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The Actuary The magazine of the Institute & Faculty of Actuaries
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GI: It’s no accident…

The UK personal motor market is not profitable. Financial Services Authority returns show an industry loss ratio of nearly 100% and a combined ratio in excess of 120% for the accident year of 2009. Furthermore, based on a recent survey1 of pricing actuaries from leading UK insurer, the consensus seems to be that, even with underwriting rate increases of 10-15% over the next two to three years, the personal motor market will remain unprofitable through 2015.

Behind these numbers is a crash-for-cash mentality pervading society, in which the Insurance Fraud Bureau (IFB) estimated over 30,000 such ‘accidents’ took place in 2009. It is precisely these type of fraudulent claims, along with higher incidence of ‘soft’ fraud, which is driving the unprofitability of the motor market.

Although the picture appears bleak, not all insurers are in trouble. Tier 1 companies, who proactively manage their claims process, are actually seeing a decrease in the number of third-party bodily injury claims, a steady ratio of claimants-to-claim and severity increasing in line with long-term inflation trends.

The extent of the problem
With claims management companies increasingly utilising third-party databases and referral fees, and using direct marketing to urge would-be claimants to file, third-party bodily injury (TPBI) claim frequency is up — hovering around 2%, almost double the industry frequency a decade ago. Further, driven both by a rising number of claimants per claim and an increasing tendency for claims management companies to engage solicitors early and often, TPBI claim severity has risen as well — just short of £11,000 (capped at £100K), almost 60% greater than industry severity a decade ago.

The UK Actuarial Profession’s working party on third-party motor insurance notes that “with both numbers and average costs up, the cost of injury claims settling is now growing by 30% each year”. Figure 1, which is based on benchmark data for the period 2001 through to March 2010, documents the extent of this problem with rising frequency and severity compounding to produce TPBI loss ratios that, on average, are almost two-and-a-half times as large as they were 10 years ago.

The cause of the problem
But these trends are no accident... literally. Accidents are down; hospital admissions due to accidents are down; the number of serious casualties from motor accidents is down; and the number of minor casualties from motor accidents is down. Figure 2 overlays data taken from the UK Department for Transport (DFT) and the National Health Service’s (NHS’s) Hospital Episode Statistics. Therefore, it is not apparent that motor policyholders represent a worsening risk — so what is the problem?

Fraud — both hard and soft. The UK personal motor market should be profitable but, instead, as insurance companies continue to let fraudulent claims through their defences, any chance of industry profitability quickly dissolves. The IFB notes that “undetected general insurance claims fraud totals £1.9bn a year adding, on average, £44 to the annual costs individual policyholders face each year”.

At the bottom line, this adds approximately five points to the industry, all-lines, combined ratio. As the economy struggles to recover, these trends aren’t going away. With unemployment at nearly 8%, the highest it has been in 16 years, a further increase in fraud is likely as potential claimants look for ‘alternative’ sources of funds as their primary income disappears. In particular, a study by the Association of British Insurers noted a 30% increase in the value of fraudulent claims made in 2008 over 2007.

Managing the bottom line
Insurers have been down this road before. In the late ‘80s/early ‘90s, the Insurance Research Council (IRC) documented a similar trend in the US — increasing numbers of claimants per claim and the cost of claims rising far quicker than underlying inflation, while the number of accidents was actually decreasing.

At the time, it was noted in several studies by US actuaries that focused claims-handling techniques, such as using algorithms to red flag claims that appear suspicious, auditing the medical and wage elements of certain claims and pushing back rather than settling mechanically, lessened the effect of fraudulent behaviour significantly. More recently, data recorded under pay-as-you-drive options has been used in several Italian court cases to prove that the damage claimed was in excess of the damage possible given the telematic data immediately prior to the incident. This is certainly another incentive to implement such plans in the UK.

Then, as now, we see the same conclusion — proactive claims management is key to personal motor insurance profitability during times of increased fraudulent activity. Ten years ago, the best insurers differentiated themselves from the worst primarily on the strength of their sophisticated pricing systems and underwriting criteria, which allowed them to identify and focus on profitable niche market. Claims management mattered but just wasn’t as important.

However, as fraudulent claims activity continues to spiral out of control, the relative importance of claims management is fast becoming apparent, as figure 3 documents. As the insurance markets become increasingly competitive, especially in the personal lines markets where aggregators are turning the insurance product into something nearing a pure commodity, pricing and underwriting are that more critical. But setting the right price and selecting the right business is no longer enough; managing claims is just as essential.

A parting thought
Although it is easy to focus on glamorous pricing models and nouveau business models, even with the right price and the right market, every fraudulent claim that slips through your defences means so many more points off your bottom line. And at the end of the day, those few points really start to add up.

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George Maher is a fellow of the Institute of Actuaries and a director of Towers Watson and Andy Staudt is a fellow of the Casualty Actuarial Society and a consultant with Towers Watson