Insurers depend on accurate reserving estimates, and nowhere is this process more complex than in liability claims. Alex Murray explains
Reserving for claims has been called the black art of insurance. The balance sheets of insurance companies depend on the accuracy of reserving estimates. But these are often way off.
Nowhere is the hit and miss of reserving more apparent than in liability claims.
There is a lot of mystery surrounding liability reserving. However the starting point for setting any reserve must, of course, be the value of the underlying claim, whether this is triggered by damage to property, personal injury or financial loss.
It is stating the obvious, perhaps, but selection of the right resources to provide incisive and timely information from the outset is the building block on which any meaningful reserve must be built.
The techniques for establishing this are fundamentally the same as for property and liability claims; whether evaluating the cost of an insured’s factory that has burnt down, or the cost of a third party’s factory that an insured has negligently caused to be burnt down.
The critical difference, however, in a liability situation is likely to be the level of direct access that the insurer has to the subject matter of the claim. Delays in obtaining the information available – and/or the gaps in it – will clearly have a direct impact on the ability to set an accurate reserve at an early stage.
The ultimate claims spend, and therefore the reserve, is not determined solely from the value of the loss suffered by the claimant. The other key component which needs to be identified is the estimate for costs, both those incurred in any defence of a claim, and those incurred by the claimant.
In the case of a claimant’s costs, while legal systems within different jurisdictions deal with these in varying ways, they will always form part of the expectation of the third party (either as a separate item or within the settlement value) and accordingly need to be taken into account when setting the reserve.
Indeed, it is not uncommon within some areas of liability claims litigation, for costs to exceed the value of the indemnity settlement. A review of small and medium level personal injury claims, where liability was not conceded for over 12 months but was ultimately accepted, showed that 75% of the settlements paid comprised third party solicitor’s costs.
Recognition of such exposures at the early reserving stage should, at the very least, give insurers cause to pause for thought, if not to galvanise them into actively handling the claims to avoid these costs.
Having identified the impact of these components, the remaining and critical variable that needs to be established for the purposes of setting a reserve, is the assessment of legal (and associated policy) liability.
The outcome of this question can mean that all or nothing is paid to the third party for their claim and costs, and it is here that the art, or skill, of liability reserving really comes under scrutiny.
The task is not made any easier by the timescale over which many liability claims run. The professional responsibility of an architect involved in the design of a building, or the long term effects of an injury, can take many years to resolve, and the result may simply turn on the credibility of opposing experts.
So, is liability reserving in this context, at best an educated guess and at worst a wild one, and is there anything that can be done to improve the chances of getting it right?
The answer lies in a methodical approach, identifying each and every element from the outset, and recognising the relationship between these elements, for any particular claim, at any given point in time. In this way it is possible to construct a reserving framework within which a range of data and circumstances can be considered.
To continue this process and translate the assessment of the reserve into the handling of the claim, a clearly defined case plan is invaluable.
Those claims operations that have adopted and enforced this discipline have typically been able to measure its value in a reduction of the adverse movements of liability claims reserves.
In summary, damages can be valued, whatever the obstacles that have to be overcome and, in this respect, insurers need to be prepared to challenge the information provided to them by their own adjusters/experts and by third party sources.
Costs, whether incurred in the defence of the claim or potentially recoverable by the third party, can also be assessed, measured and, if appropriate, challenged. This is an area where cost specialists can be of assistance, particularly when there is not always the capacity or expertise to deal with this within the claims department.
Once hard figures are available, it is usually much easier to determine a defence strategy, focus on the core issues of liability, and accordingly establish a more accurate reserve. The environment in which liability claims are handled is often an emotive one, involving accusations and counter allegations.
The task of setting a reserve against this background requires a clear headed review of the issues and an objective evaluation of the realistic chances of success when liability is defended.
Having established a reserve, taking into account all aspects of the exposure including costs, and a structured review of legal liability, the job is still not over. As more information becomes available, the assessment of both valuations and liability needs to be kept under regular review.
This can only be achieved when insurers are prepared to apply competent experienced resources to the task. The temptation for a hard pressed claims operation may be to conduct routine “tick box” reviews of outstanding reserves, which invariably means that an established reserve does not get seriously challenged until settlement is imminent.
The very real danger in taking this approach, as many insurers have discovered to their cost, is that reserves have to be stepped up at a late stage, with a consequent adverse impact on the balance sheet.
Conversely, the rewards are there for those insurers who focus on the process of setting and reviewing their liability reserves, including:
• Reduced total claims spend on indemnity and costs
• More reliable balance sheet information from reserves
• Savings from the closure of ‘dead’ files subjected to regular review.
?Alex Murray is a director of FitzGerald Consulting and an expert on liability claims