The headline in the December 17, 2012 issue of Property Casualty 360—National Underwriter read "Uncertainty Rules Risk Management Outlook in 2013." Risk managers were worried about what happened in 2012. Well, a lot happened last year—namely a dozen weather-related events that, along with other catastrophes, cost around $70 billion, and for that dozen, more than $1 billion each.

Last year was also the hottest year in history, and predictions of other forms of doom and gloom ranging from cyber attacks to volcanic explosions were rampant. Had the Mayans been right after all?

I recall arguing with George Head, Ph.D. of the Insurance Institute of America(IIA) in Malvern, Pa., many years ago about how one associate in risk management (ARM) course was designed back then when I was teaching it. (It may be different now.) I had spoken with his coauthor of one of the ARM texts in San Francisco. The coauthor agreed that too much emphasis on mathematical statistics could be misleading as to loss control issues. Dr. Head had cited an example of how a railroad would use statistical analysis to determine where a train might derail. As a transportation buff who has read hundreds of thousands of pages about railroads and their wrecks, I thought the example was rather silly.

A railroad would go out and inspect the track, using a dynamometer car to analyze the actual steel in the track, to see where and how a wreck might occur. The company would use engineering and track telemetries that examine the rail and a host of other factors, using science and math. The company would—just as I have advocated for decades—investigate to find out what is really going on. The powers that be would not sit in some ivory tower fiddling with statistics while that was going on. I mean, wrecks might be occurring. It's the same with claims: sitting on one's butt in an office diddling with paper or a computer is not necessarily an investigation, and it may lead to incorrect evaluation.

The Emphasis on STEMS

In late March, more than 30 teachers and administrators in the Atlantic public school system were indicted for falsifying state school test results. The school personnel cheated by changing the students' answers or by providing them the answers so the scores would show improvement and the schools would get more money the next year under the "No Child Left Behind" program. Undoubtedly a few of these teachers will end up in jail. Their students, meanwhile, will go on to become dropouts and unemployables in the 21st century job market. They could even join their teachers in jail one day.

That the United States is miles behind other advanced nations in education is not a new development. In fact, it has been that way for decades. There are many reasons for this, some having to do with the "melting pot" that America has always been. In China most the students are Chinese; in Germany they're all German; and in Japan all are Japanese and think in terms of Japanese culture, which is almost the opposite of American culture. In America two-thirds of the students are from an immigrant group where English is not their first language. To illustrate, how well would I learn when placed in a Chinese university? Frankly, a lot worse than many Chinese who attend American universities and walk away with Ph.Ds in STEMS.

STEMS—or science, technology, engineering, mathematics and its offshoot, statistics—are now the holy grail of the American education system. Forget the antiquated "three Rs" of reading, writing and arithmetic; today's fifth-graders are doing calculus and learning how to program computers. Most schools—and those standardized tests—are emphasizing STEMS, with far less emphasis on the social sciences, the so-called "liberal arts" of literature, politics, history, geography and sociology, or art, music and drama. Cursive writing is no longer taught; in fact, writing anything is rarely taught. Do kids still have to write book reports and essays? Or is the emphasis all on the testing?

One could argue the American mentality is different from that in foreign lands, where everyone shares the same mindset and certain attributes (both figuratively and literally), with little upward or downward sociological movement; one's ranking in school determines one's career and lifetime. Americans think independently. Group thinking, the "Theory Z" of Japanese management style, is foreign to most Americans. We are individualists. Maybe that is why we are so polarized.

While on a trip to Scandinavia, our Danish tour guide said, "Vee are vaating for our government to tell us vot to tink." Can you imagine an American saying that he was waiting for Congress to tell him what to think? That kind of mentality is what leads to Wahabi Islam radicalism or North Korean militant attitudes, where all you know is what you are taught to think.

STEMS and the Marketplace

Now it turns out that STEMS has been applied to economics and business, with the recent publication of The Physics of Wall Street, A Brief History of Predicting the Unpredictable, by James Owen Weatherall, Ph.D, University of California, Irvine (Houghton Mifflin Harcourt, 2012). In his New York Times January 6, 2013, review of the book, Floyd Norris, chief financial correspondent for the Times, sums up its 286 pages: "Ever since the financial crisis … Weatherall writes… 'Words like quint, derivative and model have taken on some nasty connotations. He is out to change that." It's like the word paradigm; I'd never heard the word before the mid-1980s.

Well, good luck with that, Dr. Weatherall. Norris suspects "the world's economic problems are far too complex to be reduced to a matter of physics and mathematics." A recent PBS documentary on the psychology of the stock markets clearly proved that no one can predict what the market will do from day to day or month to month. If a simple mathematical method was available, then we would not have had economic disasters in 1907, 1922, 1929–1940, recessions in every decade, and near collapse in 2008. There are cycles, but they are not quantifiable either mathematically or statistically.

The world's economic problems are far too complex to be reduced to a matter of physics and mathematical formulas, Norris suggests in his review. If STEMS could cure everything, then there would be peace in the Middle East, no energy or global warming crises, and we'd all be equally rich. I recall a nasty column I wrote in July, 1986, (Claims was still called Insurance Adjuster Magazine back then) titled, "Is the Non-MBA Adjuster Really Obsolete?" It was in response to an article in the American Risk & Insurance Association's Journal of Risk and Insurance, an academic publication to which I subscribed, but rarely completely read; it was simply a place for university professors to propose things in order to accomplish their annual "publish or perish" academic mandate.

Four professors, Carpenter, Lange, Shannon and Stevens had written a March, 1986 treatise entitled, "Methodology of Valuing Lost Earnings: A Review, Criticism and Recommendation." They had an equation called: Present Value of an Earnings Stream:

where EO = earnings in initial year, gj = growth rate in normal wages in industry, "j," and "i" = normal rate of interest; "t" must have represented time.

This was certainly not the way I addressed the evaluation of lost earnings in Casualty Insurance Claims, 4th, (Thomson Reuters West), where reference is made to factors such as state wrongful death statutes in the calculation of economic damages—something the professors did not include in their formula. Undoubtedly adjusters with an MBA or mathematics and statistical degrees will fully comprehend the good professors' reasoning. In the 1986 column, however, my criticism was that the hurried casualty adjuster will probably not use statistical analysis to evaluate a lost income claim. He or she would contact the employer, obtain a report detailing earnings over at least the past 13 months or more, or in the case of those paid in other ways, obtain income tax records, and then investigate.

The Adjuster and STEMS

Yet each of the five STEMS factors do have a significant role in the insurance, claims adjustment and risk management field. They help in determining things like actual cash value and good faith offers. Without math, actuaries could not provide accurate rates. Without engineering, loss control would be useless. Scientific analysis of loss tells us what went wrong so that we can prevent similar loss in the future. But statistics basically tell us about the past; we need good brains, not computers, to use such data to predict what will happen in the future.

Like medicine, multiple disciplines are combined to provide cures in any field. Businesses can use statistics to see what has occurred and where there are trends, but as I have pointed out several times, Tom Peters' "management by wandering around" is generally superior to "management by objective." Goals are needed, but it is better to go and see what employees think, what the customers think, and what the competitor is doing. Big fancy conceptual words like paradigm, module, and the whole business of derivatives led us into bubbles that burst, as did the dot-com bubble in 2000 and sub-prime mortgages in 2007, and left businessmen and their banks in bankruptcy. What statistical analysis generally cannot take into account is the human emotion of greed. If we keep our heads stuck in a computer, we may be missing the boat.

Once we thought in terms of "building the better mouse trap"; today we think in terms of cell phones, tablets, and "apps." Cell phones undoubtedly outsell mouse traps, but after all three hundred-plus million of us have one, then what?

The STEMS of Adjusting

Boiled down to the basic physical laws that apply in any form of science, it is six words that make up the nine steps of claims adjustment: investigation, evaluation and resolution or negotiation of first the coverage, then the liability, and finally the damages. It must go in that precise order. It is a simple formula, yet we spend billions of dollars in litigation of claims every year because somebody didn't do that "science" correctly.

What is the technology of adjusting? Like any tool, technology is an aid. Norris, in his review of Professor Weatherall's book, says he was reminded of "the adage that if all you have is a hammer, every problem looks like a nail." The Iconoclast once suggested that sellers of medical technology would like to convince us that "the scalpel did the surgery," and while computerized scalpels now can do the cutting, there is a well-prepared surgeon behind the controls. (But there is a growing number of medical malpractice claims arising out of robotic surgery as well.) Technology cannot adjust an insurance claim; it would be GIGO (garbage in, garbage out), but technology can be a very useful tool.

Are adjusters engineers? No, but we sure do need engineering to handle claims correctly. At the same time we must use the same caution that has controlled engineering for millenniums: test, try, test again, and keep on testing until it is perfect. In law "social engineers" are often employed for jury selection, personality evaluation, etc. They don't always get it right—that's the beauty of the American legal system—it is not a science.

If you don't use mathematics in your claim settlements, then what do you use? One cannot evaluate any kind of claim without math, and a successful disposition of a claim is far easier with mathematical evidence of value. But what is the value of pain or the loss of a loved one due to wrongful death, or a lifetime of a painful disability from an accident? Does the university professors' formula answer that? I have used formulas for claim evaluation too, but they were highly subjective, not objective.

Finally, there are statistics. I'm not a fan. After last November's election, the GOP isn't either! Statistically, there are more guns than there are Americans, but we still want more of them. Statistically we all cheat on our income taxes and insurance claims, but practically we do nothing to prevent that. Statistically we over-treat ourselves medically, if insurance is paying. If it isn't, we forego treatment, and may survive anyway. We should do something about that. So statistics are important because they give us objectives, and those are necessary. But they can also mislead and fool us.

We do need STEMS, but we also need the non-STEMS subjects if STEMS are to have a purpose. We need the social sciences and the arts as well as the physical sciences. But what we really need is common sense-thinking, and that is not always what is being taught in our schools and universities.

Special Reports /

Adjusters and STEMS

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