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Five Claims-Handling Considerations for Indemnity Bond Investors

FIVE CLAIMS-HANDLING CONSIDERATIONS FOR INDEMNITY BOND INVESTORS

The growth in indemnity-triggered catastrophe bonds has given sponsors around the world added flexibility. While this approach helps mitigate basis risk, it creates additional risk for investors which requires additional evaluation effort. Beyond needing to spend time analyzing the sponsors underwriting practices, investors need to spend more time studying the sponsors catastrophe claims-handling practices. The quality of catastrophe claims handling can significantly influence the likelihood of attachment as well as the total time it takes to settle the transaction. Here are the five key claims-handling considerations investors in indemnity bonds need to understand: 1. Catastrophe designation: Historically, clearly defining which claims are included as part of the catastrophe has been among the top concerns investors have voiced about indemnitytriggered catastrophe bonds. Sponsors may not have solid control mechanisms in place or a sufficiently developed infrastructure to ensure noncatastrophe claims are properly distinguished from catastrophe claims. There is also the potential for moral hazard, which can lead to the catastrophe designation of claims not directly attributable to a catastrophe in order to reach the attachment point sooner, which thus accelerates the erosion of investor capital. ACTION ITEM: Invest in indemnity-triggered transactions that use PCS for catastrophe designation. When the sponsor uses a trusted independent third party (e.g., Property Claim Services, PCS) to identify qualifying events, there is significantly less confusion about what should or shouldnt be included. Only claims with a PCS catastrophe serial number are counted as losses for the transaction, and this serial number clearly outlines the location, perils, and dates associated with the catastrophe. This simple, inexpensive step can significantly reduce moral hazard and facilitate catastrophe claims tracking and management. 2. Settlement and payment cycle time: Time is among the greatest risks indemnity transaction investors face. A robust, efficient claims organization mitigates that risk significantly through better handling and a faster conclusion. However, a claims organization that takes longer to close claims and aggregate the results can impede the catastrophe bond settlement, tying up investor capital longer. Undeveloped cycle time processes not only tie up investor capital, they also result in a significant risk of higher claims payments. ACTION ITEM: Investigate the sponsors claims operation, including the three crucial elements: people, processes, and technology. Understand the strengths and weaknesses of the catastrophe plans and adjuster presence in areas where there are concentrations of insureds. Understand whether the claims operation has well-developed relationships with independent adjusting firms or if they will be relegated to lower-tier adjusters from lesser-known firms. Further, get to know what independent adjuster training and oversight plans are in place to ensure each claim is coded and handled correctly, regardless of whether handled by internal staff or an independent adjuster.

3. Catastrophe claims tracking: The same systems and operations that affect cycle time also speak to the reliability of the claim results the sponsor reports. The sponsor should be able to demonstrate that it can pull accurate catastrophe claims data quickly, preferably with a third-party catastrophe designation (e.g., a PCS catastrophe serial number). Fast, reliable data can help all parties to a transaction identify collateral events and facilitate settlement when necessary. ACTION ITEM: Invest time in understanding the systems used by the sponsor to track claims particularly catastrophe claims. Learn about the capabilities in place for sufficient and timely reporting and the ability to pool and track catastrophe claims; identify any potential difficulties that could arise in the wake of a catastrophe event. 4. Dispute resolution: Indemnity-triggered transactions can present significant challenges if some form of dispute resolution is necessary for settlement. With the PCS catastrophe serial number, the parties can identify relevant claims faster, as those without the serial number are not related to a catastrophe. The lack of a PCS number leaves open potential dispute regarding location, perils, or dates. Providing a common definition for what constitutes a catastrophe claim provides for more effective discussion and settlement. ACTION ITEM: Third-party catastrophe designation can help a sponsor and investors when dispute resolution becomes necessary. PCS currently defines a catastrophe as an event in the United States or Canada with estimated insured losses of at least $25 million and a significant number of insurers and insureds affected. The PCS approach prevents attachment because of a single large loss that could affect a limited number of carriers but not be industrywide in scope. 5. Fraud detection: Claims fraud can result in an increased likelihood of attachment. With fraud responsible for as much as 10 percent of claim payments and loss adjustment expense, according to the Insurance Information Institutes The Insurance Fact Book 2013, it can have a profound impact on catastrophe bond attachment. Strong claims fraud detection processes and technology can protect investor capital and result in more accurate settlement. ACTION ITEM: Make sure you understand the antifraud measures a sponsor has in place, including the use of systems such as ISO ClaimSearch (from Verisk Analytics) and related products for visual link analysis to detect activity indicative of organized fraud, claim scoring to accelerate the handling of suspicious and meritorious claims, and the integration of weather forensic data from Atmospheric and Environmental Research (a Verisk Analytics company). These systems help claims organizations identify suspicious activity and prevent or mitigate claims fraud. A commitment in this area can keep unnecessary payment from accelerating the triggering of a transaction.

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To learn how PCS can help you in the ILS space, please contact: Joe Louwagie Assistant Vice President Property Claim Services Phone: +1 551-208-3418 E-mail: jlouwagie@verisk.com

Insurance Services Office, Inc., 2013. ISO, the ISO logo, ISO ClaimSearch, Verisk Analytics, and the Verisk Analytics logo are registered trademarks and Verisk, Verisk Insurance Solutions, and the Verisk Insurance Solutions logo are trademarks of Insurance Services Office, Inc. Property Claim Services and PCS are registered trademarks of ISO Services, Inc. AIR Worldwide and the AIR Worldwide logo are registered trademarks of AIR Worldwide Corporation. Xactware is a registered trademark of Xactware Solutions, Inc. All other product or corporate names are trademarks or registered trademarks of their respective companies.

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