Part 3 of 4
Written by Ronald T. Kuehn FCAS, MAAA, CPCU, ARM, FCA,
Kim Piersol FCAS, MAAA, Todd Dashoff ACAS, MAAA, ARM
In Part 3 of this article, we discuss another method of employing predictive modeling and claims leakage studies.
The Problem: The Happy Person Insurance Company was a new insurer writing liability coverage in the State of Bliss. In order to make sure that the company was adequately reserved, the claims examiners for Happy Person were instructed to reserve every claim at their opinion of the maximum amount that might be paid if the company’s insured was found to be fully liable. In addition, the reserve amount was only input once the examiner was sure that there was enough information in the claim file to support the decision on the reserves’ value.
Because of this “worst-case” claims settlement philosophy, the reserves for the company emerged very slowly, taking approximately 36 months to reach their supposed final value (see Exhibit 1 below). Since Happy Person’s insureds were generally careful and intelligent, many claims would settle for lower values than the amount input by the claim examiner, and in some cases where the insured was found not to be liable, settled for no payment. The right hand portion of Exhibit 1 shows that after reaching a peak of $20 million at 36 months, the actual value of the claims steadily declined over time, until reaching a final value of $10 million approximately 90 months from the inception of the accident year. The claims examiners’ stated that their estimates were generally always sufficient to cover the cost of the claim at settlement and frequently resulted in a “win for the Company. However, this resulted in the actuary for Happy Person determining that there was a large reserve redundancy at the end of the year when the Statutory Loss Reserve Opinion was issued.
The Solution: Using predictive modeling techniques, including various benchmarks and industry averages by type of claim, a review was conducted of the company’s claims settlement history by data code. The results of the analysis indicated that the company was overpaying for all types of claims due to the method by which the reserves were being set.
For example, assume that the claim examiner set a reserve of $400,000, based on their estimate of the maximum that could be paid if the insured was found to be liable. When the claim finally settled for a payment of $300,000, it appeared that the company had saved $100,000. However, if the claim had originally been reserved at $250,000 according to industry benchmarks, the claim examiner would be provided with an incentive to negotiate the claim in order to avoid an adverse result. This extra step was able to produce a settlement at the $250,000 amount. The belief of the examiner that they were “saving” $100,000 actually ended up costing the company $50,000 in claim leakage.
Based on the results of the claim leakage study, it was recommended that a new claims handling philosophy be adopted that directly included an estimate of the probability that the claim would result in a payment in the calculation of the reserve to be assigned to the claim. The company implemented this recommendation and subsequently performed a second review of their claim experience.
In total, as seen on Exhibit 2 (see below), the revised claims handling philosophy produced a significantly different result. The total value of all claims for the year peaked at 30 months, six months sooner than under the original philosophy. In addition, the total value as of that point, $8 million, held steady from that point on, rather than gradually declining as it had under the original claims handling philosophy, since the revised philosophy also accounted for the possibility that a claim could result in no payment when it finally settled.
The Result: A comparison of the two claims handling philosophies is shown on Exhibit 3 (see below). It can be seen that the original philosophy did result in significant claim savings as the claim redundancy gap was burned off over time as claims settled for amounts lower than the “worst-case” reserves. However, this required approximately five additional years to occur. Under the revised philosophy, the cost of claims for the year reached their peak value much more quickly and resulted in a claim leakage savings of an additional $2 million over the cost of claims under the original claims handling philosophy.
Once the new philosophy had time to become completely implemented, there was a much smaller redundancy indicated by the actuary’s review, and total claim payments were reduced as compared to the amounts paid under the previous philosophy since the examiners’ estimates were much closer to the actual final values of the claims. The new reserving philosophy resulted in the elimination of the “claim leakage gap” between the settlement values under the original philosophy and the values using the revised claims handling philosophy. The company therefore also had a much more consistent value for claims to include in the Annual Statements, which improved their budgeting and the perception of the company by outside reviewers.
In Part 4 of this article we will discuss additional claims leakage studies, and will provide a summary of the advantages to performing these types of analyses.