Tag Archives: accident fund insurance company

Minding the Gap: Investment Risk Management in a Low-Yield Environment

A significant component of managing a property/casualty insurance company’s investment portfolio is gap management — ensuring that asset cash flows and returns always exceed claims and expenses by a healthy amount. Because risk-based capital levels, as well as loss and combined ratios, inform various aspects of an insurer’s existence on everything from basic solvency to growth capacity to credit rating, protecting and growing this margin is an imperative. Yet as nearly every insurer is aware today, maintaining portfolio income levels and minding that gap is an adventure fraught with peril.

This article sets forth some reminders about concentration risk management, appropriate duration strategies and suggests possible modes of investment, such as ETFs, to boost yields while maintaining liquidity.

For P/C insurers, while catastrophe-related losses in 2012 were lower than in 2011 (notwithstanding some estimates that Hurricane Sandy could cost upward of $20 billion in the final tally), the liability side of the ledger also remains challenged, with a middling ability to raise premiums in many market segments due in part to slow economic growth.

For life insurers, product guarantees combined with low interest rates on long-dated investment options make for an uncomfortable forecast, though life insurers typically have more time to work through the low rate dilemma than do P/C insurers.

Insurer balance sheets continue to be squeezed from both sides, and, based on the Fed’s last bit of commentary, insurers could still face another two years of policy-suppressed interest rates. In the midst of this yield drought, it is easy to get out over one’s skis by moving into areas of the market with which one is not familiar.

The trends are similar across time and market cycles, although the downturn from 2008 to present has been deeper and lasted longer than many other cycles. According to SNL Financial, the aggregate net investment yield for P/C insurers has declined from 4.20% in 2008 to 3.68% in 2012. When yield is scarce, fixed income investors of all types — not just insurers — tend to begin seeking yield by stretching credit parameters or duration targets, and sometimes both.

For insurers, this has the potential to create exposure to capital volatility, as credit “drift” in a portfolio might lead to heavier weightings in certain lower quality parts of the fixed income market. This might equate to a greater allocation to BBB category securities, or to a particular segment such as financials, which have maintained generally higher credit ratings on their debt, but whose performance may correlate more closely with an insurer’s own performance during another downturn.

There has also been a general trend among insurers toward diversifying into asset classes that many have not historically utilized: REITs, MLPs (master limited partnerships), bank loans, emerging market debt and even gold, which offers no current income but simply the opportunity for capital appreciation.

The foregoing can create a new operating framework for insurers who manage their portfolios in-house, because it requires a more active portfolio management effort than has historically been employed. The effort needs to focus on questions, such as:

What are the proper thresholds for allocation to the lower levels of the investment grade bond universe? How does extending duration play into this decision? Given such changes to an insurer’s portfolio, what is the impact on risk-based capital of market corrections of varying magnitudes? How quickly can the portfolio be repositioned in down-trending markets? What is the liquidity profile of so-called alternative asset classes? What is their exposure to event risk?

Fueling these portfolio management questions is the substantial increase in issuance by those credits that make up the Barclays U.S. Aggregate Bond Index—a proxy that many total-return insurance portfolios benchmark themselves against. There were over 5,000 issues brought to market in 2012, while over the preceding 24 years the average has been approximately 3,300 issues per year.

Further complicating an insurer’s decision-making framework is the fact that since 2005 the trend line in credit quality of the issues in the Agg index has been toward lesser-rated credits. This is especially evident with new issuance: Approximately 47% of issuance in 2012 was BBB, while the average over 25 years was 37%. The glut of issuance in 2012 saw greater nominal numbers of fixed income issues in the AAA, AA and A credit categories, but as a percent of total issuance both the AA and A credit categories were below 25-year averages.

In the context of this data, it may be easier for an insurer to — somewhat unwittingly — let portfolio credit quality drift when the universe of available issues has itself drifted! Compound this with entry into unfamiliar and potentially less liquid asset classes, and it is easy to see that minding the gap never took so much work.

Despite these numerous market challenges, we must be constructive about finding responsive solutions for insurance portfolios. Standing still is not really an option, as inaction and inattentiveness carry their own risk. In some regards, solutions are simple, though that is not to say they are easy. To wit:

Risk management in the portfolio. Keep a close eye on concentration issues, whether by credit rating, industry or issuer.

Understand the specific dynamics that portfolio targets create, such as that a focus on more highly rated credits can lead to an overweight in financials. Conversely, there are many solid BBB names, including many industrials and utilities whose steady performance over time fits well in a portfolio that aims for low volatility.

There are also a host of “new” BBB names resulting from credit downgrades in recent years.

Credit research and selection and an understanding of the liquidity of a given bond are still paramount issues.

Maintain a defensive posture. Inflation does not appear to be looming large at the moment, but fixed income market volatility over the past few years—and even the past few months—has been significant. Extending duration on the core capital portfolio could create undesired downside capital volatility when interest rates rise.

Keeping a defensive posture can mean keeping portfolio duration slightly short of benchmark duration, as it can allow active portfolio managers to seek alpha, i.e., excess return above a market index, through sector and name selection, while subjecting the insurer’s portfolio to less price volatility.

Take risk smartly. This is a principal issue when insurers begin to extend their portfolio into asset classes where they have not historically invested. The modality of the investment can be as important as the asset class.

There are now more than 85 NAIC-rated exchange-traded funds available for insurers, a number of which cover NAIC-3 and NAIC-4 rated investments, such as convertible bonds, preferred stocks and high-yield debt. If an insurer determines that it wishes to seek out additional yield in the high-yield space, is it better to do so via individual bonds or via a single ETF composed of several hundred securities?

Embrace discomfort. This is more of a psychological tactic than a portfolio management tool. But understand that market dislocations, disruptions, downturns and disorder are likely to have a quicker and more widespread impact across economies and industries given global economic connectedness.

The capacity to assimilate market cues and quickly make adjustments to a portfolio can safeguard an insurer’s capital.

For an insurance portfolio, having a risk budget can function akin to a stop-loss policy—if the portfolio or a sub-component erodes by “X” percent over a period of time, the position is reduced or eliminated according to the risk budget parameters. And pursuant to the prior bullet point, the modality of the investment is a component of swiftly executing on a plan. It’s unlikely an insurance portfolio can avoid entirely the pain that down markets can inflict; the key is having a plan to minimize the pain.

For a P/C carrier’s investment portfolio, having a risk budget can function akin to a stop-loss policy on the underwriting portfolio.

These preceding points are not overly complex. Yet they require an active focus and a dexterity that market conditions have not always demanded of insurance portfolio managers. The current environment demands a daily discipline to make sure: that the good risk management practices overlay portfolio construction, that the insurer’s portfolio is positioned with an appropriate duration given market and inflation outlooks, and that any “plus” or return-seeking asset classes complement the rest of the portfolio and remain as liquid as possible.

There are plenty of spots where one can get tripped up and see some erosion in the all-important gap between assets and liabilities, but there are also numerous opportunities for an insurance portfolio to thrive while maintaining low volatility.

Step lively, have a plan and execute on it. The gap shouldn’t be enough to trip us up!

This article first appeared in Carrier Management Magazine.

An Inside Perspective On Automobile Insurance Fraud, Part 1

This is Part 1 in a two-part series on automobile insurance fraud. Part 2 in the series can be found here.


Traffic engineers would love to unblock the clogged arteries of Southern California's freeway system, where rush hour is anything but “rush” — more like gridlock.

But in a land where one's car is one's empire, one's freedom and personal statement, carpooling is a tough sell. The high-occupancy vehicle (HOV) lanes have scant occupancy.

In fact, cars carrying multiple passengers are such a rarity that this scenario alone raises red flags for auto insurance claims adjusters.

Operating under the radar is a fast-growing segment of the so-called “underground economy” — organized criminal enterprises that stage automobile collisions with the intent to defraud insurance companies of medical payments. In some cases, the entire incident is created on paper, with fictitious vehicles and false identities. In other cases, the perpetrators take real vehicles with legitimate insurance policies out to vacant lots or remote fields to crash them and then fill out a counter report. The most compelling cases are the ones where participants intentionally ram vehicles together on city streets — often a rear-end collision in a left turn lane — then dial 911 and wait for police and emergency medical services (EMS) to arrive. This approach triggers a police report and EMS records, which lend an air of legitimacy to the event. It really happened.

Based on instructions from a stager, the driver and two or three passengers — who are known as “stuffed passengers” — report neck and back injuries. The passengers later visit a physician or chiropractor who is in collusion with the criminal ring. The patients sign in and leave without receiving any treatment. If the insurance company balks at paying the specious claim, the claimant enlists the help of an attorney who is also party to the scheme. The attorney is tenacious, willing to go to court, generally able to bluff until the insurance company backs down and settles.

In the process, everybody except the insurance company gets easy money. Property damage to the vehicle is paid to the owner of the vehicle, while multiple players split the proceeds of the settlement for medical payments. In a typical case where the insurance company settles for, say, $6,000, each vehicle occupant might get $1,000, the lawyers and doctors collect their fees, and the enterprise leader retains 50 percent of the professional services fees plus the balance of the claimants' settlement, if any. If the enterprise leader successfully stages dozens of such incidents a month, it's a lucrative business.

This practice exploded in Southern California in the mid-1990s. If you are a Special Investigations Unit investigator, you are dealing with this every day. The average caseload for an adjuster or claims representative might be 150 or 200 a day, depending on the size of the company. At least 25 percent of that is some flavor of fraud. It's either a false claim or an embellishment to it. People are doing it. Even people who think of themselves as law-abiding are doing it, because they don't think of insurance companies as victims. This type of activity is so prevalent that our undercover investigators would hear paramedics on the scene saying, “Okay, which one of you is going to the hospital this time?”

Automobile insurance fraud is such easy money that the business is even creating unlikely bedfellows. For example, in South Central Los Angeles, the Bloods and Crips — gangs that have had an intense and bitter rivalry — are now cooperating with one another in organized insurance fraud, because it's more powerful and profitable to join forces.

Six Steps to a Successful Insurance Scam

Constantin Borloff (not his real name), the former leader of a successful and sophisticated fraud enterprise that operated in San Diego, Los Angeles and San Francisco, shares his top tips for making fraud pay. Having paid his debt to society, the ring leader now tells insurance companies how he was able to steal so much money from them, who does it and why it's so easy.

Go For The Med Pay Money
Borloff would insist that vehicle insurance policies have med pay coverage — coverage for reasonable expenses to treat accident-related bodily injury. Since this coverage follows the vehicle, passengers in a vehicle that has med pay coverage will likely be covered as well. Borloff gave vehicle owners a list of insurance companies who would freely provide these policies.

In theory, claimants are supposed to repay med pay money if they receive a settlement, but that doesn't happen according to Borloff. “For all history, maybe two times the insurance company asked for money back. If you say you don't have money and can't pay it back, they say, 'Okay, don't pay back the money.'”

Find the Inattentive Insurance Companies
Borloff also selected insurance companies with a reputation for laxity, the ones whose claims representatives didn't take a stand and ask the hard questions. “Big companies like State Farm or Farmers have millions of policies, good special investigation units and more experienced adjusters, so that's where you would see more problems. It's better to go to the smaller company or where it's not their main business. These companies usually pay more, while the big companies usually pay a little less.”

Insiders in the business share this information, so they know which companies to avoid and which ones would pay off like loose slot machines in Henderson, Nevada.

What would make an insurance company an unattractive target? “I don't know what will stop me,” said Borloff. “All insurance companies are bound by law to pay. So for us, the system is working perfectly. The insurance company can fight, and they have a lot of resources to fight, but eventually they have to pay something. Maybe more, maybe less, but eventually they have to pay something.”

Choose Participants Who Won't Raise Suspicion
In a perfect world, your participants are white American citizens with clean driving records and their own drivers' licenses. Judges and juries look most kindly upon this type of claimant, according to Borloff.

It is equally important that their behavior fits accepted patterns. For instance, policies would be active for four to eight months before the staged collision. Claims would be modest, usually no more than $5,000 or $6,000. Activities were choreographed to avoid triggering red flags. “I know insurance companies have about 25 red flags,” Borloff says. “What the claims adjusters know, the criminal enterprise knows twice. I knew about all these red flags, and I tried to avoid them.”

Distributing the cases is one way to avoid detection, said Borloff. “If the enterprise will do, say, 20 collisions a month, the claims will go to five different insurance companies, each to a different attorney — 10, 15 or 20 different attorneys — and any given adjuster will have at most two cases to a specific attorney. Will the adjuster be suspicious about it? I don't think so. It's very dif!cult for the insurance company to catch these people in this situation.”

Borloff tells of a fringe case where a woman, working against the advice of her stager, staged four accidents in a single week. She submitted claims to four different insurance agencies. All four claims were paid, but this pattern of activity could have exposed everybody in the fraud enterprise to scrutiny and discovery.

Pay More Than Lip Service To The Medical Treatment
When private investigators were first sent to wait outside medical clinics to observe and videotape (the comings and goings of visitors), the first people they caught were the ones who walked in, signed in and left within a minute. People quickly learned to stay longer inside the clinic and have follow-up visits at intervals that would seem appropriate for their injuries and type of care.

Keep Your Stories Straight
Cappers and stagers write notes for people so they can remember their stories when talking to claims representatives, and later on, if they meet with an attorney and go into depositions. Somehow, somewhere, there is a record of all this. If the ring is dealing in volume, there must be good notes, or they won't remember the details of a case, and that's how they get tripped up. Some stagers get tripped up simply by having these notes in their possession — in their offices or briefcases, waiting to be found during a routine traffic stop or search.

Insulate The Players From Each Other
These groups tend to function as classic cell networks. In an effective cell network, the claimant may or may not be exposed to the other people involved, or may be only exposed to the doctor but not to the attorney. That's how these people are protected from one another. Participants may not have a knowledge of what else the group is doing. When we arrested 72 people on a state level and brought them into interrogation rooms for 72 hours, it was pretty clear that they only knew their own activities or those of friends they had brought into the group. They had no knowledge of the bigger scheme. That's how you protect your enterprise.

The parties in these fraud rings learn never to admit to anybody that the accident was staged. Everybody in the enterprise knows it, but if you tell even one person, there's a point of vulnerability. It is especially important to insulate the medical and legal providers, because their professional licenses are critical to facilitate these claims. They take it all the way and never back down.

How often would a criminal enterprise walk away from a case because an insurance company's Special Investigations Unit got involved? “I would not walk away, but I would accept lower settlement, for sure,” said Borloff. “One time one of my colleagues made a terrible mistake, and sent 63 cases to Allstate — one attorney, same office. They came to me and said, 'What should we do now, SIU is after us?' I said, 'Don't give up, try to fight,' but they decided to give up. It was the biggest red flag. They lost money. It upset people.” Giving up is tantamount to an admission of wrongdoing.

This series of articles is taken from the SAS white paper of the same name. © 2013, SAS Institute Inc. Used by permission.