Six Steps To Prevent Bad Faith Claims

Some authorities believe there needs to be more financial discipline and accountability applied to claims units in order to get adjusters to think about how their daily decisions impact business. Such pay schemes may not be inherently wrong. Much of this analysis is contingent upon the context and the blend of performance incentive criteria. Taken to an extreme, though, this linkage can spawn liability risks in the form of bad faith lawsuits.

Management Practices On Trial
When it comes to institutional bad faith claims, more than just the claim file comes under scrutiny. Rather, it is the culture of the company that  is under indictment. Plaintiff attorneys try to make the case that – due to financial incentives—the adjuster's good faith duties are subverted and perverted to "max out" financial rewards. They will try to paint a disturbing picture for the jury of what they think drove the company in its handling of claims. They will weave a story showing that claims handling is not about good faith, fiduciary relationships and/or covenants of fair dealing.

Instead, they will try to show that, in claims handling, it is "all about the Benjamins," saving money at the expense of policyholders and claimants. Furthermore, the jury won't be comprised of CFOs or claim executives. It will be made up of consumers, some of whom may dislike insurers.

A Balanced Scorecard Needed
Financial incentives, though, may or may not be inappropriate. Much depends upon whether there are also countervailing yardsticks that factor into adjuster pay. Such countervailing yardsticks are part of a "balanced scorecard." The latter might include metrics like customer service, file handling quality and continuing education training in badfaith. Countervailing criteria can check adjuster temptations to play fast and loose with claim-handling decisions simply to maximize income from hitting financial targets. 

Still, some pay practices expose companies to institutional bad faith claims. Compensation policies that can become magnets for institutional bad faith claims include:

• Base compensation tied to lower claim payments.
• Bonus compensation linked to reducing claim payments.
• Adjuster quotas for claim denials, with job tenure jeopardized if adjusters don't meet a requisite number.
• "Spiffs" or rewards for reducing claim payments.

Performance reviews that implicitly or explicitly reward claim denials, coverage denials and loss payment reductions.

Companies with these compensation practices may, from an "enterprise risk" standpoint, expose themselves to institutional bad faith claims. The allegation will be that the "carrots" and incentives seeping down to adjusters caused them to breach fiduciary duties to policyholders and their good faith duties to claimants. Claims professionals often offer tips to others about managing risk. It is time to look in the mirror. 

Six Tips Revealed

Here are six management practice tips for preventing institutional bad faith and resutant claims:

1. Prefer 'macro' financial targets over 'micro' goals. "Macro" targets would be improving things such as profitability, loss ratio and combined ratio. At the file or desk level, it is tough to move the needle here. Good claims handling can, however, yield better financial measures from:

• Reducing overpayments.
• Quick and accurate settlement offers that trim legal expenses.
• Treating customers well to create and retain happy clients.
• Expanding market share by delivering superior claim service.

From a bad faith standpoint, macro incentives may be on firmer ground than micro incentives. 

2. Reassess 'carrots' linked to specific file outcomes. The more compensation ties to individual file results, the more suspect the comp system. Society must be wary of financial spiffs tied to specific file results. Here's an example: "You've reserved this case at $200,000. If you settle it under XX amount, we'll pay you 10 percent of what you save." This incentivizes (a) over-reserving and (b) low-balling individual claim files to get a direct financial payback.

Looking at professional athletes, NFL players often have incentive clauses in their contacts. They earn bonuses for recording sacks, fumble recoveries, interceptions and other statistical accomplishments. No one suggests that these incentives are unethical or dysfunctional. Financial incentives can cross the line, though, even in the rough and tumble NFL. Providing bonuses for hurting players, for example, is  considered beyond the pale. The current  "Bounty Gate" scandal, which saw players receive spot bonuses for hurting players—"kill shots," cart-offs, and so on—caused Commissioner Roger Goodell to come down hard on players, coaches and even the entire New Orleans Saints organization. Such activities are considered outside the lines.  

The prior context dealt with professional sports. But what should we do about professional claims adjusting? In this world, some targets are considered legit. Others can be seen as going too far. Managing risk lies in knowing the difference and where to draw the line as a pay practice.

3. Establish countervailing yardsticks via a balanced scorecard: Such a scorecard might include not only financial metrics but also customer service measures, customer satisfaction and audited adherence to good faith practices. Financial metrics, which in isolation are suspect, can be neutralized by other yardsticks that check suspect activity. If management also evaluates adjusters on customer satisfaction, number of complaints, adherence to quality claims handling and good faith training, this can a blunt temptation to "low ball" claims to meet financial goals. That is why it is important to survey the whole scope of performance evaluation yardsticks. 

4. Check the weight. It is important to assess the weight that management gives to each major performance evaluation category. Not only should an evaluation scorecard be balanced, but the weight of each category should be relevant. If, among these categories, financial metrics are disproportionately weighted – like, say, 50 percent – that could be problematic. The scorecard should be balanced, not only including key components, but also in terms of  weighting the categories themselves.

5. Invest in ongoing good faith training and refreshers. Companies should invest in ongoing training in good faith claims handling. Managers should conduct recurring training on good faith claim practices and bad faith prevention. Management must weave training into a company's culture. Approaches can include:  

• "Brown bag" lunch seminars. 
• In-service training using outside resources. 
• Webinars. 
• Memos. 
• Circulated articles and recent court rulings.

6. Stay "on message" to emphasize fairness and reducing overpayments. Insurers want to trim "leakage" and save money. There is nothing wrong with that. However, misguided adjusters might hear the corporate message and cut corners to save money. To counteract this, management can build an ongoing messaging campaign that:

• Adjusters should not underpay claims. 
• Adjusters should not shortchange claimants or policyholders. 
• The claims department captures "savings" by fighting fraud, overpayments and through astute subrogation pursuit. 

Such a corporate mantra balances the drumbeat of expense reduction and curbing leakage.

The linchpin of a risk management strategy is prevention at the management level. There is nothing inherently wrong with profitability, saving money or trimming expenses. These goals, though, must harmonize with other aims to ensure that incentives do not become distorted and any vaunted savings are not offset by bad faith settlements, judgments, punitive damages and market conduct sanctions.

Perhaps money is not the root of all evil. Monetary incentives, however, can lead to claims-handling mischief, short-cuts, and pitfalls. "The road to hell may be paved with good intentions," but the path to institutional bad faith is often paved with dysfunctional incentives. Use these six practice pointers to travel down the right path.