4 Reasons for Reserve Deficiencies That No One Talks About

Article

Reserve accuracy is a key performance indicator for claims departments and is usually the primary focus of claims audits. Regardless of whether companies outsource claims to a third party administrator (TPA) or handle them internally, the establishment of proper case reserves is one of a claims department’s most important responsibilities. Some of the problems that inadequate reserving can create include:

Raising the attention of regulatory agencies that the carrier may not be in compliance with capital requirements;
Key investigative and legal strategies that may mitigate exposure are not implemented in a timely fashion (or at all) because management was not aware of potentially large losses that could adversely impact the company’s financial stability;
Reinsurance recovery can be jeopardized if the reinsurer demonstrates it was prejudiced by the delay or failure of the carrier to report a loss that would have met the loss reporting threshold requirements outlined in the reinsurance contract had an accurate reserve been set.

Is setting reserves art or science?

It’s both. While there is no single correct method of estimating case reserves, leading industry practice is to set a case reserve based on the ultimate probable cost of the claim. While this method may result in more frequent adjustments than other methods, it provides the most accurate picture of loss exposure at any given time. At a minimum reserving should consider:

If reserves are sufficient to meet all expected payments;
All applicable loss and damage facts particular to the elements presented in that loss alone and not set solely based upon a formula;
All documentation supplied to support the claim value and not based on gut feelings or unfounded expectations;
All liability and damage issues that were considered when the value of the loss was determined;
If, when new information is available, the reserve needs to be adjusted.

Moreover:

Expense reserves should be set to cover expenses through the conclusion of the claim.
Reserves should be reviewed for accuracy at each diary date. All reserve changes should be documented and explained in the adjuster activity log or file notes.

Why are reserves often inaccurate?

Outside of the normal and expected day-to-day changes that occur throughout the claims process, there are more uncommon yet troubling reasons why reserves are often inaccurate, including:

Claims Staff Turnover – Whether because of burnout, a shorter commute or a higher salary, losing an experienced adjuster is often problematic. While temporary employees can help fill gaps, they are not a long term solution. There are inherent lost opportunities in each and every claim file when there is adjuster turnover, which equal higher claim costs and reserve adequacy issues. Consider that it usually takes 90 days to recruit and hire a new adjuster. Once the new adjuster finishes training on systems and procedures, it generally takes another 90 days before he cycles through his claims inventory. This means there is a potential six-month reserve lag on any given file at any given time. Lurking in the dark could be that one claim that destroys the profitability of a program.

Lack of Training & Experience –Education and training of valued employees is an investment rather than just an expense, because it helps companies retain quality talent. If a company invests in an adjuster’s continuing education, it is only natural that employee satisfaction increases because the adjuster has the opportunity to hone existing skills and develop new ones. Moreover, well-educated staff give the company a ready pool of candidates to promote when openings occur, again resulting in more employee loyalty.

High Caseloads – All too often, companies increase adjuster caseloads in an effort to reduce operating expenses. While there may be an initial expense reduction, there are likely to be oversights in critical areas of the adjustment process over the long term because workloads are not manageable. To avoid high caseloads, contracts for claims administration should limit the number of claims each adjuster can manage at a given time.

Outdated Claims Systems – Many claim departments are working with old systems, tools and methods that are no longer effective or efficient. Having web-based, real time information helps adjusters sort and analyze files more efficiently. Systems’ business rules can be configured to support the reserve process by prompting adjusters to set or change a reserve or reserve authority levels. Machine learning, claim analytics and computer-based intelligence are now automating the reserve process and adding a little more “science” to the equation.

What can you do?

Early intervention in reviewing reserves by experienced claims professionals has benefits that ultimately can improve the quality of the entire claim handling process, including:

Identification of training needs;
Identification of trends that may require different strategies to control claims costs;
Promotion of accurate representation of the company’s philosophy;
Reinforcement of consistent claim handling; and,
Protection against violating unfair claims practice laws.

The first thing to do, whether you are a claims department manager or a risk manager, is to review loss runs on a monthly basis. Monthly reports measuring financial activity should include:

Average paid for loss and expense by line of business;
Age of inventory;
Average number of reserve adjustments per file by line of business;
Percentage aggregate reserve increase at 30,60,90 and 180 days;
Aggregate variance between reserves and settlements in total by loss year;
Volume: number of new losses, closed losses, and reopened losses;
Claims where payments were made on closed files;
Claims where there was no activity for 360 days;

A review of loss triangle reports also can be helpful in monitoring reserve development, claim volume development and case reserves at 24, 36 and 48 month intervals.

If loss runs reflect large reserve adjustments (ten percent or more) to the total claim reserve, then you should investigate further in order to understand the cause of the activity. Particular circumstances often will explain it. However, further investigation sometimes uncovers a systemic pattern of behavior (i.e., stair step reserving) that is responsible for the poor results. This will require management to implement a solution that complies with leading industry practices and hopefully leads to better results.

If there is a continuing pattern of large reserve adjustments on claims files right before or when a claim closes, then completing a claims file audit can help explain why. A reserve adequacy audit will sample open and closed claims in an effort to validate claims exposures compared to damages and coverage. A claims reserve audit can validate reserve philosophy and current case reserve adequacy, as well as provide claims staff with insights into how to change or improve current operating procedures or philosophies.

Finally, some other solutions that can help mitigate reserve deficiency challenges include:

Developing reserving policies and procedures that comport with leading industry practices;
Conducting routine adjuster training on reserve components, company philosophy, and the interaction the financials developed by the claim department impact other business units;
Establishing staff reserve authority levels and implementing system business rules;
Establishing a large loss committee that includes claims, actuarial, underwriting, and loss control representatives;
Seeking defense counsel’s opinion of settlement value and jury verdict value.

Todd DeStefano is the director of PwC’s insurance practice.