CICMA/CIAA Joint Conference 2002 Focus on Indemnity

There is widespread industry agreement that claims costs are spiraling out of control. The industry’s economic woes cannot simply be tied to inadequate rates, or even catastrophic events such as September 11. At the recent Joint Claims Conference in Toronto, a discussion of the merits of outsourcing became a lesson to insurers in what needs to be done to address rising loss costs, and the focus fell squarely on the issue of indemnity.

Say the word “indemnity” and some insurers may be shaking in their boots. Recent claims payout statistics suggest that insurers are shelling out more and more, at a time when rates are only beginning to harden. At the recent Joint Claims Conference sponsored by the Canadian Independent Adjusters Association (CIAA) and the Canadian Insurance Claims Managers Association (CICMA) in Toronto, speakers noted that insurers are looking at ways to harness claims costs, but may not be looking in the right direction.

In a discussion on outsourcing, panel members agreed that claims costs are becoming a key concern for the industry. With claims inflation at 14.7%, this outstrips last year’s average rate increases of 12%, notes Carole Jardine of Royal and SunAlliance Insurance Co. of Canada. Furthermore, “leakage” is another cost factor that is averaging 10% a year as well, she adds.

Insurers are not only dealing with the cost impact of the September 11 events, but also continuing asbestos issues and the growth of class action lawsuits. “Often as claims people we say, ‘oh well, the underwriting people aren’t getting the rates they want’,” she says. As such, there is a “back of the bus” attitude about claims, perhaps partly because most CEOs do not originate from the claims department as well. Technology spending, among other things, does not seem as targeted towards claims as it is to underwriting and sales.

Claims, like underwriting, is a core competency, Jardine argues, but many CEOs do not understand claims, and are not well informed on claims cost issues. For example, she notes that most CEOs are unaware that all claims costs, including salaries for claims staff, are part of the loss ratio rather than the expense ratio.

Understanding “loss”

Hence the “indemnity issue” is an outcome of insurers trying to tackle claims costs by simply reducing staff or outsourcing the department. Loss ratios are up dramatically, Jardine admits, over 80% for many companies. In 2001, insurers are expected to have faced $17 billion in total claims. The question, she asks, is “how do we learn to measure indemnity behavior?” How do companies continue to be fair to customers in paying claims while addressing losses? The answer is to look at how and why companies are paying claims, rather than staffing and other claims expenses. “We have to get more comfortable in talking about indemnity, the top half of the claim,” she says.

Loss control and indemnity are the keys, agrees Steve Smith of Kingsway General Insurance Co. Companies are paying claims they should not be, and with claims payouts representing 70 of each premium dollar, this is the number that has to be controlled.

Jardine and Smith both agree that with loss adjustment expenses (LAE) representing just 11%-13% of the loss ratio, this is not the area where companies are going to be able to reduce costs dramatically.

Regardless of whether companies outsource claims or not (Smith is a proponent of outsourcing, while Jardine has kept most claims handling inhouse at Royal), LAE remains consistent (see chart on pg. 46). Expenses should be “absolutely the least component of outsourcing”, says Smith. Many companies are currently facing combined (loss and expense) ratios of 120% and seek to bring this below 100%. A change of 1% or 2% on the LAE is not going to translate into reducing combined ratios (expenses and losses) to the extent companies require.

Outsourcing benefits

The true benefit of outsourcing then, is not lower expenses, Smith says. Kingsway, which outsources 75% of its claims files is looking at other factors, including capital and human resources. The company also outsources legal, appraisal, inspection and investigation services.

Among the “perks” is the ability of independents to leverage volume to reduce costs from suppliers. As well, if independents can reduce the time a file is open, savings will follow. The advanced technology at independents’ disposal is also a factor, as many companies would find installing such systems inhouse cost prohibitive. But, one key advantage is in greater fraud control, Smith asserts. Independents have the time to go “face-to-face” with claimants, have expertise in investigation and have local knowledge of fraud trends.

He expects outsourcing to bring about loss development control, especially in bodily injury (BI) claims, a sore spot for the industry in terms of rising claims costs. “BI claims are coming through the wall,” says Smith. “You’ve got to be in their [claimants’] faces” or risk future claims months, maybe even years after an accident. As such, he believes, the objectivity of independents can “act as a buffer” against bad faith claims.

Outsourcing nearly doubled between 1997 and 2000, and now totals about $55 billion in business in Canada, notes Keith Edwards of independent adjusters McLarens Toplis. Also president of the CIAA, Edwards is an obvious proponent of outsourcing, however, he does feel that insurers need to adopt better outsourcing strategies. The “tactical” model often used, which involves fee-for-service, “purchase-like” agreements that are short-term and often adversarial, is outdated, he notes. This is a response to insurers’ “back of the bus” view of claims. “You look at [insurance company] mission statements and claims doesn’t appear,” he says. As a result, despite the growing number of companies using independents, turnover rates have also been high. Companies are more concerned with quality than cost in outsourcing and should be looking for partners that share their strategic vision. The strategic model is long-term and tied to overall corporate goals, and offers independents incentive to participate in the transformation of the business, he adds.

Measuring results

Outsourcing has value in functions that require specialist skills, to deal with variable workloads, during peak claims periods or in concentrated geographic incidents, says Jardine. However, Royal keeps 80% of claims services inhouse, and says insurers making the call on outsourcing have to ask themselves if an independent “can actually execute that [business objectives] when juggling 14 other insurance companies”.

She sees independents as having more value on higher value claims, over $25,000, but maintains that inhouse operations are more efficient on typical, lower value claims.

One thing Edwards and Jardine do agree on is the right of insurers to expect independents to produce measurable results.

Jardine says insurers need to look at whether their outsourcing arrangement is addressing corporate goals: reducing loss ratios, loss adjustment expenses and, of course, customer satisfaction. Royal uses a balance-sheet to assess how independents are measuring up.

Edwards encourages insurers to create a scorecard and to review the process on an ongoing basis with independents. They should look at metrics such as timeliness, pricing and adherence to the requirements laid out in individual agreements. The goals set out for any outsourcing arrangement, he stresses, must “reflect the true need of the organization”.