The ethical storm clouds hanging over insurance claims practices

  • 12 February 2020

The biggest ethical exposure facing insurers over the next 24 months will come from claims practices. They are presenting a level of exposure that deserves to be one of the big financial risks that insurers typically detail in their annual report and accounts. Why? Because some insurers have walked into an ethical minefield that could bring a financial storm down upon them.

Why has this come about? What could trigger that financial storm? And what can insurers do to avert the worst downsides of that storm? That’s what I’ll be covering in this blog post.

Why is this such a big exposure?

The reason why I believe claims practices present insurers with a greater financial and reputation risk than say pricing is down to the nature of the relationships that exists at the time of each of those two activities. With pricing, it is pre-contact (or at contract end/renewal) and influenced by market relations. With claims, it is mid-contract and centred around one-to-one relationships between policyholder and insurer. The two dynamics are very different.

Those differences influence what could emerge from greater scrutiny of the practices being used. With pricing, the most likely repercussions are going to be a fine for lack of fairness and some new regulatory parameters for acceptable practices. Disruptive of course, but not catastrophic.

With claims, the repercussion will be much more serious. A regulatory fine could follow any findings of misconduct, but should that misconduct point to consumers having systemically received anything other than a fair claims settlement, then the doors swing open to claims management companies (CMC) pushing for compensation on behalf of their claimant clients. It’s happened before, albeit in simpler circumstances, with firms in the short term credit market.

This for insurers would be a nightmare scenario, and a bitter one too, given past relations between the CMC and insurance sectors. In risk management language, the severity would be very high, which of course then begs the question as to what the likelihood looks like. In my opinion, the growing adoption in recent years of certain claims practices has placed that likelihood much higher up the scale than insurers realise.

The question for chief risk officers is quite simple – does that severity and that likelihood turn this into a material financial risk? I believe it does, at least to the extent that makes it worth monitoring, now.

What are the claims practices that could bring this about?

Three claims practices are fuelling these concerns…

  • Claims optimisation (more here)
  • Predictive analytics (more here)
  • Counter fraud measures (more here)

Rather than explore the origins of each of these three practices (the links to earlier posts serve better for that), I’m going to concentrate in this post on how insurers might take on board their implications.

What could trigger that financial storm?

Three developments could trigger the financial and reputational storm that I believe certain claims practices have settled over the market.

The first goes back to the Liberty Mutual case in 2018. To what extent did that investigation put the FCA on alert to market practices that signalled the potential for systemic consumer detriment? Have they been researching and monitoring that since then?

The second development is taking place at the moment in the United States, where the National Association of Insurance Commissioners has a working party currently investigating the use of predictive modelling in claims and fraud (more here). Their findings will undoubtedly be shared with regulators like the FCA.

And the third development will come out of analysis within the FCA. This could be around either discrimination and/or vulnerability, for example in relation to the use of credit data (more here).

There are signs of developments other than these three, but it will probably take one or more of the above to move the danger lights for insurers to red.

What can insurers do to prepare for this?

Any such preparations should start with a simple question: do you think that your firm’s claims practices could be creating conduct risks?

If you ‘just don’t see it’, then of course you’ll probably not be reading any further than here. If however you do see the possibility of conduct risks in claims practices, then you need to decide what proactive steps you can take as a firm to understand the scope and depth of that risk. Don’t give any time to the option to just ‘wait and see’, for it will be seen as a failure of leadership by the regulator. The key word here is proactive. 

What should your firm be looking for?

You should use two lens here. There’s the compliance lens, which should identify problems relating to rules such as best interests of the customer and the ‘honest, fair and professional’ obligations. Add to that legal obligations such as set out in equality legislation and data protection legislation.

Yet some of you will ask why this is necessary, given that such a lens has been in active use through the firm’s three lines of defence. If problems haven’t been identified so far, and especially big problems as outlined earlier, then surely the risk is less serious than I say? Well, that holds water so long as those three lines of defence have been working properly. The super complaint and pricing review provide enough evidence to point to it having some significant weaknesses (more here).

The second lens is an ethical one. How you use such a lens will depend on your firm’s purpose and culture. To use a sailing analogy, if the firm is happy to sail close to a regulatory wind (i.e. be just within the rules), then it will see little need for this second ethical lens. Yet such firms should remember that with principles based, outcomes orientated regulation, that would be a strikingly confident decision. And from what I’ve been reliably told is happening in the market, it would be a strikingly dangerous decision, even before you consider the implications that the Senior Managers and Certification Regime would present both corporately and individually.

More than Compliance

It is often said (at least in the US) that a compliance programme relies on there being a parallel ethical programme in order to be successful. And that is so evidently the case here. Firms need to have their risk radar tuned to reflect their appetite for reputational and financial certitude, and so be able to see and interpret decisions and developments within the firm in that light. This means thinking in terms of  ‘should we’ rather than just ‘can we’.

Where can firms find their ruler to measure that ‘should we’ and ‘can we’ spectrum? It will come from the purpose they have set for their firm (more here) and the ethical values they’ve adopted to deliver it.

And all this raises of course the tricky questions as to who should use those lenses, who should use that ruler? Given earlier comments about the three lines of defence, internal audit, compliance and function managers do not seem to be strong candidates, although I would caveat that with ‘not in their present form’.

Perhaps external advisers from the like of the big four would help? I’m not convinced they are capable of addressing the significant conflicts of interest that would undoubtedly be present. This then points to the need for some form of forensic conduct audit, but they are not in ready supply. A combination of skills and approaches will need to be brought together for this.

Dealing with the Outcomes

Let’s assume that review is complete. Then what? As a possible material risk to the business, the issues identified need to be quantified as exposures, so that their overall significance can be established. This needs then to be tested against a variety of scenarios. The outcomes of that analysis should then feed into these next steps:

  • people taking responsibility for addressing the issues identified;
  • resources being given to make the necessary changes;
  • leadership being given to ensure that the changes are being delivered.

These types of steps should be familiar, given that it’s what the FCA has been telling the wholesale banking sector for a number of years now.

There is one further step that firms should consider, and it involves addressing two rather awkward questions: what led to this problem arising in the first place, and what can we do to make sure that it doesn’t happen again? And here we get into the realm of ethical decision making, and of leadership on ethics. Is your firm’s learning and development programme building the right knowledge and skills around those two things? (more here) Time for someone to cast a ‘critical friend’ ethical eye over it? 

To sum up

There are dark ethical clouds gathering over claims practices, with triggers coming that could turn them into a reputational storm. How insurers react to this situation will be influenced by their culture and risk appetite. The real danger for insurers is that they will be judged not on their own criteria, but on the outcomes that are being generated. If for some firms there’s a material difference between the two, then claims management companies could come in and reap financial and reputational havoc. This is a risk that regulators and investors will expect chief risk officers to have a handle on.

If you have any questions about this post, please get in touch

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These two posts will also be of interest...

  1. How data analytics introduces ethical risks into insurance claims
  2. What lessons can insurance people learn from the Liberty Mutual fine?