Social Inflation: The Benefits

Coins in front of a clock. The phenomena of higher total volume of dollars associated with liability claims is called social inflation. Photo by Pixabay via Pexels.

Most millennials grew up hearing the story about the “evil lady” who spilled McDonald’s coffee on herself and received $3 million. However, this story is widely misunderstood. The facts are that Stella Liebeck — the woman who spilled coffee on herself — received third degree burns and needed skin grafting that cost $20K, and when she asked McDonald’s to pay for her medical bill, the corporation refused to pay more than $800.  

This was in 1992, when the trend was that workers were company people. This corporate loyalty has been able to hide unethical practices of major corporations such as McDonald’s, which actually received 700 previous reports of coffee burns. To McDonald’s, this number is miniscule compared to the number of coffee it sells daily; however, there is a real person behind each case.  

General corporation distrust built up during the early 2000s with the 2008 financial crisis and following political scandals. Now there is a new pool of decision makers in our society who have grown up during times of heightened corporate distrust, and believe that the maltreated should be compensated for higher value. More things historically and in the present are being brought up for claims. The phenomena of higher total volume of dollars associated with liability claims is called social inflation.  

Thanks to the advent of social media, people understand their rights more, and filing claims is easier in the digital age. People are making sure to hold corporations liable for unethical actions. It makes sense to expect someone to pay reasonable amounts for injured parties; however, when punitive damages are taken into account the welfare of society doesn’t increase as much as the person who files the claim. We want McDonald’s to compensate the 700 reports of coffee burns rather than pay out millions to one person.  

However, in the status quo, with North American businesses paying for more insurance coverage, the question becomes will the insurance industry be able to responsibly cover the risks? Professor John Coffee from Columbia Law School calls this specific liability that social inflation creates as “event driven securities litigation.”  

Most security litigations stem from accounting and other disclosure issues that allow wrong earning restatements and result in stock price drops, however in event-driven securities, operational risks are not disclosed to investors. Stock values drop at a later event as the issue is revealed. Similarly, social inflation is caused by corporations paying out large sums of money as damages are revealed from historical actions. Pharmaceutical companies earned billions in profits during the late 1990’s when opioid pain medications were marketed and prescribed for treating chronic pain unrelated to cancer. Since 2014, various pharmaceuticals had to pay millions to settle claims that it misled shareholders about the safety of the drug.  

President and CEO Randy Ramlo of United Fire Group, an insurance company, said during an earnings call, “I think [social inflation] is more a changing idea of society.” People now and in the future will hold corporations accountable, and assessing the magnitude of that risk is important. Providing coverages that face social inflation is hard to do since it will need to be based on societal attitudes such as perceived justice towards the company. A better approach is to demand a greater level of transparency between insurance coverage providers and corporations. Through this transparency, corporations will minimize their risks since higher risks means they will have to pay higher premiums.  

In the status quo, lawsuits are the only way that people receive compensation. With plaintiff-friendly legal decisions and third-party investors who help claims stand longer in court, corporations pay out high sums of money. However, as insurers develop coverages that take on part of this risk, corporations are incentivized to minimize their risk and make more ethical decisions. A future Stella Liebeck should have a lower risk of injury and if the injury occurs she should be given adequate resources toward recovery.   

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