What happens when insurers fail?

This month I will be a panelist at a National Conference of Insurance Guaranty Funds Workshop in Ft. Lauderdale, Fla. I spoke once about guaranty funds about 25 years ago, but other than a brief mention in my textbooks, I’m no expert.

In television advertisements insurers, describe the wonderful things customers receive if they switch to another insurer — wonderful rates, excellent coverage, great service. Why, you’ll even get a new car for your old one if you wreck it, and they will forgive you for the accident (at least this time). It’s simply dazzling!

Every year a number of insurers go into receivership. State guaranty funds take over those insurers and “run off” the claims, sometimes for pennies on a dollar. They may keep the insurer’s staff to do this, retain an independent adjusting firm to handle remaining claims, or have some other insurer take over the remnants of the failed insurer and handle the claims. It depends on assets the failed insurer still has, if any.

Cause and remedy

AON reports that $1.54 billion in claims resulted from last year’s storms. How many more billions in loss will 2018 produce, and how many insurers will fail? The National Association of Insurance Commissioners (NAIC) has an “Insurer Receivership Model Act” that requires state regulators who have entered into the rehabilitation phase of a receivership proceeding to coordinate with the guaranty association that is triggered by an order of liquidation. According to NAIC, all states have such an association, funded by “assessments on solvent insurers.” In most circumstances, solvency means that real assets exceed liabilities.

AON’s $1.54 billion in storm claims is peanuts compared with the Insurance Information Institute’s estimate of $34 billion in property and casualty insurance fraud loss annually. This is about 10% of all claims costs; auto claim fraud and “buildup” only accounted for $5.6 to $7.7 billion. Fraud is at least one major cause of insurer bankruptcy. The Iconoclast would suggest that unnecessary insurance litigation costs for disputed claims is another.

In 2016, the U.S. Department of Labor Statistics says there were 328,700 claims adjusters, appraisers, examiners and investigators, down 3,600 from 2015, or about 1%, with 2017 median pay at $64,690 each. Considering there are hundreds of insurers in the U.S., the actual number of adjusters per insurer is relatively low; a trend for a decade or more.

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Consider how an insurance premium is calculated: first, all the claim costs (including reserves) and allocated expenses — outside services, defense costs, etc. — are actuarially projected out to their probable maximum cost and divided by the number of units. This is called the “pure premium” and is usually somewhere between 60% and 75% of the total premium.

“Loading” is added, which includes expenses such as marketing, taxes, investments to surplus, administrative costs and even a percentage for profit. Hence, the higher the “pure premium,” the higher the profit as a percentage of the total. It makes fraud loss quite profitable!

What if the cost of the claims department was transferred from the “unallocated” cost column to the “allocated expense” column, becoming part of the pure premium? This would increase the “pure premium” unless spending more adjusting claims reduced the fraud loss and the number of lawsuits against the insurer. Carrier profit would not change, but the “pure premium” loss due to fraud and litigation would decrease as better trained adjusters were hired.

Ken Brownlee, CPCU, (kenbrownlee@msn.com) is a former adjuster and risk manager based in Atlanta, Ga. He now authors and edits claims-adjusting textbooks. Opinions expressed are the author’s own.