The Acme Insurance Company Approach to Claims Management: Before, During and After.

The intention of this, and other, articles is to try to convey some good advice about insurance in general, but aviation insurance in particular. In doing so, I hope I have given occasional pause for thought. From time to time, the subject of aviation insurance appears in Internet forums, particularly one called Avcom. Recent discussions on the subject have tended to centre around the cost of insuring aircraft and how, if you shop around for long enough, you will always find something cheaper.

I have often tried to sound a warning about the dangers of buying aviation insurance on the basis of price alone, without looking carefully at the qualifications and experience of the people or organisations involved, the coverage being provided, the service levels offered and the financial security and claims-paying record of the ultimate risk-taker: the Insurer, whether it be an insurance company or Lloyd’s syndicate.

So in this article, I make no apology for gravitating once more towards the same general subject, but this time I would like to offer some observations about the manner in which Insurers work. If you look hard enough, there is a lesson in there to be learned!

Would you agree that an Insurer is in business to make profit? Put another way, if an Insurer did not make a profit, there wouldn’t be much point to it, would there? I am going to explain why, when it comes to my personal insurances, I want an Insurer in my corner that makes a healthy profit every year.

In order to make a profit, our Insurer – let’s call it Acme Insurance – needs to sell insurance policies at a price that will comfortably exceed the claims that are made and paid under those policies. Does that sound like a fair assessment? How much is “comfortably”? Well, it largely depends on the way in which Acme is structured, but a good rule of thumb is that about 30% of the premium will be spent in running Acme’s business and the balance will be available for claims settlements. If Acme’s shareholders are expecting a ROI (return on investment) of, say, 10%, this would mean that the claims should not exceed 90% of 70% of the premium income.

A secondary source of income for Acme will be the interest it can earn on the premium it receives. However, no Insurer can take chances and invest its premium in “high risk, high return” investments, so investment income is seen as a something of a bonus, rather than a means to an end.

Now, no Insurer can afford to hold 100% of every risk under the policies it sells. If it did so, it would run the risk of being wiped out in the event of a major loss, in much the same way as you would be if you didn’t insure and your house burned down.

The general principle of insurance is neatly encapsulated in an early English Act of Parliament of around 1601 (and I quote):

“by means whereof it cometh to pass that upon the loss or perishing of any ship there followeth not the undoing of any man, but the loss lighteth rather easily upon many than heavily upon few, and rather upon them that adventure not, than upon those that do adventure; whereby all merchants, especially those of the younger sort, are allured to venture more willingly and more freely”

You might need to read that a couple of times, but you will see that it is essentially saying that insurance is a means of transferring and spreading risk, so that each person pays a little (premium) in order to be protected against a lot (a potential loss).

Insurers need to spread their risk as well, much as a bookie at the racecourse must: he cannot afford to be too exposed to the odds-on favourite, or a rank outsider winning the feature race, so bookies “lay off” part of their book with other bookies. Insurance companies do the same: it’s call Reinsurance and it is what gives them to capacity to write larger volumes of business than they could otherwise do and remain solvent.

Returning to Acme, the first step in the profit-making process is to sell its policies. How does Acme do that in a highly competitive industry like aviation? Well, the easy way is to “stack ‘em high, sell ‘em cheap!”. In other words, if Acme sells its policies at half the price of its competitors, it’s gonna sell a lot of ‘em! At least it will in the early stages of its foray into the aviation market and provided it has been able to arrange appropriate reinsurance programmes to support its activities. If nothing else, this approach will start a price war in which the existing Insurers are forced to reduce their own premiums to sub-economic levels, simply to protect their account which might have taken many years to develop.

But let’s assume that Acme has sold a bunch of policies at the cheapest price in the market. It has now achieved what its marketing gurus refer to as “critical mass”. In other words, it has built a “book” of business that is sufficiently large to support the infrastructure that Acme must set up to run its aviation account: underwriters, reinsurance programmes, accounts staff, claims-handlers, etc.

Now, you can argue as much as you like about the merits of your particular risk profile, or how Joe is a better risk than Fred (poor old Fred, he really does get it in the neck, doesn’t he?!), or why a Bloggs Aerowhat is a safer aircraft than a Smithers Flycat. But one thing is true: if you take a certain number of aircraft, being operated by a range of pilots for all the usual things aircraft are used for, there will, over a fixed period of time, arise a certain average number of accidents that give rise to a certain average value of hull and liability loss.

So let’s assume that Acme’s “book” of risks is of such a size that losses of R30,000,000 can be predicted to occur over a 12-month period. Using the formula (claims must not exceed 90% of 70% of premium), we can say that Acme’s premium income should be around R48,000,000 (you can check the maths!).

Problem is, Acme had to reduce the price of its policies in order to sell them. In some cases, Acme reduced its price to as little as 35% or 40% of its competitors (who have been in the business for much longer than Acme, so perhaps they know something about it). On average, let’s assume Acme was only 33% below where it needed to be. That means its premium income was R32,000,000 instead of R48,000,000. However, apply the formula and you will see that Acme’s premium income can only support claims of R20,000,000 if it is to hit its ROI targets.

So now that Acme has sold the policies and knows that the claims are coming as sure as night follows day, what can it do to get out of its predicament? Put another way, what can its staff do to keep their jobs?

Well, there are two things.

Firstly, try to increase premium midstream. Charge extra premium for any possible reason, justified or not. Want to add another pilot to your policy? R2,500 extra. Want to include an additional type of use? That’ll be another 1% on your Hull rate. Want to visit some or other foregoing country? That’ll be another 20% loading. And so forth. Once you’ve bought the basic policy, the game is on as Acme tries to maximise its income by charging you every time you want to make any sort of change.

But that sort of approach won’t really make much difference to Acme’s overall premium income and only alienates the customer. So what’s left?

Be afraid…be very afraid! It’s called “Claims Management”.

There are three elements to claims management. How any Insurer approaches them says more about them than their premiums ever could. The three elements might be called Before, During and After.

The “Before” phase starts when a loss is reported, but before it becomes a claim. First up, an assessor will be appointed to carry out an investigation into the loss. Assuming this has been an operational accident, the investigation will look into the background to the flight in question, the maintenance status of the aircraft, the flight crew records, etc.

At this early stage, the Insurer has not yet admitted liability. If it can find a way of denying the claim, it might avoid paying anything at all. So, the approach which is adopted by Acme is “find a legal reason and then deny, deny, deny”.

It was the famous English author, GK Chesterton, who said: “ To have a right to do a thing is not at all the same as to be right in doing it”. It’s a lesson that Insurers like Acme would do well to remember.

But let’s assume that we’ve managed to get past Phase 1 of Acme’s Claims Management programme and Acme, no matter how reluctantly, has agreed there is a valid claim. So now we move into Phase 2: During.

In the During phase, Acme’s aim will be to reduce the amount it pays by any means possible. The first step in this process is to ensure that the assessor is instructed to arrange as many repair quotes as possible, applying as much pressure as possible on the repair facility in order to cut costs, reduce margins and limit ancillary costs such as overtime, airfreight charges, etc.

Acme will be quick to point out that its strict legal obligation under the policy is to repair the aircraft (assuming we’re dealing with accident damage). There is no obligation to pay for the aircraft to be repaired by the owner’s preferred facility, or the official representative of the aircraft manufacturer. So if the assessor can find a cheaper alternative, Acme will use it, no matter how long the repairs will take and, even worse, no matter where that repairer is located. So the owner may find itsself in the position of being unable to oversee progress as the repair facility may be hundreds of kilometres away.

The owner mustn’t try arguing, either. “Remember,” he will be reminded endlessly, “it was you that wanted the cheapest possible premium and shopped your insurance account around, giving a mandate to 4 different insurance brokers, of varying degrees of experience or ability.”

It gets even worse if there were injuries in the accident which give rise to claims for compensation. Acme will now pull out all the stops to ensure that it doesn’t pay claims, whether this involves invoking ticket conditions, or simply using the tactic described in John Grisham’s excellent novel, The Rainmaker, where an Insurer denied all claims as a matter of course and only settled those where the claimant had the resources (physical, emotional and financial) to take the fight to the Insurer for long enough.

But we digress. At last, Acme has been dragged, kicking and screaming, to the point where the chequebook is out and the amount has been agreed. Now we move into the final phase of Acme’s Claims Management system: the After.

One of the features of short term insurance, which I have referred to before in this column, is the doctrine of subrogation. Simply put, this says that, one Acme has paid a claim, it is entitled to take over the policyholder’s rights against any other party and to pursue a recovery. Anyone who has been involved in a collision with another vehicle has probably become involved in a subrogation action as one Insurer tries to recover its loss from the “guilty” party’s Insurer.

The position is not much different when it comes to aviation insurance. The principles are the same. If your Insurer indemnifies you, it is entitled to recover it loss in subrogation against the responsible party, if one can be found and identified.

Most Insurers act ethically when assessing whether to subrogate. Most often, if the responsible party has insurance of its own, the Insurers will handle the matter between themselves; no-one will be the wiser and no-one really suffers.

But, hey, Acme can’t afford to worry too much about the ethics. The only question it ask will be: is it legal? If so, Acme will have a go at anyone or any company in order to recover its loss. And, yes, this means pilots get sued in their personal capacities for having done nothing wrong other than making a mistake.

There are occasions when even the most saintly insurance company might be tempted to put aside its halo (or umbrella!) and resort to litigation. And pilots who fly non-owned aircraft need to be aware of the possible consequences of flagrant breaches of applicable regulations, if they should lead to an accident. The most obvious of these is running out of fuel as a result of mismanagement or lack of proper flight planning. If you ever find yourself in the position when you’re not sure whether you can make your destination safely (with the requisite 45 minute fuel reserve), don’t press on: rather, find a suitable airstrip and land before you hear your engine giving a wheezy cough. Another cardinal sin that pilots would do well to avoid is the temptation to press on in marginal weather without the appropriate IFR qualifications. Even if the pilot is killed in the inevitable accident, don’t think the Insurer won’t go after the pilot’s estate…it will, particularly if it perceives that the estate has sufficient assets to respond to the Insurer’s claim. Fly without a valid license, or with an expired medical certificate, and any pilot would do well to ensure that he or she does not have an accident!

Sometimes, accidents occur in circumstances where the Insurers would normally have the right to deny a claim – if the pilot in the examples I have given also happens to own the aircraft – but is obliged to pay off a finance company in terms of what is known as Breach of Warranty insurance. Some Insurers will make such payments and call it a day (with a file note to ensure they never offer to insure the individual responsible). However, Acme cannot afford to make such magnanimous gestures and will exercise rights of subrogation against its own policyholder. Whilst this may sound completely bizarre, Acme is legally able to do this as it takes over the rights of the finance company in terms of the finance agreement itself. There have been a number of cases recently where pilots – both living and dead – have been pursued by Acme-type Insurers, desperate to recover their losses in order to balance the books.

Whether you are an aircraft owner or pilot, or both, I urge you to take a much closer interest in the insurance coverage relating to any aircraft that you own or plan to fly. Look closely at your broker/agent and consider whether he/she truly has the sort of expertise and experience you want in your corner, or whether you are just another account for him or her to practise on. He may be a friend, but this is a serious business. Look at the insurance company you are insured with and consider its own experience, reputation and history in the aviation insurance game. Don’t be tempted by a cheaper price – EVER! Weigh up the essential elements of Cost, Coverage, Service and Security. Always go for a balanced approach. Remember the comment made by the wise old broker when his client was shrieking down the phone that he wanted to save money:

“Certainly, Sir, and when would you like to save it? Now? Or later?”