How an Insurer’s Combined Ratio Affects Its Employees’ Decisions

Did You Know?  Insurance companies often use performance ratios to determine how well they are doing.  Many insurers tie their employees’ compensation and incentives to how well they contribute to those ratios.  The primary ratio insurers monitor for performance of employees is the “combined ratio.” The combined ratio is a key financial metric used by insurance companies to assess their underwriting performance and profitability. It is calculated by dividing claims paid out in a given year by the earned premiums brought in during that year. When an insurance company sets a specific combined ratio target as a performance goal for itself and its employees, it can significantly influence their priorities and decision-making. Let’s delve into the analysis of this impact.

Profitability Focus:

Setting a combined ratio target typically reflects the company’s focus on profitability. When employees are aware that meeting or exceeding the target is crucial for the company’s financial success, it can shape their decision-making process. They may prioritize activities and strategies that contribute to reducing the combined ratio, such as careful risk selection, pricing adjustments, and cost control measures. These may directly affect your experience as a consumer.

1. Risk Assessment and Underwriting:

To achieve a favorable combined ratio, employees involved in underwriting and risk assessment may become more cautious in evaluating and selecting potential insured risks. They might adopt more stringent criteria and guidelines to minimize the likelihood of high-risk policies that could lead to higher claim payouts. This focus on risk management can result in more conservative underwriting decisions and potentially lead to a reduced appetite for certain types of coverage.

2. Claims Management:

Claims adjusters play a critical role in the insurance process. When a combined ratio target is in place, claims professionals may face pressure to manage claims more efficiently and cost-effectively. They may scrutinize claims more rigorously, aiming to identify potential areas for cost containment or claims denial. This focus on controlling claim expenses can lead to heightened scrutiny and potential disputes with policyholders over coverage.

Cost Control Measures:

Achieving a target combined ratio often requires a disciplined approach to cost management throughout the organization. Employees may be incentivized to find ways to reduce operational expenses, streamline processes, and optimize resource allocation. However, there is a risk that such cost-cutting measures could impact the quality of service provided to policyholders or compromise the accuracy and thoroughness of certain activities, such as claims investigations.  In the disability insurance context, a major cost cutting measure is reliance on in-house medical professionals. These medical professionals – they often are not doctors – are supposed to provide objective analysis of an insured’s medical records.  Where they are paid by the insurer and their incentives are often directly tied to keeping claim payments down, this necessarily results in a biased review.  In the property insurance context, a growing cost-control measure is the use of replacement value software and reconstruction cost software to determine how much a property might cost to rebuild, and then in the event of a catastrophe, how much it should cost to rebuild.  Unsurprisingly, a growing number of lawsuits around the country have rightly noted that these software products are often incredibly inaccurate – an issue worsened by the lack of training provided on their use.  While a lower replacement cost estimate will result in a lower insurance amount, that will be a very small difference on the premium, but can be literally millions of dollars they save in payments owed in the event the property need to be rebuilt.

Customer Service and Retention:

Balancing the drive for profitability with customer satisfaction and retention can be a delicate task. The combined ratio target influences employees to prioritize short-term financial gains over maintaining positive customer relationships. For example, decisions to deny claims, rescind policies once a claim is made, or increase premiums may be driven more by the financial impact on the combined ratio than by a genuine assessment of the insured’s needs or the risk involved.

Employee Incentives:

Insurance companies often tie employee incentives and bonuses to meeting or exceeding performance targets, including the combined ratio. This can further reinforce the influence of the target on employees’ decision-making. Many insurers hire third party administrators to run their claims and underwriting for them, and explicitly pay for that service based on the combined ratio achieved by the administrator.  The pressure to achieve the target encourages unethical behavior, such as manipulating claim assessments or compromising policyholder interests.   It is crucial for companies to establish clear ethical guidelines and monitoring mechanisms to prevent such misconduct. Failure to do so can support a cause of action for breach of the implied covenant of good faith and fair dealing, which in turn opens the door to awards of punitive damages.

When an insurance company sets a combined ratio target as a performance goal for itself and its employees, it significantly influences their priorities and decision-making. While it can drive cost control, risk management, and profitability, it also drives a very personal desire by employees to demonstrate a positive effect on the combined ratio in the only ways they are empowered to do so — usually denying claims, denying requests for policy reformation, and rescinding policies. If you are bringing a lawsuit for breach of contract and bad faith against your insurer, make sure that your attorney finds out how the insurer’s employers are incentivized to perform.  It could prove very helpful to your suit.