Last month, in our social inflation note, we demonstrated how the trend had added $233bn over the past fifteen years to commercial lines' ultimate losses. Since there is some degree of correlation between social inflation and defense and cost containment (DCC) expenses, we showed that on a sequential basis, both commercial and personal DCC were up.
With this note, we revisit our prior analysis, showing the movements by lines of business and states to discern trends. (See our prior note for the definition of DCC expenses and why it matters).
Our analysis of select personal and commercial lines of business showed that several social inflation-exposed lines, which account for about a quarter of industry premiums, continue to face incremental pressure from rising defense costs. Other liability DCC increased slightly, while medical professional liability DCC decreased, reflecting insurers' willingness to settle. The uptick seen in the casualty lines we observed is being offset by significantly lower personal lines DCC expenses, driven by rate and re-underwriting efforts in the segment.
Additionally, we found that apart from Florida, which is benefiting from extensive tort reform, the top states and overall US remained mostly consistent with 2023, staying in the low-to-mid single digit range. There is no new problematic state – for now.
Briefly, loss adjustment expenses include allocated loss adjustment expenses (ALAE) and unallocated loss adjustment expenses (ULAE). DCC is the NAIC’s revised terminology for ALAE, including all items related to the defense, settlement or reduction of claims. Think lawyer fees, expert witness testimony, mediation and arbitration costs, to name a few.
DCC trends can reflect various loss cost trends over time. These notably include changes in the litigation and regulatory environment as well as litigious behavior.
We expand upon these points in the following analysis.
DCC ratios continue to tick up for social inflation-exposed lines, including other liability
The chart below shows the direct DCC ratios for select casualty lines.
Many lines had declining ratios going into Covid-19 but have since inverted and are continuing to tick up, albeit modestly.
Other liability (occurrence) and product liability had the largest year-over-year shifts. Other liability increased by 0.8pts to 10%, while product liability ticked up by 1.7pts to 20% for 2024.
Other liability continues to be a difficult line for the industry. In our 2024 Schedule P analysis, we found that the industry had about $9bn in net adverse reserve development in the line last year.
The second chart below provides an alternative perspective on the trend lines for both personal and commercial lines. Note the materially lower DCC burden in personal lines when compared to commercial lines. For commercial lines, claims are more complex, involve greater attorney involvement, and tend to linger longer in the system.
Industry observers in recent years have discussed the pressure on defense costs for personal lines, which have now started declining as the industry addresses these challenges via rates and re-underwriting.
Contrastingly, the problematic lines we showcased above, such as other liability and product liability, have significantly higher ratios. Also, note the decline in medical professional liability, which shows these insurers' willingness to settle.
Commercial auto, which the industry is struggling with, is also featured, and we can see the DCC ratio has been steadily rising over the past four years. Commercial multi-peril (CMP) also saw a slight uptick, continuing the trend reversal from consistently improving DCC ratios in the early 2020s.
These commercial lines alone — other liability (occurrence), product liability, commercial auto, and CMP — comprise just over 25% of the industry’s total written premium.
In other words, about a quarter of the industry’s premium is showing a modest rise in DCC ratios, a further testament to the industry’s struggle to combat worsening loss costs driven by social inflation.
Florida’s defense costs drop as legislative reforms take effect, but other states and the US are stable
The chart below shows the direct DCC incurred ratios for the top five largest states in terms of written premium, as well as the nationwide ratio. The appendix provides a further breakdown of the state-level data in additional exhibits.
Of the top states, only Illinois and Texas had DCC ratios below the overall industry ratio of 4% in 2024. Note that despite the uptick we observed across several commercial long-tail lines, significantly lower personal lines DCC expenses across the US offset this, contributing to largely stable state-level DCC ratios.
In terms of directionality, we see a divergence among the top states. As previously discussed, Florida stands out for its improvement in recent years. Legal abuse led to an unevenly accelerating DCC ratio for the state throughout the late 2010s and early 2020s.
It reached an all-time high in 2022, peaking at 7%, nearly 2x the national ratio at the time of about 4%. It has since fallen to 5%, which is much closer to the US ratio than in recent years.
Beyond this, California, Texas, and New York remained largely in line with last year in the mid-single-digit range. Illinois fell 1.1pts to 3%, but the trendline here remains unclear as the state’s DCC ratio has been rangebound over the past two years.
Louisiana and Georgia are two other states in the past year alone that have either approved or signed into law substantial tort reform. Specifically, the Louisiana senate approved a series of legal reforms, including a tweak to auto accident liability.
Georgia’s governor signed long-awaited tort reform into law this past April, including but not limited to changes in state premises liability as well as limitations on third-party litigation finance. It is still early days, so the impact of the tort reform is not yet reflected in the data. As of 2024, both Louisiana and Georgia had DCC ratios of about 4%, in line with the total US.
Taking a step back, a concern we raised previously that remains is whether tort reform in Florida or other states could be reversed if results continue to improve substantially. Critics have previously questioned whether tort reform had gone too far, and such efforts to roll back changes could reappear and threaten insurers once more.
In summary, select long-tail commercial lines of business comprising just over a quarter of the industry’s total written premium show an ongoing rise in DCC expenses, reflective of the industry’s struggle with social inflation driving litigation costs. However, state-level DCC ratios remain stable, with Florida continuing to improve as sweeping tort reform takes effect.
The stability we observed at the state level is in part due to significantly lower personal lines DCC expenses offsetting the uptick in commercial lines.
Appendix
The charts below show the top ten states with the highest DCC ratios on the left as well as the top ten states with the lowest DCC ratios on the right as of 2024 and 2019. New York, New Jersey and California remain in the top ten post-Covid-19. New York, which ranks fourth in percent share of total written premium in the US, remains the state with the highest DCC ratio in the US of 6.3%.
Additionally, there are several states which have large DCC ratios relative to their premium share. The District of Columbia, Hawaii, and Rhode Island all rank in the top ten despite their individual shares of national premium being less than 1%.
The table below shows the top 10 states with the largest increases (i.e., worsening) and decreases (i.e., improvement) in DCC ratios since 2023.
Michigan, Hawaii, Massachusetts, and Illinois all saw improvements to their DCC ratios greater than 1pt. West Virginia, District of Columbia and California all had deteriorations greater than half a point.
