Reinsurance Audit Format

The following is a format for preparing reports following reinsurance claim reviews. When conducting claim reviews at various ceding companies, we will see different approaches to reserving, investigating, and the settling claims. We discuss here the common practices and the strengths and weaknesses of each.

This format was prepared to focus in on the most important things a reinsurer would want to know about a ceding company: its reserving accuracy, the overall quality of its claims handling, and its relations with the reinsurer.

A.     Reserving

a.1.       Adequacy of Initial Reserves

The establishment of initial reserves can provide insight into the ceding company?s overall approach to its claims handling.  There are three basic approaches to initial reserves:

-        formula reserving?

-        individual case estimate; and

-        no reserve for a short period of time.

a.1.1.   Formula Reserving

            The most common form of formula reserves is the choosing of $1,000 or some other random number as a reserve to ?get it in the system?.  Most companies, who use this method, do a disservice to themselves and to the reinsurer.  These randomly selected initial reserves replace individual thought with a mechanical process.

            Using this method, the claims person can delay for quite some time the establishment of a reasoned and well-thought out reserve.  He or she is not required, initially, to make a preliminary evaluation of the liability and damages.  He or she has no need to develop, from the beginning, a plan for the investigation and to develop a case estimate based on facts.

One exception, to this general rule, is in the situation where the claims manager allows a nominal first reserve, but requires the claims person to establish an initial case estimate within a short time period of say 30 days.  Given this leeway, the claims person can develop some preliminary facts about the case and produce some first estimate of what the case is going to be worth.  From the beginning it is important that the reserves be individually considered and established in a timely fashion.

The other method of formula reserving is using past claims statistical experience.  This can be done either through the company?s own experience or through industry standards.  For example, the company?s statistician would be able to say that all claims involving bodily injury have an average settlement value of $22,500 and all property damage claims are settled for an average of $3,500.  This method has a statistical foundation.

a.1.2.   Individual Case Estimates

            Using this method, the claims specialist evaluates the sketchy information which he has and comes up with some preliminary reserve.  He or she probably does not have all the details of the incident nor does he know about all the damages.

The initial reserve will not be very accurate but, at the very least, it forces the claims person to identify the facts that he does not know.  It is valuable to identify the areas which are unknown because this naturally leads to a plan for the investigation.

Using the individual case estimate for the initial reserves forces the claims specialist to evaluate the case right from the beginning so that a plan of action can immediately be outlined.

a.1.3.   No Reserve

            Sometimes companies delay the establishment of initial reserves until preliminary details can be obtained.  So long as the delay is not too long, this is an acceptable method of initial reserving.

It is similar to the individual case estimate since it provides the claims specialist with some breathing space to obtain basic information abut the claim.  Delaying the establishment of an initial reserve for thirty to sixty days would certainly be acceptable so long as there is evidence that the claims specialist is pursuing the matter.

a.2.   Reserve Adjustments

         For numerous reasons, including rating and tax purposes, the reserves have to be adequate within a reasonable time period.  If it takes five to ten years for the reserves to become accurate overall, the company has lost money in the inadequate rates that it charges on renewal business and it has lost money in the taxes that it has paid unnecessarily.

It is, therefore, important for the company to set time standards for the establishment of accurate reserves.  These standards will necessarily vary from class of business to class of business.  In automobile claims, the reserves should be accurate within sixty to ninety days.  On the other side of the spectrum, it is nearly impossible to have any confidence in reserves on EPA dumpsite cases because of the numerous imponderable questions regarding coverage, liability and damages.

In general, however, the company should be aiming for accurate overall reserves within the first year to maintain financial health.

Sometimes, companies have a low reserve throughout the pendency of the case and raise the it only at the last moment when the case is settled.  In other instances, the company keeps raising the reserves gradually with every adverse development (step-laddering).  If these are patterns, they are not acceptable.

In general, the reserves should be based on the claims specialist?s estimate of the jury verdict multiplied by the probability of losing the case.  For example, if a claim has a jury verdict value of $100,000 but there is only a 10% chance that the case will be lost, then the reserve should be established at $10,000.

For simplicity let us consider 10 identical claims, in which the verdict value is $100,000 and the chance of losing is 10%.  If all the cases are tied to a jury, the law of large numbers tells us that 9 out of the 10 will result in defense verdicts and no money will be paid.  In the tenth case, however, the case will be lost and the jury will return a verdict of $100,000.  If we reserved each of the ten cases at $10,000 our overall reserve would be accurate ($100,000), although the reserve on the individual cases would not be.

This example is simplistic since it overlooks the fact that nearly all claims are settled and not tried.  Therefore, another important factor in the reserving process is to consider the settlement value of the case as well.

Needless to say, judgment and experience go into the estimate of the settlement value, the jury verdict and the chance of winning or losing the case.  So long as all of these judgments are within a normal range, they would be acceptable to the reinsurer.

a.3.   Adequacy of Net Reserves

         If these ?net? reserves are low, then there may be some questions as to the company?s solvency. Net reserves are those which are less than the reinsurance retention.  This needs to be considered.

B.    Realistic Case Evaluation

      In this area, we are concerned as to whether the company is evaluating its cases 1) intelligently, 2) practically, and 3) in a timely fashion.

We would like to see that the assured?s liability has been evaluated, whether there are any defendants who could be brought into the action, contributory negligence, assumption of the risk, evaluation of the damages, etc.

Documentation is important.  If there is no evidence of thought processes in the file, we assume that these claims evaluations have not taken place.  Even if an examiner has thoroughly considered the case and can discuss its every aspect it with the reinsurer, he has not done a complete job if he has not written down his mental processes on paper.  People have a tendency to forget important items and the adjuster may leave the company or move onto another job in the company.

Also, the thoughts and ideas of the claims specialist must be conveyed in detail to the defense attorney or other investigators.  The in-house people are expected to take an active role in controlling the discovery and negotiations.  If the file is merely a repository for the letters and reports from the defense counsel and investigators, then the in-house staff is not of much value.

C.    Reasonable Offers

      Nearly all cases are settled, not tried.  With this in mind, the company must focus much of its efforts on bringing the claim to a conclusion at the most propitious moment.

It is, therefore, important to determine whether the company is willing to extend an appropriate sum of money to settle a case when a claim objectively warrants a resolution.  Here there is a question of judgment.  The company should not be making settlement offers without some basis.  But there is a great deal to be said for a settled case:  it cuts off all future loss adjustment expenses.  It provides the rating unit and underwriters with a precise idea of what the claim was worth.  Finally, it frees the claims department to go on to other problems.

If the company does not make timely reasonable offers and is more likely to go to trial, the reinsurers have a greater likelihood of being hit on a runaway verdict.  It is, therefore, important to determine whether the company is a ?settling? company or a ?trying? Company.

D.    Promptness and Completeness of Investigation

      Here we are evaluating the ceding company?s performance in investigating claims promptly and completely.  The areas we are focusing in on are the timing, resources, and degree of expertise brought to bear in these efforts.

E.     Claims Staffing

e.1.   Supervision

e.2.   Claims Staff

         Under this heading we are considering case loads, talents and the responsibilities of the various people on the claims staff.

Consideration of case loads is important because the best specialist in the world is not of much value if he or she is overwhelmed with work.  The evaluation of claims takes time.

It goes without saying that more complex cases take more time to evaluate.  Thus, if a person is handling automobile cases, he might be able to supervise 300 to 400 of these cases.  The facts tend to be very similar and the injuries are typically broken bones or whiplash.  On the other hand, a complex D&O claim, dumpsite matter or professional liability claim requires considerable time to evaluate and monitor.  In the professional liability area, an experienced claims person could handle in the area of 150 to 250 claims.  When his case load exceeds this amount, his effectiveness declines.

D&O claims involve a paradox.  They are typically complex but there are usually more people following the case.  The assured and his personal attorney may be following the case in addition to a monitoring attorney retained by the insurer.  It may be that the in-house person can handle more D&O claims because he is not weighed down by their complexity.

The skills that the claims manager needs are varied and include the following:

e.1.1.   Technical Skills - education and experience in claims handling;

e.1.2.   Interpersonal Skills - to communicate with, understand, and motivate others;

e.1.3.   Conceptual Skills - to think abstractly and ?see the big picture?;

e.1.4.   Diagnostic Skills - to detect problems and develop solutions and strategies; and

e.1.5.   Analytical Skills - to identify a situation?s key variables and to choose among strategies.

We are particularly interested in the experience of the claims staff and its education which hopefully is on-going.

F.     Promptness and Completeness of Reporting to Reinsurers

g.1.   Initial Reporting

g.2.   Subsequent Reporting

         It is important to monitor reinsurance reports and to raise this subject during the reviews.  Even though the treaty or facultative certificate has reporting criteria, we may wish to discuss increasing the claims reporting.

Typically, the treaty provides for reports on cases where the reserve exceeds 50% of the retention or where certain bodily injuries are involved such as death, dismemberment and paralysis.  However, these criteria do not help in many professional liability areas where there are no bodily injuries (such as in accounting malpractice).  Here alternative reporting criteria must be developed with the company.  One alternative is to ask for reports on all cases where the provable damages exceed 50% of the retention.

During the reviews, we need to stress reporting to Reinsurers, to provide us with an opportunity to ask more questions and to generally provide us with a comfort level that there is nothing out there which can hurt us.

G.    Performance in Dealing with Excess of Policy Limit Exposure

      If the company?s philosophy is to try its cases rather than settle them, the reinsurer is exposed to large run-away verdicts.

We must, therefore, explore what attitude the company has in terms of trying its cases and whether it is protecting both itself and its reinsurers.

H.  Claim Count/Suit Count

      We are concerned about this, generally, to see what the average case load is.

      Also, by comparing this count with the previous year, we see whether the number of cases is going up, whether the company is settling its cases and whether there are any problems on the horizon.

I.    Rapport with Underwriters

      It is important that the claims staff keep the underwriters informed.

During our reviews, we are looking into whether the claims and underwriting staff are physically close and whether there is contact between the departments on both a formal and informal basis.

If the underwriters are kept in the dark as to problems which the claims people see, then we have a problem.  The claims department has valuable information to provide to the underwriters and it should be doing this on a continuous basis.  The underwriters also must be supplying the claims people with underwriting information and providing input regarding coverage.

One alarming situation which we have seen from time to time is that the claims department reports directly to the underwriters or to the President who is the head of the underwriting department.  This is like asking the fox to guard the chickens.  The claims department must have independent judgment in establishing its reserves.  Its performance should be measured and the claims department must be held accountable.  But it is unacceptable for an underwriter to determine the reserves on a piece of business that he or one of his subordinates has written.

J.      Special Underwriting Considerations

      Here we identify any problems that we would like to convey to the Reinsurance Underwriters.  These normally involve coverage questions that recur in the claims, whether we think any of these assureds seem dubious, or any other such matter.

Our purpose is not to take over the underwriting role.  The decision to write a piece of business is entirely up the underwriters.  We remain quiet on this factor because the underwriters and producers have more information than the claims department as to whether a piece of business would be profitable or not.

When we can, we do schedule time with the ceding company underwriter to discuss plans for new business, changes in the mix of business or any other item.  As long as we are at the company, we might be able to find something for our underwriters that would be of value.

K.   Average Settlement Time

      This item is always an estimate since most companies do not keep statistics on average settlement time.

It is important for our statistical department to have some idea as to how long these cases are going to be open.

It is also important for our underwriters to know whether the company is moving to settle the cases or is not acting vigorously to bring claims to a close.

General Remarks

Here we summarize some of the salient items which we discuss in the body of the report.

We would like our ?internal clients? to read the full report, but we realize that a summary of outstanding items can be helpful.  We will also make recommendations if necessary.