Magazine article Risk Management

The Decline of Certainty. (End Analysis)

Magazine article Risk Management

The Decline of Certainty. (End Analysis)

Article excerpt

The underlying assumption of insurance buyers is that, in the event of a loss, a claim will be paid in full. If insurance is seen as less than reliable and certain, its perceived value drops, dramatically. Why? Because certainty--or rather, the quest for certainty--is the main reason for insurance. Despite the fact that we know nothing in life is truly certain, we continue to buy insurance, primarily because it makes us feel more secure.

Economists Richard and Barbara Stewart have carefully analyzed this assumption as it relates to insurance purchasing and have determined that certainty is no longer likely or even feasible. In their article, "The Loss of the Certainty Effect" (Risk Management and Insurance Review, May 2001), they assert that while "the insurance buyer's belief that claims will be paid is essential to the value of what insurers sell ... recent changes in the insurance business have placed a cloud over the assumption of certain payment, particularly for large commercial buyers of property/casualty insurance."

The individual wrongful denial of claims, when taken cumulatively, is leading to a loss of the so-called certainty effect. This loss, the Stewarts believe, could ultimately bring about the demise of insurance companies as we know them. "From an insurer's point of view, denying coverage for large claims has become an effective--perhaps even necessary--strategy. Insurance companies have economic incentives not to pay. The damage to any one insurance company when it wrongfully denies a claim occurs some time in the future, whereas the benefits of refusing to pay a claim are immediate. From a policyholder's point of view, the cost of collecting a claim has gone up and the reliability of insurance has gone down."

If insurance were seen by buyers as less than certain, the Stewarts argue, the resulting discounting of its value and buyers' willingness to pay for it would be drastically impacted.

What, then, are the remedies for the loss of certainty? One approach is increased disclosure. An insurance department in a market conduct examination, or a court in a punitive damages trial, could require an insurance company to disclose its handling of all comparable claims.

Or insurers could make claims payment practices a competitive advantage. …

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