One consumer myth that many adjusters confront is the idea thatclaim people get paid by how much they “save” on a given claim. Asif adjusters get a commission if they can settle a $20,000 auto orhomeowners claim for, say, $10,000.

Although this fantasy always seemed farfetched, some insurancecompanies do link adjusters' incentive compensation to broaderfinancial goals that the company wants to hit. In sucharrangements, an adjuster's base compensation may be fixed, but theclaim person earns extra incentive income, depending on the companyor claim unit's ability to meet certain financial targets.

Say that an adjuster's base pay is $50,000 per year. Anincentive comp plan might pay adjusters an extra 15 percent bonusif the claim department drops its loss ratio from 79 percent to 74percent, or achieves a 10 percent reduction in loss payments fromthe prior year. If adjusters meet these goals, they will get anextra $7,500 in contingent or incentive income for the year. Thatis enough to get the attention of many claim people.

The rationale is two-fold. First, it sensitizes claim people tothe huge financial responsibility that they have when guarding thecompany coffers. Claim payments and reserving practices can make orbreak an insurance company. Such a pay system can move adjustersfrom a micro perspective (“How do I handle this claim?”) to a macroviewpoint (“How do my duties support the overall corporatemission?”). Maybe now, those adjusters will be more bottom-lineoriented and start thinking like business people. Second, it getseveryone pulling in the same direction, having a unity of purposethat they can work on as a team.

Such is the theory. The reality can be different, as we will seemomentarily.

Recipe for Bad Faith

Is this relevant to risk management? Yes. One huge risk thatinsurers manage is the peril of bad faith. If contingent incomeschemes tempt adjusters to cut corners in order to boost financialresults, bad faith exposures increase. Furthermore, such pay plansmay invite scrutiny from state insurance commissions, any of whomcan initiate market conduct surveys.

Any adjuster pay plan that heightens that risk becomes acorporate liability, meriting re-examination on risk managementgrounds. Most insurance companies have a risk manager or someone,perhaps without that title, who fulfills this role. A well managedinsurance company or TPA risk management program must assess therisk of bad faith or market conduct woes due to adjustercompensation plans, no matter how well-meaning. Pay schemes thatincrease bad faith and market conduct risks may flunk on riskmanagement grounds.

The job of the claim department is to pay claims. Adjustersshould pay claims frugally and prudently. They should pay onlymeritorious claims. They should fight bogus claims. Their job is topay claims consistent with the insurance contract language.Period.

The adjuster's job is not to turn a profit for the company, toadvance a company's A.M. Best rating, or to max out on theincentive compensation plan. Once these factors seep into theadjuster's consciousness at the file-handling level, mischiefcreeps in. Dysfunctional incentives drive suspect claimpractices.

Hmmm, low-ball those settlement offers to save something off thereserve. Overstate early reserves in order to game them and lookheroic to the bosses later. Ignore a policyholder's demand tosettle a potential excess claim within policy limits because youthink that you can save something by rolling the dice at trial.Drag out payments to defense law firms to minimize payouts andmaximize company cash flow. Delay issuing claim payments in orderto boost the financials that will go to the board of directors orto shareholders.

Before you call me na?ve or a Neanderthal, we all understand andvalue the role of profit. Insurance companies are financial, notphilanthropic, institutions. Usually, they are for-profitenterprises. This is legitimate. So is having a good A.M. Bestrating or hitting the jackpot on incentive compensation.

These cannot be the claim department's preoccupation,however.

Nevertheless, if you are a bad faith attorney, it is a wonderfulway to guarantee full employment. Contingent pay schemes keep badfaith attorneys busy. I recently attended a Mealey's continuingeducation seminar in Philadelphia on Top 10 Insurance CoverageIssues. The speakers included an attorney from Anderson Kill, whichspecializes in representing policyholders in insurance coveragedisputes. After his speech, I buttonholed him and asked aboutinsurer compensation schemes that tie adjuster pay, or a portion ofit, to attaining lowered claim payments or similar financialyardsticks.

His eyes lit up and he said that it was a dream come true in badfaith litigation. “Attorneys love to learn about such compensationplans in discovery and expose them to juries,” he said, weaving atale that financial incentives encourage sharp practices.

Alternative Approaches

Okay Quinley, if you don't use financial yardsticks such asthese, how are you going to motivate adjusters? Are we back totouchy-feely stuff like “Does a good job,” and, “Has a goodattitude?”

If incentive income were not tied to financial goals, companiescould link contingent compensation to criteria such as:

oadjuster productivity (caseload size, turnover, efficiency)

ocustomer satisfaction, measured by client surveys or anecdotalfeedback (complimentary or complaint letters)

oprofessional development (continuing education courses, seminarattendance)

oqualitative assessments (thoroughness of investigation,analysis of coverage and damages, negotiating skill, etc.).

Unfortunately, these seem soft and fuzzy to financial people andare not pegged to hard numbers. They also take longer to evaluatethan does punching data into a calculator or spreadsheet. Insurancemanagement and shareholders want hard numbers. It is easier tomeasure loss payments this year versus next, rather than grapplingwith squishier concepts such as client satisfaction.

The latter takes more work. A customer survey must be hammeredout on which everyone agrees. Decide how many clients to sample.Which clients to sample? Are they surveyed once or on an ongoingbasis? Who tabulates the results? Sounds like a lot of work. Hey,why don't we just go back to measuring claim payments or lossratio, as that is a lot easier?

It is a lot less work but, perhaps, a lot more dangerous in thelong run. Savvy claim handling will help insurers turn profits,retain pristine A.M. Best ratings, and produce sweet payouts inincentive compensation. Those are byproducts, however, of goodfaith claim practices. They cannot be the North Star or the guidingprinciples. The pernicious effect of twisted financial incentivescan create dysfunctional behavior by claim people who now see theirjobs, not as acting in good faith toward insureds and claimants,but as, somehow, transforming claim departments into profitcenters.

Recently, I taught an AIC 36 class, Liability Claim Practices. Inoted to the class that there are more than 300 textbook pagesdiscussing the adjuster's roles and duties in various types ofliability claims. Interestingly, nothing in the text says that theadjuster's role is to turn a profit, burnish a financial rating, orimprove the employer's financial results.

Claim people rarely run insurance companies. Top managementusually comprises financial types with quantitative bents orproduction people who “go by the numbers.” They have understandablebiases toward hitting the numbers when it comes to claimoperations. This may trickle down to adjuster-level goals such as,“Reduce claim payments by 10 percent in 2004.”

Case Study

Bad faith risks from adjuster comp schemes tied to financialoutcomes are not purely theoretical. A recent claim suppressionplan got some carriers in trouble. A federal jury hit threeinsurance companies, including Travelers, with a total of $12million in punitive damages and $60,000 in compensatory damages inJanuary 2004, after they denied an $8,000 workers' compensationclaim for carpal tunnel syndrome.

In Torres v. Travelers Insurance Company, No. 01-5056 (D.S.D.),attorneys for former nursing home cook Alice Torres discovered anincentive program at Travelers Insurance Co. Under this plan, thecarrier allegedly offered adjusters up to 100 percent of theirsalaries in bonuses for reducing the overall payout of insuranceclaims from one year to the next. Travelers denied the existence ofany such program, as did its co-defendants, Constitution StateServices and Insurance Co. of the State of Pennsylvania.

The insurers insisted that the underlying claim was bogus, andthat the carpal tunnel syndrome was not work-related. Still,Travelers was hit with $8.5 million of the punitive damages.Despite that, the focus of the litigation shifted from theunderlying claim's legitimacy to the propriety of the insurers'adjuster compensation plans. Doubtlessly, when they launch suchplans, insurers' top financial management teams applaud themselvesfor their result-oriented thinking in linking adjuster pay to thecorporation's financial goals.

Right on. About time we held those claim people accountable forfinancial results.

Right on, indeed. Right on … into the bad faith cesspool.

Kevin Quinley is senior vice president of Medmarc InsuranceGroup in Chantilly, Va. Reach him at [email protected] orwww.kevinquinley.com.