Claim Evaluation: Determining Valuation

Determining Claim Value

The accuracy and interpretation of facts gathered in the investigatory process are at the heart of determining first the extent of the contractual and/or legal obligation among the parties and ultimately where, to what extent, and how insurance coverage applies. These elements most affect the value of the claim upon which, in general, claimants want to maximize and insureds want to minimize the claim value.

Of course, fairness and equity should be the claim professional's end goal regardless of what the final claim costs are. Claim value also undergirds the reserve setting and adjustment process and is often the key element driving whether a claim will be resolved voluntarily and efficiently. By extension, accurate reserves, based on the evaluation and interpretation of the facts, are essential to managing both individual losses and the portfolio of losses under any one or collective group of policies.

Managing Total Cost of Risk (TCOR)

Equitable and informed evaluation information is also essential to underwriters who set the premium for the coverage purchased both now and in future periods, both all-important to managing total cost of risk (TCOR). To the extent there's a large variation between the collective reserves that drive "ultimate" values for a book of business and the final total cost at the closure of the book, financial performance of the insurer/self-insurer hangs in the balance. Thus, the ultimate value of losses represents the difference between profit or loss on each policy. This then is clearly a very important aspect of claim management activity requiring diligence and consistency in its application. In fact, a key professional liability exposure for claim professionals is the possibility of significant inconsistency in the execution of day-to-day claim evaluation processes.

TCOR dominates the risk manager's view of the financial aspects of claims both individually in the short run and collectively in the long run. This view is informed by the cumulative value of all claims under each policy for each policy term. Collectively, the claims under all policies are the biggest determinant of long-term loss and premium trends and ultimately the TCOR year over year. TCOR tends to be the primary success measurement for traditional (hazard-based risk) risk management.

As a result, accurately managing the reserves on each claim file determines the ability of actuaries to accurately validate total reserves for loss obligations under individual policies and entire books for business for each specific line of coverage. Accurate reserves are the key determinant of the trends that risk managers track as they monitor the evolving and dynamic risk profiles of their organizations.

Determining Ultimate Values

For risk managers who retain or self-insure large amounts of insurable risks, the accuracy of individual file reserves is as critical to them as it is to insurers for similar reasons. The big difference, however, is that risk managers are much more vulnerable to the pain of large swings in aggregate reserves for retained losses that typically go to the bottom line of their organization's income statements. Significant and unexpected variations in reserves are, therefore, unwelcome but, for obvious reasons, get management's attention for better or worse.

At the heart of determining the value of a line of coverage is not surprisingly actuarial techniques and processes that take the individual amounts paid and reserves set on each claim file and develop those "paid and incurred" values into "ultimate" values. This development process considers many factors that affect the values of the various component parts of claim costs.

For example, in a workers compensation claim, the cost of medical care is often the most-significant contributor to a final claim value. Medical care costs have been highly variable over recent years, from state to state, across the myriad of medical procedures to the many variations in injury outcomes that define the world of employee injuries. Thus, medical cost trends are one area of analysis that actuaries evaluate carefully to both validate prior estimates of actuarial ulimates, the development factors that lead to them, and the many other factors that influence final claim values.

Another example of such factors is the general inflation in wages, the other most significant component of workers compensation claim costs. These costs vary markedly from locale to locale, from company to company, from job to job and from period to period among other influencing factors.

Actuarial Methods

And so it is in every line of coverage—from automobile liability, where the cost of car parts and repair labor is paramount to general liability, where actuarial projections are influenced by factors including gross sales, customer transaction counts, and the litigation environment in the affected locales. The accuracy of actuarial techniques and process is central to the accurate projections and evaluations they make that are essential to determining insurer performance and self-insurer expense projection accuracy (affecting a self-insured's bottom line).

While the intricacies of actuarial methods are beyond the scope of this article, the accurate, timely, and effective work of the claim professional is critical to actuarial reliability and the effective use of the output. And though claim professionals rarely interact directly with actuaries, that makes it even more important that claim evaluations and valuations get done well and that the results are transmitted timely and accurately. Thus, claim professionals should take the time to understand actuarial fundamentals to facilitate the best claim outcomes.

Important to the evaluation and valuation process is input from others, especially for the less experienced. The days of simple formulas for setting claim reserves and values are long over. Today's claim professionals receive thorough training, continuing education, and supervisory oversight that helps them move more closely toward the consistency sought in their work.

This is especially true in the areas of evaluation and reserve setting, which affects so many other important areas downstream, as referenced earlier. For some larger value claims, committees of claims professionals often collectively debate the interpretation of case facts and reserve recommendations set by the individual claim handler, again in the interest of both accuracy and consistency. Clearly, these processes are subject to strong subjective tendencies of individual opinions, which each of us holds. Vetting these opinions often leads to a better, more accurate evaluation and valuation of each claim.

Setting Reserves

Finally, great debate continues over how best to evaluate claims and set the best, most accurate reserves as early in the investigative process as feasible. The issue of "stair-stepping" reserves over time is an interesting challenge in practice. On the one hand, it is obvious that early in the life of a claim, there is only limited information available to evaluate and set reserves. Over time, as more facts are uncovered, collected, and evaluated, a more accurate, complete picture of the claim scenario emerges.

With this additional information comes a natural tendency to revisit key questions like compensability (in workers compensation), liability (in auto and general-type claims), and claim value and related reserves. Thus, periodic adjustments to initial reserves seem only appropriate and helpful to more accurately represent the evolving understanding of the claim and the legal obligation surrounding it.

Stair-stepping, however, by definition is more of a methodical, less-informed process of revising (typically upward) a claim's value, which is often the result of an early, more obligatory reserve posting required by some claim process standards. While not fundamentally wrong, stair-stepping reserves doesn't serve much of a useful purpose when it doesn't represent at least a reasonable assessment of known facts at any point in time, early or late, in the investigative development process.

In short, best practice reserve setting entails reasonably assessing that the set of facts being gathered at any point in time and posting a reserve commensurate with the best judgment available to the claim professional at that time are based on that information. Revising reserves as other significant facts are developed has no one right frequency or pattern.

Conclusion

In the final analysis, the value of each claim will bear itself out over time and only when the file is closed does it become final. Before that day, and from the day the loss is first reported, there is an often-wide swath of time over which appropriate investigative work gets accomplished (each iteration of which provides more insight and a better view into what happened, what legal obligation results, and what the claim is worth at the end of the day). Throughout the life of each claim, claim professionals endeavor to evaluate the facts as timely and accurately as possible, leading to the fairest and equitable conclusion for all parties involved. Ultimately, claim evaluation, valuation, and reserve setting are critically important to many stakeholders in the claim management process.

In the next and final installment in this series on claim best practices, I'll dive deep into claim resolution and settlement, the final curtain for all claims, and the goal of every claim professional.