Mission critical for captives
By Michael J. Moody, MBA, ARM
As the property/casualty insurance market appears poised for hardening in 2013, some organizations are beginning to consider the possibility of moving a portion of their commercial insurance program into the captive arena. In general, growth within the alternative risk transfer (ART) market, specifically captives, has been steady over the past 10 to 15 years, despite soft pricing in most lines of coverage. Much of the growth over this time period has been the result of buyers who wished to take more control of their destiny.
Captive ownership has proven to be one of the best ways to obtain this control; however, several operational areas must be considered when reviewing the feasibility of the captive. Claims management is one such operational area, since it is the largest expense of the captive. Frequently, the claims function has been a determining factor in the selection of the captive in the first place.
Captive ownership comes with a number of claims-related advantages for the captive owner(s). Among the more important advantages are:
• control over decisions on how claims should be settled and if they should be taken to trial
• the ability to take advantage of good claims experience to the captive's and, ultimately, to the parent's bottom line
• the use of specialized knowledge of the parent's industry to better understand and manage exposures and thus lower claim costs
• the ability to improve overall risk management and rapidly address emerging claims issues, thereby reducing future losses
As important as it is to control costs, captive owners must realize that they are now in the position of providing timely claims payments to injured parties. This can occur only if the claims function is properly designed and managed. Failure to handle claims properly can result in a number of major problems. In addition to concern from claimants, improper claims handling can cause problems with domicile regulators, reinsurers, as well as state insurance departments, all of which can erode the parent's good will and reputation. And, ultimately, slow claims processing can increase overall costs and expenses.
Being aware of all these issues is critical before a decision can be made on how best to manage claims. When forming a captive, the potential owner should consider the following four key points related to claims management:
1. What type of coverage will be included in the captive?—Understanding the nature of the claims to be handled in the captive is critical so that the owner knows what type of operation should be put in place. For example, how many claims are anticipated? Will there be a significant amount of claims activity (frequency type coverage) or more high-value, infrequent claims (severity type coverage)? Are there extensive regulatory reporting issues (i.e., workers compensation) that need to be addressed?
2. What is the best way to handle claims?—Keep in mind that claims handling requires specific procedures and skilled adjusters to be in place to be done properly. The key to successful claims management is to determine the specific skills that will be required to provide a prompt response to claims notifications.
3. Establishment of a program to handle or monitor claims—Regardless of the approach taken to handle claims (internal or outside service providers), it will need to be understood that files will need to be preserved, costs will need to be controlled, and all will need to be tracked using some kind of electronic system that can be accessed immediately to gain recent and relevant information. It will be important to understand any reporting requirements for the types of claims being handled, and make sure that the system can provide the necessary reports.
4. Controls must also be put in place—Controls are essential to prevent fraud and ensure that company assets are not wasted. According to the Insurance Information Institute, current projections show that claims fraud and abuse now account for about 10% of all claims dollars spent in the insurance industry. Specific measures must be incorporated into any claims system including that of a captive to assure that fraud and abuse are kept to a minimum.
TPA can be the answer
Time has proven that those organizations that start captives or other ART forms (i.e., self-insurance, etc.) can initially benefit the most from the utilization of a third-party administrator (TPA). This is especially true for organizations that are new to the practice of maintaining their own insurance operations. Most have found that by outsourcing the claims management function, they can have the advantages of a staff of claims management professionals without the expense of creating this critical infrastructure element internally. This strategy has proven so successful that many smaller commercial insurers are also now utilizing TPAs to obtain the maximum benefit from the claims operations.
Organizations considering the involvement of a TPA must remember that the claims operation is, for the most part, the public face of the operation. This is particularly important when dealing with employees, as well as customers, vendors, and other outside parties. For this reason, the selection of the TPA is critical. Care must be taken to identify the most appropriate TPA for the job.
While there are a number of specific claims-related issues that must be reviewed prior to the selection of a captive's TPA, one of the more significant is prior experience. First and foremost, the TPA must have specific experience in the line of coverage that the captive will be providing. If specialized skills are required, the TPA should already possess these skills and be known as a leader in this area. One method to assure that the TPA has the needed skills is to contact references that it provides. It is also important to contact past and present clients to verify the TPA's expertise.
Every situation is unique and will require specific skill sets to assure the best fit between the captive's needs and the TPA's qualifications. At a minimum, any claims organization needs to develop and implement a number of specific requirements. Among the more important ones are:
• an online claims management system to track claims, make and record transactions, and provide metrics to measure and report claims performance
• a claims reserving philosophy for better financial planning and understanding of current exposures, so that claims are settled on a consistent basis
• authorities and controls over payments and reserves to minimize fraud and abuse
• claims handling "best practice" guidelines for the specific coverages in the captive
• a program for monitoring vendors to enforce compliance with the captive's wishes
• a program to assure that the captive is meeting previously established long-term goals
Careful monitoring is especially important if the determination is made to outsource claims to a TPA. Don't forget that the TPA is spending your captive's assets while acting on the captive's behalf. The best way to make sure the TPA is spending money according to the wishes of the captive is to monitor them closely through regular claims file audits. Establishing a set routine for claims audits at the beginning of the relationship can go a long way to achieving the maximum advantages available to the captive owner. Additionally, the pricing of the TPA's services can be established so as to pass some of the risk of adverse claims experience on to them. Similarly, pricing can also contain provisions allowing the TPA to share in better-than-expected results.
Typically, organizations put a lot of thought into the decision to form a captive. Obviously, many things go into that decision; however, one of the best ways to ensure success and take advantage of the claims benefits is to plan correctly and be prepared in advance. Actively managing the claims aspect of a captive, whether via a third-party service provider, or internally, should offer one of the best methods for real savings.
Since claims continue to make up the largest share of the captive's expenses, this area also provides the best opportunity for savings. When structured properly, a proactive claims operation can provide an excellent chance to demonstrate a true concern for claimants, while maintaining a strong cost control element. At the end of the day, this is the key to controlling a corporation's insurance destiny.