Milliman White Paper
Non-life insurance claims
in a recession
Gary Wells, FIA, FSAI
Derek Newton, FIA, FSAI
David Sanders, FIA, ASA, MAAA
The media worldwide is awash with news and commentary on the
recession. Much of it has been at a macro level, with comments
at lower levels tending to focus on specific industries, such as
banking or car manufacturing.
In this article we turn the spotlight onto the likely impact of the
recession on the non-life insurance industry, in particular on its
claim experience and the implications of that experience for
claim reserving.
In economic terms, a country is in recession if it experiences
a general slowdown in economic activity, or a business cycle
contraction, over a sustained period of time. During recessions,
many macroeconomic indicators tend to move in a similar way.
For example, production, employment, business earnings and
profits, the availability of credit, investment spending, asset
values, and household incomes all fall during recessions. At a
less macro level, the real estate market tends to decline in a
recession. Demand for commercial property is reined in, and falling
incomes and earnings as well as increased numbers of company
failures lead to an increasing incidence of mortgage defaults
and property foreclosures. Turning to insurance, recessions tend
to lead to surges in claim costs across most lines of business.
The causes are manifold; we will explore some of them and their
consequences in this article.
Fraudulent activities
Whether prompted by financial hardship, boredom, or general
disaffection, recessions appear to coincide with increased
dishonesty. We will discuss later on the impact of theft. But a
major issue that affects the insurance industry is fraud.
Statistics released recently by the Association of British Insurers
indicated that, during 2008, UK insurers identified 107,000 non-life
insurance claims as fraudulent, with a total value of £730m — 4%
by value of all general insurance claims made during 2008. Half of
these by number were false or exaggerated household insurance
and half by amount were fraudulent motor claims. These numbers
and amounts were significantly higher than the equivalent figures
for 2007. And they only relate to the attempted frauds that have
been detected so far — there are probably a very large number that
have passed unnoticed.
The frauds take a variety of forms. Some are completely false
claims and the supposed claim incident never occurred; some
are opportunistic, when a genuine claim incident has occurred
but in making the claim the claimant has deliberately overstated
the extent of the losses incurred, such as inflating the costs of
business interruption; and some relate to deliberate (i.e., non-
accidental) acts. For example, it is common in a recession to
June 2009
see an increase in the frequency of commercial property claims,
especially relating to businesses that are in financial ill health.
Claiming on insurance policy, say for losses caused by fire, is
seen by some as a quicker and easier way of realising the value
of an asset than going through a conventional sale. The motor
insurance market is also seeing an increase in staged accidents.
In most cases, these are actual but prearranged crashes, usually
involving several people, all of whom then claim for minor injuries
supposedly caused by the staged crash.
UK non-life insurers are intensifying their efforts to identify and
weed out fraudulent claims. However, they have a tough job in
that many people in the UK do not regard defrauding insurers
as criminally or even morally wrong. Even people who would
normally regard themselves as completely law-abiding see little
reprehensible in, say, inflating a household insurance claim to
enable them to recoup the value of the deductible, or to provide
a new replacement for a lost item. Many consider insurance fraud
to be a victimless crime, if they consider it a crime at all. That
insurers recoup the cost of fraud through higher premiums to all
policyholders is not widely understood. Insurers might themselves
have unwittingly perpetuated this situation, ironically through
advertising their financial strength and stability. This is often
manifested by their impressive offices and annual turnover in the
hundreds or thousands of millions – which are both reasons why
many people feel that their insurer won’t miss a few extra pounds
added onto their insurance claims. And this feeling escalates when
the policyholders themselves are feeling hard up.
The presence in the arrangement of a third party – such as a loss
adjustor or an administrator – increases the potential for fraud,
particularly in claim cost inflation.
Also in the category of fraud, when policyholders are under
financial pressure they are understandably loath to do anything
that might lead to increased premiums. Under-insurance becomes
more common, as does failure to declare all material facts at the
point of underwriting. These matters can be expected to result in
subsequent claims being scaled down or even refuted, and so they
should have little adverse impact upon the claim amounts per se.
However, they would affect the indirect claim-handling expenses,
through the extra efforts made to identify fraudulent claims or
declarations, and also through dealing with the increased number
of policyholders who want to challenge their insurers’ decisions.
Theft experience
Turning now to theft, Jacqui Smith, who was then the UK Home
Secretary, was widely criticised when it was leaked last year that
she had warned the Prime Minister that she expected crime rates,
particularly those relating to theft, to increase as the economy
Milliman White Paper
started to fall back. Yet what she said is indeed consistent with
what insurers have seen in each previous downturn, and also
with the latest set of crime figures released by the Home Office
and also by the British Crime Survey. Burglary tends to increase,
with less appearing to be opportunistic and urban. Incidence of
theft from the person – such as mugging or pickpocketing – also
rises. Car theft, too, has traditionally increased when times are
tough – indeed, the recession in the early 1990s, which resulted
in particularly high levels of youth unemployment, coincided with
a spate of joyriding as disaffected youths targeted the then cool
cars (mostly hot hatches) and took them racing in the streets. In
1993, during the last major UK recession, vehicle crimes peaked
at 4.3 million, whereas by 2007 there were fewer than 2 million. As
with burglary, the number of thefts from cars has already started
to increase, according to the recently released statistics, but it is
generally thought that the improved security devices within most
new vehicles will partially mitigate future deterioration.
On the subject of motor insurance, the UK government recently
announced a one-year initiative whereby it will provide a grant of
£2,000 for any fully licenced car over 10 years that is scrapped
and replaced by a new car. This is intended to stimulate sales of
new cars. A consequence is that it effectively places a minimum
value of £2,000 on all cars. This would increase the write-off cost
for insurers of damaged vehicles that previously had a value less
than £2,000.
Unemployment and sickness
We have already mentioned that recession goes hand in hand with
higher unemployment rates. This has an immediate impact upon
risk exposure for those providing employers’ liability coverage.
Recession also goes hand in hand with higher long-term sickness
rates. Some of that is clearly genuine – doctors report seeing
larger numbers of stress-related, or stress-exacerbated, conditions
as their patients cope with the personal impact of economic
downturns. However, it is usually cheaper for an employer to sign
off someone onto long-term sickness than to make that person
redundant and, when finance is tight, that is a path that many
employers pursue with vigour.
For many years credit insurance has been a lucrative line of
business for many insurers, and for the intermediaries who have
benefited from both high levels of commission and profit sharing.
But the rise in unemployment and long-term sickness is likely to
change that.
As already mentioned, higher rates of unemployment and long-term
disability will also lead to increasing incidence of mortgage
defaults and property foreclosures. But lenders who consequentially
then hold the title to foreclosed properties will find the realisable
values of those properties much lower than they were just a
few months earlier. In many cases the realisable values will be
substantially below the value of the loans that the lenders had
originally provided. Lenders therefore stand to lose materially
on property loans and will turn to their insurers for recompense,
through coverage such as mortgage indemnity. In order to
prevent a repetition of the large mortgage indemnity losses made
by insurers in the early 1990s, the industry introduced various
standard terms and conditions that encouraged tighter lending
criteria and lower maximum loan-to-value ratios. However, the
media reports of very high loan-to-value ratios, some even above
100%, and of extensive subprime lending, indicate either that
Non-life insurance claims in a recession
Gary Wells, Derek Newton, David Sanders
lenders have been operating without insurance protection at the
high-risk end of their lending or that there has been relaxation of
the enhanced controls. We suspect that there has been some
relaxation and that, as a result, the insurance industry might well
face some big losses from this source.
Residual values
Aside from real estate, property values have, so far in this
recession, moved in different ways, depending on various supply
and demand factors. High discounts on new property have
served to reduce residual values. However, where sales of new
property have been low, residual values are expected to increase
as there will, in future, be fewer available older/used properties.
On the demand side, potential users who are cash-strapped
might well consider buying secondhand what they would hitherto
have bought new, which would push up residual values. On
the other hand, cash-strapped potential users might decide
to defer purchase – either new or secondhand – which would
then cause values to drop. All this means that the outlook for
insurers providing coverage for (non-real estate) residual values
is uncertain. It is worth remembering that the secondhand market
in items such as ambulances, refuse collection vehicles, factory
machinery, etc., is international and so the global effects of the
recession have more direct impact on this line of business than on
the more local lines of business.
Corporate failures
High numbers of corporate failures – often including some well-
established names – are a typical feature of a recession. In recent
years, UK society has become more litigious and more of the
view that if something has gone wrong then someone is to blame
and should be held accountable. As a result, many UK corporate
failures – and indeed many elsewhere in the world – will trigger
a series of legal actions, against the failed firm’s professional
advisors, against its directors and officers, against the regulator,
against any advisor who promoted investment in the failed
enterprise, etc. And, in most cases, these will ultimately end up as
insurance claims, whether the insurers pay the full cost of settled
claims or just the costs of contesting the claim.
One problem with liability claims such as these is that they can
take a long time to materialise, let alone to settle. Claims arising
within the UK that relate to the subprime crisis that triggered
the current recession have, to date, not been extensive, but it
is still too early to be certain that they will not be very material.
Similarly, it is expected that the massive failure of the fraudulent
investment operation run by Bernard Madoff will result in some
very substantial claims, which might not be reported to affected
insurers for a number of years. In these circumstances, it is
essential that insurers monitor their exposures, both direct and
indirect, to prevent the sudden and unexpected emergence of
significant losses in certain lines of business.
More criminal activity
It should be noted that not only are non-life insurers potential direct
victims of fraud perpetrated against the insurers themselves, they
can also become indirect victims of fraud perpetrated against their
policyholders. Organised fraudsters pose a rising threat as they
seek to commit financial crimes using increasingly sophisticated
techniques. Developments in the criminal use of technology allow
easier and faster access to valuable personal data, for example
via fraudulent phishing Web sites. A survey conducted last year
2 June 2009
Milliman White Paper
by the Financial Services Authority (FSA) implies that the level of
awareness of, and preparedness against,
financial crime remains poor. Employees disgruntled by the threat
of redundancy, poor pay increases, and increasing financial
pressures present potentially good targets or entrees for fraudsters.
It should also be noted that rising company bankruptcies, rising
unemployment, falling earnings, and squeezes on cash flow
generate general disaffection, and a wish to pin the blame for
one’s woes on someone or something else, to make someone
else pay for one’s hardship. This leads to a greater propensity
to claim on insurance, in both personal and commercial lines. In
normal conditions, product features such as profit sharing and
no-claim discounts/bonuses mitigate the propensity to make small
claims. However, if the market is soft (and hence the marginal
value of these features is low) or if the insured places more value
on immediate positive cash flow than on deferred benefits, then
it is likely that these product features will have less effect on
the propensity to claim. We are also seeing evidence in the US
of elements of the public sector, which themselves have major
funding issues, scrutinising more closely the recoveries they make
against insurers, to ensure that they are not in any way short-
changed. One can anticipate something similar occurring in the UK.
Claim handling and reserving in a recession
The above provides a quick review of the potential impact of the
recession on the frequency and size of notified claims. What
impact will the recession have on the way these claims are handled
and managed by non-life insurers, and how does that affect the
level of claims as reported in their periodic regulatory returns?
The reported claim costs for non-life business comprise three
parts: the notified claim amount; an additional amount to allow
for any underestimation, the incurred but not enough reported
(IBNER) amount; and a further additional amount to allow for
claims that have been incurred but not yet reported (IBNR). All
three components can be affected by the prevailing economic
factors, particularly by a recession.
Case estimates
Starting first with the notified claim amount, this is an aggregation
of the amounts booked for each notified claim by the insurer’s
claim team. The amounts will be based upon information provided
by the claimant or by the intermediary, which, as we have seen,
might be distorted. However, except for very short-tailed claims or
ones that are very close to settlement, the notified claim amount
can be subject to considerable judgment by the claim team, for
example in assessing how injuries sustained in a car accident
might develop and what loss of earnings amounts might eventually
be claimed. Clearly, judgments of future earnings and of appropriate
discount factors will depend on one’s views of current and future
economic conditions. Also, over a long period, there is rarely
consistency of approach in this application of judgment. In our
experience, insurers frequently revise the approaches taken by
their claim teams in order to improve efficiency and effectiveness.
Moreover, when economic conditions are tough and the insurers
themselves are short of capital, there has been a tendency to
instigate measures that reduce potential overstatement of
case reserves.
Estimating IBNER and IBNR
In assessing their IBNER provisions, insurers should take
account of the degree to which current case estimates might be
Non-life insurance claims in a recession
Gary Wells, Derek Newton, David Sanders
understated (or indeed overstated) relative to the level held, as
at previous times. They should also take into account the degree
to which the claim amounts might be more or less developed
than they have been historically. As we have already discussed,
recession tends to lead to increased volumes of notified claims.
Unless there is an equivalent expansion in the claim-handling and
management capability, the increased volumes tend to lead in turn
to slower claim development and settlement, especially if additional
effort is being made to identify and exclude fraudulent claims.
Insurers need to be very careful with their performance targets at
such times, to ensure that, in order to achieve, for example, an
overall settlement target rate, the claim team does not focus on the
easy claims that can be settled quickly at the expense of ignoring
the harder to settle and (usually) more expensive claims. Such
issues can result in claim development being even slower and,
unless that issue is fully identified, the IBNER provision being
understated, perhaps materially.
Similar issues apply when considering the IBNR provision. In
addition, one needs to consider the speed of claim notification,
and hence the number of claims incurred that are still to be
reported. For example, potential claimants under professional
indemnity policies or directors and officers (D&O) coverage might
well delay making a claim while they concentrate on dealing with
immediate business issues. This has certainly been a feature in
past recessions.
Efficiency programmes within claim-handling teams?
In short we believe that the expected increases in non-life claim
volumes will require more careful management and monitoring by
insurers, to maintain control over leakage. However, what we are
seeing, not just in the UK but also in other major non-life markets,
is a concerted effort by the industry to reduce expenses, including
the expenses of claim handling and management. The expense
cuts are taking place through reductions in staffing as well as the
elimination of expenses that are considered non-essential, such as
training and development. Few organisations are instigating forced
redundancy programmes, so most of the staff losses are through
voluntary redundancies and early retirements. The danger is that
insurers then lose a disproportionate number of experienced claim
staff, leaving the larger workloads to be handled by smaller teams
comprising less experienced claim staff.
Action of this type has an immediate impact upon the visible
expenses of an insurer and would probably serve to reduce any
provision for unallocated claim handling expenses. However,
it also generally results in less efficient and effective claim
handling, evidenced by delayed investigations of damages
and liability, delays in establishing appropriate case reserves,
increased claim longevity, increased allocated claim-handling
expenses, and increased average settlement costs. If the action
is a carefully considered, balanced drive for improved efficiency,
which has taken into account the likely increases in claim
volumes that are due to the recession, then all is well and good;
but if it is not carefully considered, or is primarily focused on
cost reduction and not claim management effectiveness, then it
is quite possible that cost of the additional leakage (which will
take some time to manifest itself) will outweigh the achieved
direct expense savings, perhaps materially so.
3 June 2009
Milliman White Paper

Turning back to reserving… For more information, please contact:

For the more recent years of account, for which the claim data Gary Wells (gary.wells@milliman.com)
might be comparatively undeveloped and thus would not provide Derek Newton (derek.newton@milliman.com)
a stable base from which to project ultimate claim costs, many David Sanders (david.sanders@milliman.com)
insurers derive ultimate claim amounts using methodologies
based upon exposure measures. However, for a number of
Amsterdam
types of business (such as general liability), there is no reliable
Baarnsche Dijk 12c
exposure measure and so insurers will use as a proxy for exposure
the premium volumes, adjusted from period to period to allow 3741 LS Baarn, Netherlands
for such factors as premium rate changes, underlying claim (+) 31 35 5488013 tel
inflation, changes in the terms and conditions, and changes in
the underwriting. These adjustments tend to be subjective and Bucharest
therefore can easily be affected by the prevailing economic Str. C. A. Rosetti 17
conditions as well as by the position within the underwriting cycle Sector 2, Bucuresti, Romania
(in a softening market, insurers tend to underestimate the adjusted (+) 40 21 527 0376 tel
fall in the adequacy of their recent premium rates, which then
results in understatement of their reserves for recent years – this
London
is one of the causes of the reserving cycle whereby the relative
strength of reserves held follows a cycle that is correlated with, but Finsbury Tower
slightly later than, the underwriting cycle). 103-105 Bunhill Row
London EC1Y 8LZ, UK
The overall effect of these issues is that, all other things being (+) 44 (0) 20 7847 1500 tel
equal, held claim reserves are relatively weaker during a recession
than they are when the economy is healthy. This is only to be Madrid
expected. Claim reserves are estimates of future outcomes that are Edificio Cuzco IV
themselves uncertain. Insurers would not wish to constrain their
Paseo de la Castellana,
business unnecessarily by tying up capital in what might prove
141 P. 18-20
to be excessive margins for prudence in their reserve estimates.
So smaller margins tend to be held. This is not to suggest that 28046 Madrid, Spain
insurers under-reserve during a recession – the absolute adequacy (+) 34 91 789 3470 tel
of reserves at a point of time can only be determined several years
hence when the majority of claims have been settled – but we do Milan
suggest that, during a recession, insurers hold reserves that are, Corso Europa, 5 Floor 5
on balance, less strong than they would be at other times. 20122 Milan, Italy
(+) 39 02 7626 0521 tel
In conclusion…
In conclusion, the UK economy is now in recession. This will,
Munich
indeed it has already started to, result in increased claim frequency
across a wide range of product lines. Certain lines, such as Maximilianstrasse 35a
mortgage indemnity and credit insurance, will be particularly 80539 München, Germany
affected. Some of this increased frequency will be due to (+) 49 89 5908 2395 tel
fraudulent claims, and some of that will be identified by insurers
and excluded. But some will remain. The increased activity will Paris
result in slower development and settlement and, unless properly Milliman SAS
managed, could result in increased claim costs. All of these factors 3ème étage
and their impact need to be understood when estimating the
64 rue Pierre Charron
reserves required to meet outstanding claim liabilities.
75008 Paris, France
We have concentrated in this article upon the UK non-life (+) 33 1 42 99 15 60 tel
insurance market. We believe that similar issues apply to virtually
all other non-life insurance markets around the world. If you would Warsaw
like to discuss any of the issues examined in this paper, please ul. Emilii Plater 53, 11th Floor
speak with your Milliman consultant at one of the European offices 00-113 Warsaw, Poland
listed here. Alternatively, please contact the authors directly: (+) 48 22 528 6962 tel

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Gary Wells, Derek Newton, David Sanders