POSTCLAIM UNDERWRITING AND THE VERIFICATION OF INSURED INFORMATION: EVIDENCE FROM THE LIFE INSURANCE INDUSTRY

• Author: Kathleen A. McCullough,Charles M. Nyce,Jill M. Bisco
• Date: 01 March 2019
• Published date: 01 March 2019
• DOI: http://doi.org/10.1111/jori.12189

POSTCLAIM UNDERWRITING AND THE VERIFICATION OF

INSURED INFORMATION:EVIDENCE FROM THE LIFE

INSURANCE INDUSTRY

Jill M. Bisco

Kathleen A. McCullough

Charles M. Nyce

ABSTRACT

This research investigates information verification by life insurers with

respect to postclaim underwriting through denied and resisted claims. We

provide a theoretical model to explore the optimal strategy for insurers

regarding preloss versus postclaim underwriting. Using differential cost

structures, the model predicts that it is possible for some insurers to follow a

strategy of postclaim underwriting while others do not. Evidence of this is

found in the empirical analysis. Insurers that postclaim underwrite are

identified by a decrease in underwriting expenses and an increase in the

claim investigation expense in conjunction with increases in denied and

resisted claims.

INTRODUCTION

Misrepresentation and fraud are important issues across all lines in insurance and as

such have been the subject of a great deal of research (e.g., Picard, 1996, 2000, 2009;

Crocker and Tennyson, 2002; Derrig, 2002; Tennyson and Salsas-Forn, 2002; Viaene

and Dedene, 2004; Schiller, 2006; Krawczyk, 2009). Insurers use a variety of strategies

to verify insured information in an effort to minimize misrepresentation and fraud

costs. While significant research has been done on the impact of property–casualty

claims handling on the insurers productivity and profitability (e.g., Cummins and

Sommer, 1996; Epermanis and Harrington, 2006), the impact of claims-handling

practices on life insurers has gone virtually unvisited, specifically as it pertains to the

use of denied and resisted life insurance claims to verify information. To better

understand the timing in which life insurers verify information, this article uses the

Jill M. Bisco is at the Department of Finance, University of Akron, Akron, Ohio. Bisco can be

contacted via e-mail: jbisco@uakron.edu. Kathleen A. McCullough and Charles M. Nyce are at

Risk Management/Insurance, Real Estate & Legal Studies, Florida State University,

Tallahassee, Florida.

© 2017 The Journal of Risk and Insurance. Vol. 86, No. 1, 7–38 (2019).

DOI: 10.1111/jori.12189

7

requirement of life insurers to record all claims that are resisted or denied during the

year.

1

To decrease the time necessary to write policies and increase market share, life

insurers are analyzing risks much faster than they have in the past and are, in some

cases, significantly limiting initial underwriting (Schuman, 1995). When insurers limit

initial underwriting, they likely take the risk of increased claim payments and/or use

postclaim underwriting. Postclaim underwriting can be defined as the process

whereby an insurer does not assess an insured’s eligibility for insurance, according to

the risk he/she presents, until after insurance has been purchased and a claim has

been made (Cady and Gates, 1999).

2

Some insurers may be opting to forego or reduce

the initial underwriting process in favor of postclaim underwriting life insurance in

the form of denied or resisted life insurance claims.

Although previous literature has discussed, and in some cases condemned, postclaim

underwriting by insurers (Schatz, 1986; Cady and Gates, 1999; Evans, 2011), there has

been no empirical tests that have proven that insurers forgo the initial underwriting

process in favor of postclaim underwriting. Only two known articles, Weisbart (1976)

and Colquitt and Hoyt (1997), have analyzed denied and resisted claims. While this

article uses a similar framework to that utilized by Weisbart, we include a theoretical

model to explain the use of postclaim underwriting by some insurers. We also

expand the sample and time period used, create yearly indices related to

frequency and severity of denied and resisted ordinary life claims, as well as test

for evidence of postclaim underwriting through the analysis of denied and resisted

1

For the purpose of this research, denied claims are considered those claims where the insurer

refuses to make any payment toward the proceeds of the life insurance policy. Resisted claims

are those where the insurer makes a partial payment of the face value of the policy and denies

the balance or those claims where the insurer is still disputing the payment of the claim and

retains an amount as still outstanding on the financial records of the company. Denied and

resisted claims are found on Schedule F of the statutory accounting statement. This will be

discussed further in the “Data and Hypotheses Development” section. According to the

National Association of Insurance Commissioners (NAIC), a claim is considered resisted

when it is in dispute and not resolved on the financial statement date. A denied claim is one

where the insurer has determined the claim will not be paid (NAIC, 2010). In addition, claims

that are denied or resisted and close within the same year must still be reported as denied and

resisted on Schedule F. Of the claims that appear on Schedule F of the statutory financial

statements from 2003 to 2010, 42 percent are resisted claims and 58 percent are denied claims.

Denied and resisted claims do not include life insurance claims being reviewed (not disputed)

or those claims where the company is holding up payment for sufficient evidence or where a

beneficiary has made a claim and then withdraws it. These claims are considered “in the

course of settlement” (Fleming, 2013).

2

All insurers may investigate claims for various reasons (i.e., when a person disappears and is

assumed deceased, where suicide is suspected, or where there may be an error with the age of

the insured). In addition, insurers may audit claims as a matter of practice. This type of

investigation or audit does not necessarily indicate the presence of postclaim underwriting.

Postclaim underwriting is the replacement of all or some of the initial underwriting with

underwriting that occurs after a claim is submitted.

8THE JOURNAL OF RISK AND INSURANCE

claims.

3

Thus, our focus is different from Colquitt and Hoyt (1997) who try to

determine the validity of the reason given for the denial of the life insurance proceeds.

We first explore the insurer’s incentives to use a postclaim underwriting strategy with

a theoretical model based on Picard (1996).

4

Picard’s model, which investigates the

equilibrium of an insurance market where opportunists file fraudulent claims, is

modified to apply to an insurer’s decision regarding the extent to postclaim

underwrite. We consider the impact of the insurer’s cost structure and the insured’s

incentives to misrepresent to develop a framework that describes the cases in which

insurers will utilize preloss underwriting, postloss underwriting, or both. The results

of this model indicate that there are some equilibria where misrepresentation occurs

and some level of postclaim underwriting is optimal.

The theoretical model gi ves rise to a series of hypot heses related to cases in wh ich

the insurers’ cost structu re would suggest incentives to po stclaim underwrite. We

analyze whether life ins urers utilize the postcl aim underwriting proce ss to wait to

verify information fol lowing the claim. Since th ere is no direct measure of

postclaim underwriti ng, we use the reduction in in itial underwriting expe nses

coupled with an increase in claims expenses and the recording of denied and

resisted claims.

5

Since the insurer will be underwriting the policy fol lowing the

claim and these postclai m underwriting expenses are recorded as expenses

associated with claim investigation, the claim in vestigation expenses sh ould be

higher.

6

We acknowledge that the measure may bias against detecting all

postclaims underwrit ing as a firm may decide to post claim underwrite, reduce

3

The Statutory Annual Statement provides the following line of business categories for life and

health insurers: industrial life, ordinary life, individual annuities, credit life, group annuities,

group accident and health, credit accident and health, individual accident and health, and

other. Ordinary life insurance refers to term insurance and all forms of permanent insurance

(e.g., universal, variable, variable universal, whole) sold to individuals (Fleming, 2013).

Ordinary life denied and resisted claims account for 63.5 percent of all denied and resisted

claims reported on Schedule F and 89 percent of all funds being denied or resisted.

4

The model presented in this article is similar (but more simplified) to Dixit and Picard (2003)

and Picard (2009) in that there are both low-risk and high-risk insureds, low- and high-risk

policies, and potential misrepresentation. This model does not delve into uncertainty of risk

type by the insured (Dixit and Picard, 2003) or commitment to verification (Picard, 2009).

5

The majority of the claims that are denied and resisted by the insurer are still within the period

indicated in the incontestability clause. The incontestability clause is a provision which states a

period, generally 2 years, during which insurers have the opportunity to dispute or contest the

insurance in force. The incontestability clause limits the opportunity for insurers to utilize the

postunderwriting process.

6

Expenses associated with postclaim underwriting are recorded according to SSAP No.

55Unpaid Claims, Losses and Loss Adjustment Expenses, paragraph 6d. It states that claim

adjustment expenses include legal and investigative costs expected to be incurred in

connection with the adjustment and recording of life claims. In other words, life insurers that

revisit any underwriting practices during the claims-handling process would record the

associated expenses under investigation and claim settlement expense.

POSTCLAIM UNDERWRITING BY DENIED/RESISTED CLAIMS 9