How insurance works

Blog - How insurance works

Robert Aurbach | Published: September 16, 2014

I saw an interesting headline a couple days ago in an insurance trade newsletter. It said “2013 Property/Casualty Results Show Net Gain on Underwriting – First Since 2007.” The portion of the insurance industry that writes workers’ compensation insurance made $63 billion in the US last year. But for the first time in six years “underwriting” was a profit item, rather than a loss.

Underwriting is the insurance name for the difference between the premiums they collect and the benefits they pay. Saying they had underwriting losses for the last six years means that the company collected less premiums than they paid out in benefits. It’s not that they lost money in prior years – the only year in which the industry has ever lost money was 2001 (the year of the 9/11 terrorist attack).

How is that? If the insurance companies paid out more than they took in, how did they make billions in profits? Insurance companies, in Australia as well as the US, make most of their money by investing the money they accept as premiums during the period between when they take the premium payment and when they pay out benefits. The longer they hold the money, the more money they make. This explains some of insurance company behaviour. Delaying decisions on claims, taking excess time to pay providers, and denying claims – only to accept them later – are examples. KPIs for employees are set to create these results, and the rest of the world may or may not understand what drives insurance company behaviour.

This phenomenon affects those states that have private insurance most directly. However, the majority of Australian citizens are under a claims agent model. Is there a consideration there with regard to how those insurance companies make their money?

Claims agents working for the large WorkCover organisations do not make their principle income from selling the services and expertise of their workforce. The contracts are too sharply negotiated by the cost-conscious statutory agencies to make that business plan stand up. What the big claims agent organisations make their profit from is the economic incentives that are built into the contracts.

We are not privy to those contracts, and the economic incentives that are built into them are not available for public inspection. What is clear is that the insurance companies organise their work to do two things: first, they keep the expenses of performing the work as low as they can. Within contractual limits, they increase case load for individual claims managers as high as possible, and keep wages as low as possible. A quick look at the RTWMatters Jobs Bulletin will demonstrate the turnover resulting from those policies. They also do not readily invest in the education of those employees. As stakeholders, they report having little but on-the-job training for their roles. As an occasional educator, I have heard insurance company officials suggest that “other companies will just poach them anyway” if they invest in claims manager qualifications.

The other thing that economic incentives do is shape the behaviour of individuals doing the work. The KPIs of claims managers at these insurers are set mindful of the profit to be had for conducting operations so as to maximise the achievement of the incentive criteria. This has led to behaviour ranging shifting the focus to KPIs instead of helping injured people, to outright deception, file stockpiling and other improper acts. Take a look at the 2012 Victorian Ombudsman report on the activities of workers compensation insurers to get a better appreciation of why several insurers were fined millions of dollars for their behaviour.

The purpose of bringing this to your attention is not to say that insurance companies are bad corporate citizens, or that they act from inappropriate motivation. The purpose is to understand the industry better. Sometimes people think that everyone’s agendas are the same, and get perplexed when the other side sees things differently. Understanding the reasons people behave the way they do opens the possibility of finding a way for both parties to get what they want. The insurers can fulfil their incentives while allowing providers to guide worker recovery. We just need to understand that there are two separate agendas that need to be addressed.