income Projections from 2021 to 2026
While compiling this data we observed that S&P Global makes available projections for the growth in HH income, by state, from 2021 to 2026. That’s a lot of forecasting (!), but we thought it’d be interesting to see what the liability loss ratios in the ten hellhole states look like when mapped against projected HH income growth.
We flagged NY and MO earlier because their income growth is forecasted to lag the national average. NY, for example, has a 10-yr liability loss ratio that is 120% of the national average, with forecasted income growth that is only 60% of the national average. Not good!
It’s a hardening market for liability insurance, but that doesn’t mean all opportunities (products and locations) are created equal. We recommend that liability insurers consider wealth and income inequality when contemplating new liability products or geographies.
Assured Research is a research and advisory firm focused exclusively on the property/casualty insurance industry. Article and charts reprinted with permission. “Assured Briefing,” November 2020.