The End of Insurance as We Know It

by Rob Galbraith

  BI, PD, Med Pay, and PIP are liability coverages that require you to select policy limits that apply. What BI limits should you choose? 50/100? 100/200 or 100/300? How about 300/500? And perhaps you need an umbrella policy to provide additional coverage? Savvy consumers know that these limits represent, in thousands of dollars, the amount up to which the policy will pay for a single individual that is injured in an auto accident and the total amount that will be paid for a single accident. However, this is far from intuitive, and choosing the right limits is complicated; lower limits are cheaper but provide less coverage so consumers have a risk that they will still owe additional money after the auto policy limits are exhausted. What is the risk of this happening? If it does, what are the long-term consequences for the consumer? These are questions that can be informed by statistics and analogous cases but not definitively answered because each risk is unique, and each set of circumstances that led to an accident where injuries were sustained is unique.

  Shifting from the liability coverages to the physical damage coverages, Collision and Comprehensive coverages do not require the selection of a limit but rather a deductible that applies. (I won’t even go into how property damage and physical damage coverages differ even though they sound synonymous.) Deductibles (again) are a somewhat unique-to-insurance concept that represent the portion of “skin in the game” that the insured owes following a covered loss and are expressed as a dollar amount for auto insurance. (More on home insurance and percent deductibles in a bit.) So even if you are fortunate to have the exposure covered by your insurance policy, and a loss occurs that falls within the parameters of the contract that entitled you to have the loss paid for by your insurer - you may (depending on exactly what happened) still owe some money. Does that make any sense? It does to insurance professionals who have spent years in the industry, but not the average consumer.

  Who knew auto insurance, a “commoditized” product that everyone who owns a vehicle is required to have, could be so complex? Compare auto insurance to homeowners insurance, which can be equally complex and can sometimes unwittingly serve as a remedial class in fractions, decimals and percents. Homeowners insurance also provides property and liability coverages similar to auto insurance. Limits and deductibles again must be selected by the consumer. There are multiple policy limits in a standard homeowners contract, but often the consumer is only asked to choose a single limit - the Dwelling limit - which represents the maximum amount that will be paid after a covered loss for damage to the main structure itself and attached items such as a garage or fence (unattached structures are covered under a separate policy limit). The Dwelling limit (commonly known as the Coverage A limit) is generally selected with the assistance of the insurance agent who uses replacement cost estimation software that helps to estimate the minimum cost to rebuild a home from the ground up in the event of a total loss. This value is not to be confused with the price that the home was purchased for, the value that the home could be sold for if it was put on the real estate market, the amount remaining that is owed on the mortgage or the assessed value of the house for tax purposes.

  If selecting a Dwelling limit wasn’t confusing enough, add the concept of Insurance To Value (ITV) on top of it. ITV means different things to different people in different contexts, so it’s a challenging concept to describe even within the insurance industry. In essence, the idea is that consumers can select any Dwelling limit they want - as the policyholder, they have that right. This limit may, or may not, match the minimum estimated rebuild cost that is estimated by the insurance agent. To the extent that the Dwelling limit is below the estimated rebuild cost, consumers are said to not be “fully insured to value.” Conversely, consumers may choose a limit that is greater than the estimated rebuild cost. Carriers generally have restrictions on how far below or above the estimated rebuild cost. In addition, carriers may impose a coinsurance penalty on any partial losses. (Coinsurance is falling out of favor in the industry (particularly in personal lines) as they are challenging to apply and can cause significant friction at claim time - nevertheless, the concept still applies and may be relevant in some instances.)

  In addition to estimated rebuild costs, Dwelling limits and ITV there are other, separate coverage limits that apply in homeowners insurance. Often these limits are expressed as a percentage of the Dwelling limit. Other structures not attached to the main house are covered under a separate limit (Coverage B) that is generally 10% of the Dwelling limit. So if the Dwelling limit is $300,000, then the limit for other structures is 10% of $300,000 or $30,000. Contents - all the personal property or “stuff” inside of the house (Coverage C) - is generally covered at 50% of the Dwelling limit. (Note that the personal property covered under a homeowners contract does not always have to strictly be “inside” the home.) Finally, Additional Living Expenses (ALE) is also covered under a separate limit (Coverage D) that can provide limits on the dollar amount that can be reimbursed (generally up to 20-30% of the Dwelling limit) and/or a time limit (generally between 12 and 24 months). Additionally, there are many different sublimits that apply in a typical homeowners insurance contract including limits on reimbursement for cash, jewelry and other special classes of personal property.

  Deductibles work in a similar fashion to auto insurance - this is the “skin in the game” that policyholders pay whenever they file a claim. However, depending on the location, deductibles can be expressed in dollar terms or as a percentage of the Dwelling (Coverage A) limit. Deductibles can either be on an all perils (AP) basis or on a split basis where one set of perils (generally wind and hail but sometimes hurricane or named storm) is subject to a different (often higher) deductible than all other perils (AOP) which are subject to another (often lower) deductible. For example, it is quite common in the middle of the United States where there is a greater risk of severe convective storms that lead to tornadoes and hailstorms to have a wind/hail deductible of 1% or 2% and an AOP deductible of $1000 or $2000. A deductible of 1% or 2% may sound quite low - this implies that in the event of a total loss, the carrier will pay 98% or 99% of the total cost to rebuild - but expressed in dollar terms these “small” percentage deductibles add up to significant dollar thresholds for the average consumer. For example, a 1% wind/hail deductible on a home with a Dwelling limit of $300,000 is a $3,000 deductible - and a 2% wind/hail deductible on the same home is $6,000. If a consumer looking to save money on their homeowners insurance premium opted for a 5% wind/hail deductible on the same home, they would be subject to a $15,000 deductible!

  IT’S NOT (QUITE) ROCKET SCIENCE

  Regardless of the type of insurance, a common theme emerges: insurance is an exceedingly complex product to understand and use. Most major monthly expenses provide an ongoing, obvious tangible value - but this is not true for insurance. Intuitively, consumers understand that “stuff happens” - cars get in accidents, pipes burst, weather turns bad, people get injured - and that these events cause economic damage that insurance can help pay to repair. Consumers also know they are required to purchase insurance in order to achieve some greater goal - buy a car, own a house, start a business. However, protection gaps exist. In part, this is due to our ingrained optimism and human biases that “it won’t happen to me”. In part, because it’s virtually impossible to dream up every scenario that could potentially cause a loss to occur and to properly assess the likelihood and cost of each of these scenarios. I would argue that protection gaps also exist because insurance is inherently complex and thus difficult for the average consumer to properly value.

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  CHAPTER 5 - (NOT) TAKING A BITE OUT OF FRAUD

  DO YOU WANT TO PLAY A GAME?

  The combination of the massive size of the insurance industry and the complexity of insurance provides a fruitful landscape for fraudsters. The principles of indemnification, contracts of adhesion, and bad faith add to an environment that provides a lot of attractive opportunities to “game the system.” When thinking about insurance fraud
, images come to mind of sinister and nefarious actors and there are, in fact, a portion of hardened criminals whose livelihood depends on their insurance fraud to fund other illicit activities. Often, innocent parties are involved who get caught up in fraudulent schemes. Additionally, there are many opportunists looking to gain advantages from a complex system when given the chance.

  Why do people commit insurance fraud? There are a few reasons:

  •It is a target rich environment: a large a complex system with lots of money.

  •There are numerous opportunities to commit fraud throughout the insurance ecosystem.

  •It is not particularly hard to attempt to commit insurance fraud.

  •There is potentially a large reward if you get away with it.

  •The odds of getting caught have historically been low.

  •If you are caught, the consequences are often limited and mild in severity.

  •It is perceived as a “victimless” crime that is generally non-violent in nature.

  While the true cost of insurance fraud is hard to quantify, according to the Federal Bureau of Investigation (FBI) the total cost of non-health insurance fraud is estimated at $40 billion annually. This translates into an additional $400-700 cost per family in the U.S. in the form of increased premiums.[38] The Insurance Information Institute (III) reports that based on insurance industry reporting, approximately 10% of P&C losses and loss adjustment expenses annually are incurred due to fraud, although this fluctuates year-to-year.[39] According to a 2013 online poll conducted by the Insurance Research Council (IRC) found that 24% of respondents believed it was acceptable to increase an insurance claim in order to make up for the deductible they had to pay. In the same survey, 18% of people said that it was acceptable to pad a claim in order to recoup some portion of premiums paid in the past.

  YOU GOTTA HAVE (BAD) FAITH

  One of the main reasons that insurance fraud is as widespread as it has been is that a counter-problem exists: carriers denying legitimate claims. For insurance to have achieved the degree of success and widespread adoption that it has, consumers must have faith in the overall ecosystem. Specifically, consumers have a reasonable expectation that in return for the premiums they pay up front, they will be quickly and fully made whole (receive payment) when they experience a covered claim. There are two main ways in which insurance contracts are slanted in favor of the insurer and against the insured:

  1.The unbalanced nature of the insurance product where premiums are paid up front in return for the promise to pay claims that occur at a later date.

  2.The insurer unilaterally drafting the insurance contract as a take-it-or-leave-it proposition for consumers

  To provide a counterbalance, legal frameworks surrounding insurance have developed over time help level the playing field in two main ways:

  1.As a contract of adhesion where any ambiguities that arise out of the contract provisions are resolved in favor of the policyholder (insured) and against the insurer.

  2.The legal system places a burden on insurers to act in good faith towards their policyholders.

  Essentially, the requirement to act in good faith means that insurers must work to respond to any claim reported by its policyholders in a timely manner. They must follow a consistent adjusting process that treats every claim initially as a legitimate claim (i.e., not assume from the outset that a claim is fraudulent). Claims adjusters must work to ascertain the cause of loss and extent of damage caused. Then, they must determine whether or not this is a covered loss by applying the contract language and provisions to the facts of the loss. Claims adjusters must have a valid reason if denying a claim and must not unduly delay claims settlement to avoid payment when a covered loss is incurred.

  When insurers fail to treat their policyholders equitably and fairly during the claims process by placing undue burdens on the insured during the investigation of the claim, delaying payment unduly for a covered loss, or denying a claim that should in fact be covered by the policy, they run the risk of being said to have acted in bad faith by regulators and the court system. Carriers that are accused of bad faith must spend money on their legal defense to demonstrate how their actions were proper and consistent with an insurer who is making a good faith effort to resolve the claim. Carriers that are charged with acting in bad faith and/or involved in bad faith litigation certainly face reputational risk and a potential loss of business. Existing customers may seek to go elsewhere and new customers may avoid purchasing an insurance product from that insurer. If a company is found to have acted in bad faith, punitive damages could apply that are in excess (potentially far in excess) of the amount of the claims settlement. Bottom line: the threat of a cause of action and finding of having acted in bad faith is a major deterrent for insurers and provides a strong incentive to treat every claim with an abundance of caution, even those that end up being fraudulent and worthy of suspicion.

  Insurance carriers are often litigants in legal cases, most notably claims disputes. Some plaintiff attorneys have made their careers based on suing insurance carriers over their claims settlement practices. Defending these lawsuits costs a lot of money, both for a carrier’s internal legal team as well as retaining outside counsel.[40] In some jurisdictions, most notably Florida, plaintiff attorneys who successfully sue an insurance carrier also have their fees paid based on a state’s attorney fee statute. Some of these lawsuits represent legitimate grievances from policyholders seeking to obtain the full settlement value of their covered claim. Others represent a true difference of opinion over some aspect that is in dispute. There are also a number of frivolous lawsuits that are successfully defended by insurance carriers, but the related legal costs of providing the defense are incurred by the insurer and ultimately paid from policyholder premiums.

  SHAPE SHIFTERS

  Just as every claim involves a unique set of circumstances, every case of insurance fraud involves a unique set of circumstances as well. Seen from a broader perspective, insurance fraud comes in many shapes and sizes. Some of the different flavors of insurance fraud include:[41]

  •Premium diversion or embezzlement of insurance premiums that are collected by parties but never turned over to the insurance carrier

  •Reporting a false claim

  •Embellishing the value of a claim

  •Manufacturing a claim (e.g., staging an accident)

  •Faking or inflating injuries (medical fraud)

  •Material misrepresentation of facts critical to determining coverage

  •Purchasing insurance with the sole intent of subsequently filing a claim post-loss

  •Fee churning where a series of intermediaries each take a cut of premiums

  •Asset diversion

  •Post-disaster fraud where unscrupulous parties prey on victims who have already been devastated by a major storm such as a hurricane

  In addition to the different ways that insurance fraud can be perpetrated, the actors involved can be a single individual, a small group of actors or an entire web of people sowing deceit. Note that the policyholder can be a knowing party to the fraud or an unwitting participant in a scheme caused by unscrupulous roofers, building contractors, medical providers, attorneys, etc.

  Insurance fraud can have a higher correlation with other actors and activities, but the presence of those actors and activities does not necessarily imply the presence of any fraud. For example, there has been a large increase in the number of hail claims over the past decade, and the related cost of claims to repair damage from these storms. One factor (among others) is the rise of “storm chasers” or roofing contractors that use modern technology to follow where severe weather occurs and quickly show up on the scene, even from hundreds of miles away, often the next day or soon thereafter.

  These roofers and repair contractors go door-to-door asking homeowners for permission to perform a free inspection on their roof to determine whether any damage from the hail event has occurred. If given permission by the hom
eowner, the roofer will perform an inspection and then report back on any damage that they see. The contractors usually provide an dollar estimate and offer to repair the damage and submit the claim to the homeowner’s insurance carrier on their behalf (or at least assist with the claims filing process). While a carrier would prefer to have customers contact them first to make arrangements to have a claims adjuster or trusted direct repair provider perform an evaluation of any damage caused by the storm and complete an estimate, policyholders have the right to hire any contractor they wish to perform the repair work. This can leave insurance carriers in a quandary: they may not trust the initial assessment performed by the “storm chaser” roofing contractor but if they push back too hard without sufficient cause to do so, they run the risk of being accused of acting in bad faith.

  Another recent challenge for insurance carriers has been how to handle cases known as Assignment of Benefits (AOB) cases. This has garnered the most attention in Florida but is a problem to various degrees in other states as well. One of the rights that consumers have is to “assign” any benefits they may recover from their insurance policy to a third party, which could be a contractor or attorney - more broadly, anyone who is willing to accept them. The policyholder is transferring the hassle of dealing with the insurance carrier directly to someone else, often in return for something of value. The third party can then demand claims payment from the insurer and look to sue if they are not paid in a timely manner. Again, insurance carriers are placed in a difficult spot: as a practical matter, they would prefer to have all claims reported to them first in a prompt manner and deal directly with their policyholder throughout the entire claims adjustment process. However, due to the ability to assign claims to third parties, carriers may have to deal with these parties and exert the same standard of care and due diligence that they would use with their own insured.