A lot has been written about fear, by Brene Brown, and its effects on our personal lives. In unhealthy doses, it paralyzes us and deprives us of meaningful connections and achieving happiness. Yet, fear can be a powerful ally in protecting ourselves from physically or emotionally precarious situations. We would argue this same dichotomy is equally true in business. Without courage and risk taking, none of the companies that have come to shape the world of insurance would exist. Unlike our personal lives, there’s a very clear mandate within the insurance business–our risk taking must be profitable in the long run.
When we first entered the stop-loss market, almost every single insurance company we spoke to asked us to build a score that would predict catastrophic claims. Indeed, we built that score (and it works great!), but the process revealed something less obvious. Fear and courage should work like the scales of justice and balance out over time. However, it was clear to us that the industry was laser focused on preventing loss as a primary objective.
High dollar or catastrophic claims, like terrorism, are actually not common events; but when they do strike, the aftermath can be disastrous. As a result, all companies invest a lot of time and energy into preventing the next catastrophic claim. From everything we’ve observed, there will always be some level of opaqueness around high-dollar claims:
- Prevalence is low: When you look at the frequency of claims over $100,000, it’s lower than 0.5% of claims. The prevalence in the overall population is low and becomes even lower when you attribute claims to specific medical conditions. Simply put, it’s difficult to create predictive models when there’s limited data.
- Randomness: We also observed that we’re either structurally or technically unable to predict every high dollar claim, because many of them are inherently random by their very nature. Bad things happen to people that go unexplained.
- Non-recurring: Further, not all claims are caused by chronic conditions, so just because you know it happened, doesn’t mean it will happen again
While we clearly predict a significant portion of high-dollar claims based on our own behavioral models, we also now know that there are limits. This uncontrollable randomness has a ripple effect across the rest of the business because insurers have to have to compensate for these losses by increasing premium on other groups which can also make them uncompetitive in many situations.
While not losing money and being profitable tend to be highly correlated, they are not always the same thing. We have found that over 70% of groups underwritten in our analysis of three years of bound data were actually profitable groups. In fact, the top 10% of groups represented over 30% of net profit. The implication to us was clear. While saying no is clearly important to not losing money, understanding where risk is overpriced is just as important to making money.
Whether by process, data, technology or people, some insurers are finding a way to be more competitive in the right situations. So, why is this such a big deal? If you believe the stop-loss space will continue to commoditize over time, then it’s really important to find new areas of growth where there’s more likely to be overpriced risk. The most obvious place is to turn to those companies that are transitioning from fully insured to self-funded. Based on what we’ve seen, we think some insurers will be better positioned to capitalize on this long-term market trend. Both fear and risk-taking need to work together to optimize performance at an insurer.