Controlling your Own Claims

The alternative risk financing market is a truly unique challenge for the insurance industry. These transactions blur the lines between traditional insurance and the world of finance. The insurance contract is the same, but there is a secondary and equally important part of the transaction: a financial piece that helps coordinate and control the costs of both the policyholder and the insurer, mostly on third party liability and automobile exposures.

Various reasons exist for a policyholder to move into the alternative risk financing market: reduction in premiums, changes in tax status, expanded insurance coverage and/or an increased focus on risk management. However, the most practical reason to self-insure is to have greater involvement and control in the claims process. Most companies that self-insure expect claims to happen; there is often a moderate to high frequency of low-severity claims.

No matter what technique is used – be it a deductible, reimbursements, captives or other mechanisms – self-insurance enables a policyholder to have a say in the claims process because they are taking a piece of the action. They will be paying some or all of claims subject to the terms and conditions of the policy. That involvement in the claims process creates an opportunity for the policyholder to consider and respond to the impact of the claims handling process on the business.

Roles of the Parties

There are three main roles in the claims handling process. First, there is the claims handler. This might be an independent adjuster, an insurer or, in some circumstances, a policyholder might have their own claims handling area staffed with insurance professionals. Regardless of who it is, the job remains the same. Each claim must be investigated and negotiated according to the terms and conditions of the insurance contract and settled using normal industry claims handling procedures and standards. In some cases, insurers may compete with adjusting companies for claims handling responsibilities. The insurer, using funds provided by the policyholder, might set up a claims fund that the adjuster can use to pay claims. This is often called an imprest account or an escrow.

If the claims handler is someone other than the insurer, then the insurer has a responsibility to oversee the claims handling process. The responsibility is a combination of claims examining, especially on large and unusual claims, and claims management (oversight of the portfolio). The insurer’s role in this scenario has two purposes. The first is to ensure proper handling and guidance on claims, providing direction to the primary claims handlers when required. The second responsibility is to act as the claims manager on behalf of a policyholder, providing expertise and a single point of contact for any customer questions about any claim. That single point of contact is the main control the customer has over the account, and is often called the control adjuster.

Not every customer has the resources to be able to appoint an internal claims manager. They might prefer to assign that responsibility to the risk manager or designate, perhaps even at an adjusting company. If the policyholder does have a claims manager, all claims should be coordinated with the insurer.

The third role is one of audit. If the insurer is handling the claims, that audit function may simply be an internal function using the resources normally allocated to the process by the insurer. It may be a combination of self-audit, peer review and formal audit. If claims are handled by anyone other than the insurer, it is a regular audit process. The claims frequency and the line of business, along with past audit results, should dictate the frequency of audit. This process should be done jointly with the broker and a formal audit statement should be shared with the insured.

All three functions are critical to the claims handling process and are a prudent part of any sound risk managed program.

Relationships in a Self-insurance Structure

With the policyholder gaining a say in claims discussions, it would appear the roles in claims servicing might change a little. But they really don’t change all that much, especially for independent adjusters. The policyholder, along with the broker, might play a greater role in determining exactly who is going to be the primary service provider for claims.

From a regulatory perspective, the insurer is responsible for all claims. Any claims in which the payments come directly from the insurer – or from a payment fund supplied by the insurer – are the responsibility of the insurer, no matter who is actually negotiating or settling the claim. The insurer will also be responsible for recording all reserves from the first dollar. But the insurer can claim a reduction in liabilities for any amounts recoverable from the policyholder, as long as they can prove that the amounts are recoverable. This means having appropriate collateral in place, collateral that can be recorded on the insurer’s statutory filings. Without collateral, the insurer will have to hold capital against the reserves posted on behalf of policyholders.

The only exception to the rule is when there is a true self-insured retention, where the insurer has no financial responsibility for amounts below the policy. In this scenario, the self-insured retention will be documented within the policy wording.

Even with a payment structure in place negotiated (in some cases) by the policyholder, an independent adjuster – often referred to as a third party administrator – is still a representative of the insurer.

The flow of financial transactions is that the insurer pays the claim and pays the adjuster, and then seeks recovery from the policyholder. Although linked, they are in fact two separate transactions.

A unique part of the relationship between the parties is the use of the policyholder’s money to pay claims. As stated previously, the policyholder usually has some input into the settlement process. The insurer must make sure all claims are handled using normal industry practices, but has a fiduciary duty to the policyholder. Just like any other scenario in which someone else’s money is involved, the insurer has to check first with the policyholder before spending their money. The insurer should also check with the policyholder on any controversial claim, just to ensure any potential business impact can be addressed. Denying a borderline claim to the policyholder’s highest-volume customer could have far-reaching consequences!

The Claims Handling Contract

One significant difference between a standard insurance arrangement and an alternative risk arrangement is that in an alternative risk arrangement, a specific claims handling contract is usually in place outlining the terms, conditions, pricing and reporting requirements under the program.

There are a couple of variations on the contract, depending whom is doing the day-to-day claims handling. No matter what, though, every contract of this type will have a few things in common.

One way to structure contracts with a control adjuster is to qualify a number of independent adjusting firms in advance. Each adjusting company will meet a series of specifications, ranging from the fees charged to the amount of professional liability insurance each carries; a reporting structure through to a national accounts team; a general agreement about any escrow or imprest funds that are put into place (funds held by the adjuster to pay claims and then get topped up to a constant level, much like a petty cash fund); and a service agreement outlining target response times and audit provisions.

Alternatively, an insurer might handle claims directly, without the involvement of an independent adjuster. In this case, the claims handling component might be included in any other legal agreement, such as an indemnity agreement, between the client and insurer.

Once the adjust er is determined, be it an insurer or an independent, any new client will have a set of account handling instructions issued specific to the account and the coverages. A handful of things are common to any adjuster. The client may have specific requirements for certain types of claims and may ask for special reporting in these cases. The insurer will require all category claims be reported as quickly as possible, requiring both the client and, if there is an independent adjuster in place, the independent to report as quickly as possible.

Category claims are large or complex claims, mostly involving serious injury, minors or contentious claims – or possibly claims that draw significant media attention. The insurer might have further contractual reporting requirements to reinsurers in the event of one of these claims, and would prefer to know about them as soon as possible.

Other contractual requirements include service provisions outlining the time in which the adjuster has to respond to a report of a claim. There might be different response times for different types of claims. For example, pollution claims might require an immediate response, whereas other, less serious claims might be able to wait until the next business day. Authorities of the adjuster will also be specified in the contract.

In the claims handling contract, it is critical to detail the rules and procedures for any money held to pay claims. An imprest or escrow fund acts very much like a petty cash fund. The balance is usually a function of the normal monthly claims payout, usually a multiple (two or three times, for example), so money is always available. A billing requirement will be specified, monthly or quarterly (depending upon the imprest amount). The requirement will state the insurer or the client, whichever is holding the full payment fund for claims, must replenish the fund regularly to ensure the continuous payment of claims. There may also be provisions about when such money is to be returned, after a set number of years following expiry of the policy (or after settlement of the last known claim).

The final major component of this type of contract is the fee structure. Whether or not the structure includes flat fees, actual time and expenses incurred or some other scheduled amount, it is much better to determine the amounts to be charged for claims handling before the account is bound – especially if there is a known or expected claims frequency.

Reporting

One of the most important services provided by claims is the claims bordereau or loss run. This is a detailed list of claims and claims expenses outstanding and paid by the reinsured during the reporting period. Whatever the frequency, this is a foundational piece of the underwriting process; it is an important component of any client’s risk management program. Inaccurate and incomplete information can paint a vastly different picture of an account and can have severe financial consequences, not only to the insurer but also to the client.

The client will often define the key pieces of information they would like to see on each case. Some things are standard: date of loss, date reported, description of the loss, amounts paid as indemnity, expenses (perhaps even types of expenses) and the current status of the claim (open, closed or reopened).

Reporting may be done directly by an adjuster or the insurer. The large national adjusting companies all have top-notch claims reporting functionality and are capable of preparing high-quality loss runs. Some insurers have difficulty with loss runs. This is mainly because their systems have been built for statistical and regulatory reporting, as opposed to reporting to clients.

Clients will also look for individual claims reporting, especially when a large amount is involved. Just like any person, if someone else is spending your money, you probably want some say in it – or at least would like to know exactly why it is being spent. Claims payments are contractually required. In some instances, a client may need a detailed explanation to help them understand when a payment has to be made, even if they think it is unwarranted. Clients will also look to be involved when the claimant is one of the key customers. This is because the client doesn’t want a business relationship imperilled by a claim.

Summary

When it comes to alternative risk financing, there is a lot of focus on the additional financial responsibilities from an underwriting viewpoint. But the claims focus is an equally important part of the picture.

Large accounts and accounts with self-insurance mechanisms may share similar policies with other commercial customers, but the service expectations are different. Some companies have claims that can act like an entire portfolio of business, with a high claims frequency and very specific reporting requirements. Increased reporting and fiduciary responsibilities are not part of the day-to-day workload on most portfolios of commercial business. Contracts guiding a broader range of counterparties can alter normal business relationships. It is mutually beneficial to have a clear understanding of the claims process and everyone’s role when entering into a self-insurance arrangement.