The Claim Function and Best Practices

The Legal Obligation

The underlying insurance policy is at once a contractual obligation to pay certain sums on behalf of the insured under specific circumstances defined in the policies. It is typically based on obligations that emerge from civil tort laws where for example the insured's negligence creates the obligation to pay for damages caused by an act of negligence (at tort).

A common example is where failing to drive an automobile safely produces an accident, the result of one or more person's wrongdoing often leading to another party's bodily injury and possibly other damages (e.g., lost wages, mental injury, etc.). In other situations, such as in a professional liability policy, the condition triggering a claim might be a "wrongful act," such as a bad decision of a board director that led to a covered loss.

Claim Reporting

Unlike exposure areas that aren't insurable, insurable risks are "treatable" using insurance contracts that by their very nature create dual obligations among the two key parties: the insured (typically the "claimant" in a first-party claim situation) and an insurer. The terms and conditions of these agreements include many that apply to making and resolving "claims" by the parties (or in a liability agreement, a third-party against the insured) where the insurer commits to its obligations for paying specifically defined expenses and legal obligations of and/or to its insured when relevant contract conditions are met by the insured.

For example, a very basic and early obligation of the insured is to report claims, usually in a timely, accurate, and honest manner. This can be a defining moment when in a "claims-made" policy, you have conditions that require (with some exceptions) that all claims be reported before the expiration of the policy term (typically 1 year). Failure to do so could lead to a denial of coverage.

More commonly, an "occurrence" policy allows for a much more liberal time period for reporting, where in this type of policy, claims may not surface until after policy expiration and yet may still be covered when reported even then. So, something so basic as claim reporting, while seemingly simple and obvious on its face, can be a source of difficulty up to and including finding yourself without coverage. While this is much more controllable in first-party claims (e.g., a homeowner or personal auto claim situation), it can be much more challenging when claims may be significantly deferred by third parties (e.g., a product liability claim from a customer).

Needless to say, good risk management calls for a disciplined claim reporting process so that the many sources of claims (customers, employees, or members of the general public) are enabled to support best efforts to effect coverage where applicable.

Claim Investigation

The heart of claims management is the investigatory efforts that are focused on gathering the evidence, formally and informally, that allows the analysis necessary to determine the following.

• To what extent the insurance coverage applies
• Whom the coverage applies to
• What the value of the claim will be
• What the reserve should be to cover the financial obligation in its various component parts
• What information is needed to address component claim parts (e.g., disability payments, medical bill payments, retention of lawyers, etc.)
• What additional information may be needed to get to its resolution and file closure

Much of this activity revolves around not just the claimant but the other sources of information such as witnesses, law enforcement, experts, medical providers, employers, and others. Thus, the core investigative activity involves interviewing people who have the facts needed to answer the question set above. While most of this was, in the past, done in person, today's modern claim professionals are able to gather the needed evidence much more efficiently from behind a computer screen and by telephonic inquiry.

Most often, the key goal is timeliness, as failing to act quickly in the aftermath of accidents often means evidence could be lost, which degrades analysis and decision-making in the overall claims management process. In some exposure areas, there are regulatory requirements, such as under workers compensation statutes that require decisions (e.g., compensability) and payments (first and recurring wage-loss reimbursements) within specific time frames. Failure to meet regulatory rules may often result in fines and penalties for the insured and/or claim handler.

Other aspects of the investigative process that I'll cover in more detail in subsequent articles include the following.

• Preparation for litigation including civil trials
• Preservation of evidence
• Securing legal defense services
• Securing expert witnesses
• Determining the validity of documentary evidence
• Accident reconstruction services

Needless to say, this phase in the life of a claim is often the most time consuming but also the most critical to getting to an equitable resolution for all parties.

Claim Evaluation

Claim closure is only achieved when either a settlement is reached voluntarily or where there is a dispute about facts and/or claim value, which may lead to litigation up to and including a civil trial to resolve. Thus, the accuracy of facts gathered in the investigatory process are the lynchpin for determining first the extent of the obligation, if any, and ultimately where coverage applies (the value of the claim leading to a mutually agreed upon settlement). Claim value, which should undergird the reserve setting and adjustment process, is the basis of whether or not a claim will be resolved voluntarily or through litigation.

By extension, accurate reserves, based on the evaluation, are essential to managing the entire group of losses under any one or collective group of policies. This information is also essential to underwriters who set the premiums for the coverage purchased. To the extent there's a large variation between the "ultimate" reserves set for a book of business and the final total cost at closure of the book, this represents the difference between profit and loss on the line. Clearly an important aspect of claims management activity.

Claim Settlement and Resolution

Knowing as we do that claim closure is the ultimate goal of all claim professionals, all preceding activity leads up to the point where the parties, brokered by a claim professional, attempt to reach a mutually agreed upon resolution. That most often means a financial settlement that extinguishes all civil obligations under the law as well as the contractual obligations of the insurer to the insured under the policy.

Situations emerge that sometimes involve sources of payment in addition to insurance policy funds, typically where the policy limits are insufficient to settle the claim or where, by agreement, other parties may contribute to a resolution that also extinguishes the legal exposure of parties.

The claim professional essentially plays the role of an intermediary between parties in order to facilitate claim resolution. The typical way this works is the claim professional negotiates with the claimant or his or her representative (typically an attorney), debating the relevant evidence as to its reliability and thus the way it supports the claim valuation reached independently by each side. If mutual agreement is reached, the claim is settled and closed. If an agreement can't be reached, the matter typically proceeds to litigation and the threat of a civil trial, possibly in front of a jury, which then determines the final outcome.

Litigation, of course, brings another level of complexity and expense to managing claims. It often protracts the resolution time, which is directly correlated to either larger final claim values or the other extreme where a jury decides no payment is due.

Claim Reserving and Valuation

I touched on the reserving above under the evaluation section, but there's a bigger picture that dominates the risk management view of the financial aspects of claims. This view is defined 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 total cost of risk (TCOR) for each insured. All this to say that 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 all policies issued by an insurer for any specific line of coverage for all insureds.

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.

Conclusion

Claims management is, on the one hand, a relatively simple function but one with many moving parts, where no two claims or claimants are exactly the same. The variation in the specifics of each claim is endless. That makes the claim function endlessly diverse. However, the claim function is at the heart of traditional risk management and is by far the largest component of TCOR. As a result, it behooves all risk managers to ensure that claims best practices are used to get to reasonable outcomes for all parties in the most efficient way. I'll address each of these components in more detail in the future.