Have Insurance Companies Lost Track of their Purpose as Risk Transfer Agents?

 

Insurance is risk transfer. A consumer has a risk. They want to eliminate or minimize the financial impact if that risk is unfortunately realized. Therefore, they purchase an insurance policy. The insurance company takes the vast majority of the financial risk in return for a relatively small payment. The consumer eliminates the larger risk, however minimal the chances of realizing a loss, for a cost.

For example, the consumer possesses the risk that his or her house will burn down. The homeowner wants (or just as likely, their mortgage company wants) to transfer the financial burden they would have if their house burned down to a third party. Let's assume the financial risk is $300,000. An insurance company accepts the risk of losing $300,000 in return for a $1,000 premium. If the insurance company has priced the risk correctly, then on average the company will make about $2.00 based on the last ten years of results for homeowners insurance. That is quite a transfer of risk! (It may also qualify as a psychological study in madness because is it really worth $2 to go to all this effort and risk?)

Some, maybe even most, people might argue that insurance companies have absolutely lost track that they are in the business of risk transfer. Some companies clearly have taken the attitude they are not in the business of incurring claims. Everyone of course claims they understand this but actions speak louder than words, especially when internally their words echo their actions. They only want to write risks that have an incredibly tiny probability of a claim. As a reminder to all insurance company people, the world does not need you if there are no claims. This is your purpose, your reason for existing.

Insurance company people are saying, upon reading this, "What does this author think claims people do all day? Of course we have claims!" But what do claims people do all day is a valid question. On a broad scale, people do not have claims at nearly the frequency they had prior to 2001 according to A.M. Best data adjusted for more population, more cars, more homes, more businesses, and more drivers. All else being equal then, some claims employees may be twiddling their thumbs.

One reason I suspect claims frequency has decreased so much is because agents are continually telling clients to not turn in claims. They do this because companies have conniption fits if they even think an insured has had a claim. Some underwriting is so tight, I am not going to be surprised to see a nonrenewal for an insured that even utters "claim" in a conversation. Again, no one needs companies if no reasonable chance of a claim exists.

I understand the underwriting philosophy that once a person has incurred a claim they are more likely to have another claim. That philosophy is as old as Lloyds. I am not doubting a high quality statistical study has been completed that uses an entire universe to prove this point. (I'm sure someone has actually completed this study and it just is not public because I have not seen one in thirty years.)

I doubt correlations are universal across lines. I doubt too that opportunity does not exist differentiating between types of first claims and types of insureds. Insurance companies though seem to throw the baby out with the bathwater. Underwriters and underwriting managers are too scared of a large, second claim occurring. More precisely, they are scared their boss will tear into them for not nonrenewing the account after the first claim, no matter how unrelated the first claim was to the second. So they go scorched earth and nonrenew everyone. Agents know this so they tell insureds to not turn in claims.

Underwriting behavior like this is highly problematic:

  • Agencies are damaged. Companies want their agents to survive and thrive but they damage those agencies with their underwriting and claims actions.

a. When agencies tell clients to not turn in claims, the agents are creating huge E&O exposures for themselves.

b. Reputations are dulled and even damaged especially relative to the new disrupters because they have clean and better branding with no history.

  • The data used is questionable.

a. How good is a particular company's one-loss regression analysis leading to a second loss? What is the true correlation and is it really a simple regression? I doubt that. I imagine a quality statistical study would discover the correlation is a multi-factor relationship and therefore, simple underwriting rules should not be applied.

b. If a large percentage of claims, even small claims, are not being turned in, then the database used to draw the correlation is inherently and materially biased.

 

  • I am not doubting a relationship does not exist between some small claims and future larger claims. One of my first underwriting lessons is that an old man backing out of the driveway and hitting a bike only had a small claim due to luck. It could have been a kid. The nature of the claim though dictates the probability of the future claim, not that a claim may have occurred. The industry's reputation is damaged when companies are so tight. If the reader does not see this, I am not going to explain.

 

  • Premium growth is impaired. One of the reasons premium growth has been so sluggish is that in the last fifteen years tort reform, among other reforms, have arguably been too successful. I am not arguing such reforms should be relaxed because in my opinion, such reforms have been good for society. However, if fewer claims are filed and/or claims are settled for less, premiums decline. The fewer claims dollars paid, the lower premiums will be. The price for the risk transfer decreases because the risk decreases. When claims are not turned in, rates do not increase. When claims (not even claims, I’ll call them "incidents") result in automatic nonrenewals or large rate increases that force insureds to find more reasonable companies, rates do not increase. What is the definition of a claim anyway? When does a client's inquiry become a claim?

 

Reputation damage, lower premium growth, and increased litigation potential against agents should be enough to open eyes, if not at least slightly modify underwriting behaviors.

Some companies wonder why agents do not sell more of their product. The policies are good, the rates are good, and yet sales are minimal. What the agents do not say is they do not trust the company to be fair. The last thing agents want is having to deal with a client who has had a claim and is not being dealt with by the carrier fairly. The best solution is to not sell policies of those companies who have this reputation. Please believe me, most companies that have this reputation do not know they do. But look at growth rates office by office.

 

Another bad situation for agents is to rewrite policies unnecessarily. Rewriting policies is a lot of work and they do not get paid extra. So when companies take unnecessarily harsh underwriting positions, agents have to rewrite more policies. It is easier to just not write new business with those companies.

For example: A young driver is backing out of a packed parking lot during the holidays. A careless driver is screaming through the rows trying to find a parking space. The two cars touch, but the young driver stops quickly enough to avoid any damage. The dust on both cars is wiped off but the paint is not even scratched.

 

At first, the simple and novice conclusion is the young driver should be more careful. But I suggest no one is going to see the speeding driver driving any more expediently than the young driver did. Yet, the insurance company cancelled the young driver's policy simply for reporting the possibility the other driver might file a claim. The young driver did the responsible thing. The insurance company did the irresponsible thing. This is a true story.

An insurance company should at least think these "claims" through or build better algorithms. Otherwise, no one really needs insurance companies, or at least ones that do not think. At the very least, just get rid of the underwriters by 5:00 pm because human underwriting without thinking is pointless and useless.

Nothing good comes of increasing rates or nonrenewing accounts for incidents. Nothing good comes from agents telling clients to not turn in claims because insurance companies are taking ridiculous positions regarding incidents. Insurance companies are in the business of risk transfer, not writing risks that are absolutely perfect. If you run an insurance company or underwrite for one and cannot stand the pressure, sell the company or find a different job because absolutely no one needs an insurance company afraid of claims.

NOTE: The information provided herein is intended for educational and informational purposes only and it represents only the views of the authors. It is not a recommendation that a particular course of action be followed. Burand & Associates, LLC and Chris Burand assume, and will have, no responsibility for liability or damage which may result from the use of any of this information. 

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