Avoiding the Pitfalls of Late Investigations

The above scenario represents a good example of responsive claim-handling practices and definitely represents excellent customer service for what appears to be a very happy ending for all parties. Unfortunately, that was not the end of the story. Several months later in April 2004, the insured contacted the insurance company and reported that two large machines, which the company depend on heavily in their operations, had been acting "erratically." The insured concluded — based on what their vendors were telling them — that the machines were damaged as a result of the previous power surge and that they would require complete rebuilding for an estimated cost of $958,000. The insured indicated that they expected the insurance company to also provide funds to compensate them for the loss of business, since these machines would fail consistently during the day and could not produce at the volume for which they were designed to handle.

The insurance company informed the insured at that time that their claim would be investigated and looked into and that they would be paid for the damages if and when they were determined to be related to the loss. At that point, the insured informed the insurance company that they had retained a public adjuster, who later claimed that the two large machines could not be rebuilt and needed to be replaced for a total cost of $3.4 million. Additionally, the insured retained a legal counsel to help support his claim.

Obviously, the claim adjuster would have to identify the nature and extent of damage to the machines and the nature of the power failure in order to determine if the damage was related to the loss. Given that two machines were operational most of the time and the damage was limited to certain components that were not directly connected to the power supply, the adjuster decided to look deeper into the claim. That's when the adjuster discovered serious obstacles that almost prevented his investigation.

First, there was no information about the original failure of the power system because the utility company refused to provide any details about the repair and diagnostic activities completed in relation to the facility and the loss. The company later indicated that the personnel who responded to the loss were not available to provide any information and that their records were incomplete. Additionally, all damaged parts from the electric service, which were removed on the day of the loss, were not accounted for and could not be found.

Inside the building, the adjuster discovered that the two machines were connected to a separate electrical service fed from a different part of the electrical grid around the facility. When the adjuster requested to view the damages, the insured refused to shut down the two machines long enough to allow for comprehensive testing that would determine the nature and extent of the damage. The insured's employees who were present at the time of the loss were no longer employed at the facility and could not be located to provide background information.

In light of these problems and pressure exerted by the insured's public adjuster and attorney, the claim was given to a different adjuster who retained outside legal counsel and an engineering expert. The expert was asked to answer four specific questions:

1. What was the root cause of the loss?
2. Who's responsible, if anyone?
3. What is the nature and extent of damage to the machines?
4. Is the damage related to the loss?

Recognizing the Need

By now, readers may be asking themselves, "What could the previous adjuster have done differently to avoid escalation of the claim?" At the same time, readers probably recognize that in certain situations, no matter what you do, the claim can escalate and lead the insured and the insurer to a courtroom to settle their different viewpoints. Nevertheless, a full and detailed investigation immediately following the loss would have minimized the likelihood of the claim escalating and likely would have yielded more accurate and comprehensive information that could have been used to answer the questions arising from the insured's later claims.

Recognizing the need for a forensic engineering investigation can be challenging because of many factors. As in the case described, not all claims start with litigation. Instead, only a small percentage end up in litigation several months, if not years, after the loss occurs. Hence, the claim adjuster would have to recognize the need based on what he determines is the potential of a claim to end up in litigation, rather than based on initial claims made during reporting time. A general rule of thumb is to assume that any claim could end up in court and therefore should be handled as such.

Additionally, time factors add to the complexity of decision making. Insurance companies strive to deliver the highest quality service to their insureds within the shortest amount of time. Conducting a full forensic investigation might delay the conclusion of a claim and add to the insured's frustration, not to mention the impact on their financial situation as a result of the loss. Therefore, insurance adjusters work diligently to conclude claims and reach fair and equitable settlements. The problem lies in situations where a quick resolution involves destruction of the scene, spoliation of evidence or loss of information, and critical witness accounts. In these cases, an adjuster would have to find effective and efficient ways to reach settlement with the insured without compromising his ability to conduct a comprehensive and detailed forensic investigation.

Another significant factor is the cost of an investigation. Typically, the decision to investigate or not is made based on the initial estimate of the loss. Though this may make a lot of sense from a business standpoint, insurers should consider the potential cost rather than the initial amount reported by the insured. A comprehensive evaluation of the loss and the property may provide enough clues to the potential loss.

Many other factors also contribute to the problem. Some of these factors can be avoided by applying common sense business practices. Most important is direct and efficient communication between the insurance adjuster and the expert they retain to investigate a loss. Retaining the right expert as well as communicating the goal of the investigation from the beginning could save the insurance company from situations where they are caught trying to investigate a loss months after the fact.

Know Your Role

The role of an expert is crucial when it comes to advising the insurance adjuster on ways to avoid the pitfalls described. An expert with the proper experience in insurance business would advise his client about potential problems during early stages of the investigation. In our example above, the investigator hired to verify the damage should have informed his client of the involvement of other parties in the loss and the potential of future litigation against third parties. The investigator also should have documented the cause of the loss thoroughly by conducting interviews with the utility personnel as well as the insured's employees and vendors, reviewing documents such as service reports, and photographed or preserved remains of any damaged components subsequently removed from the scene. Moreover, the initial investigator should have documented the condition of all equipment connected to the power supply at the time of the initial inspection.

An expert should be able to respond promptly. He can initiate the investigation, document the scene, preserve any available artifacts, and secure evidence in a relatively quick fashion. An expert also should be able to provide the insurance company with information needed to give notice to potential parties who may have interest in the scene and evidence. Providing adjusters with a preliminary description of known facts and different possible scenarios can assist them in locating parties who may have interest in performing parallel or joint investigations. Once all parties are given notice of the loss, the scene has been well documented, and evidence has been secured and preserved, an expert can turn it over to the insured to repair or replace the damaged equipment. Many of these tasks can and should be conducted in parallel to valuation of damages, if feasible.

The insurance adjuster can request a budget for the work to be done by the expert. The expert should be able to review the tasks needed to complete the investigation and estimate the time needed for each task, then provide a budget for the work to be done. An expert also should be prepared to divide the investigation into phases and assign an estimated amount to each phase prior to initiating the investigation. That way, the preliminary investigation is completed early in the process and additional phases can be performed if and when needed based on the outcome of the claim.

But what about our friends at the manufacturing facility? What happened to them? The investigation is still continuing, with higher difficulty and expense to the insurer as we attempt to ascertain all the facts and fill in the blanks related to missing information. It's definitely a situation that could have been avoided if the investigation had been initiated earlier on in the process.

Mamoon Alyah, PE, is director of forensic engineering services for LWG Consulting in Northbrook, Ill. He may be reached at 800-326-5075, malyah@lwgconsulting.com, www.lwgconsulting.com.