Insurers and the Consumer
Whether it involves life insurance, medical insurance, car insurance, or fire insurance, controlling losses directly reflects the cost charged. At one time, the primary emphasis was on inspection of the items insured. This allowed the insurer to gather information to assist the underwriters in determining the insurability or desirability of the risk as well as appropriate classification for rating purposes. No matter what type of insurance is being written, the underwriters want to know the likelihood of loss. In medical applications, there are health related questions; in auto the underwriters review driving records. Again, no matter what the type of insurance, the likelihood of loss is important to the underwriters.
Insurance is purchased to offset the risk resulting from loss. We are using the term “risk” but similar words are often used, such as hazard, peril, or chance of loss. What, exactly, is risk or chance of loss? It is often defined as the long-run relative frequency of a loss. It is best expressed as a fraction or a percentage. Chance of loss indicates the probable number and severity of losses from a given number of exposures. When expressed as a fraction, the probable number of losses is the numerator and the number of loss exposures is the denominator. The quantity involved will change how the fraction looks. If a coin is flipped there are only two sides involved, so the fraction would be 50/50. However, if ten possible items is involved then the fraction would be 1/10 success and 9/10 failure possibilities. In other words, the chance of loss is 90%.
Our previous example of a coin is simple to understand. It becomes much more involved when loss is applied to such things as fire, wind, and other perils. While logic is still part of the equation, there are other factors that are not easily measured. Insurance companies are probably the best fact-finders or scorekeepers around. They track how many windstorms have happened in any given area. They study why and how fires happen. All of this information gathered becomes part of the equation as it applies to chance of loss.
Insurance companies want to know the “why” and “how often” a loss occurs. Both play a role in controlling future losses. While loss frequency is important to insurers, the loss-severity is perhaps even more important. Obviously a claim for $100 is not as significant to an insurer as is a claim for $100,000. Most losses are partial rather than total, but the total worth of an item always has an impact. Some types of losses are more likely to be catastrophic than others. All of this is figured into the equation that ends up at the premium cost.
Reducing a hazard also reduces the chance of loss. Insurance companies do much of the research that goes into understanding hazards. Their loss-prevention studies have led to well-defined safety precautions in business and industry that has reduced both loss of property and loss of life. Perhaps the best-known research facility is the Underwriters’ Laboratories, Inc. It was originally established by Midwestern fire insurers to test materials, devices and processes against fire hazards.
There is a distinction between “cost of risk” and “cost of loss.” The cost of risk is the before-the-loss evaluation of the cost of uncertainty about losses. The cost of risk is associated with loss-control expenditures and necessary periodic contributions to a fund to pay losses. The cost of loss is the after-the-fact evaluation of the loss.
Risk is a part of every day life. Simply walking across the street carries some degree of risk. However, we minimize that risk by using a crosswalk and by looking both ways before we cross the street. Even Charlie Brown (Peanuts cartoon column) knew daily risk; Lucy was always waiting to pull away the football at just the right moment, causing him failure.
David Bickelhaupt in the book titled General Insurance said that love is much like risk. Love is all around us, tremendously important, yet difficult to define or predict, and hard to get along with – or without. Too much love can be bad yet too little is worse. It can miraculously inspire or hopelessly frustrate.
Risk and loss control are certainly linked. If there were no risk, there would be no need to control the resulting losses. Everyone recognizes the existence of risk but we don’t always realize how it affects our lives. Many businesses couldn’t exist if they had no insurance, so how risk affects their business is a major component of whether or not it even exists.
Some people seek risk while others go to extreme measures to avoid it. We see this in our clients and how they invest. Risk-takers often seek out the types of investments that carry the greatest chance of loss (hoping for the highest rate of return). Those who have reason to avoid risk (such as those on fixed incomes) will look for the least risk, desiring to minimize their chance of loss.
The fundamental methods of loss control tend to be similar in all lines. Whether people are injured, boilers explode, structures burn down, or items are stolen the basic causes involved with personal or job-related factors are usually common to all losses. The primary function of the loss-control specialist is to determine program deficiencies that lead to these losses. Perhaps a business does not have an adequate inventory control system, or personal safety issues have not been sternly addressed with the employees. The loss-control specialist will look at issues that both cause losses or lead to losses. He or she will then advise the insured on risk elimination, loss prevention, or loss reduction measures. Obviously the intent is to eliminate or prevent losses entirely, but when losses do occur, there is also the desire to modify the effects of the loss. Both elimination and modification of loss will help the insured since losses affect the cost of insurance.
Some types of loss prevention seem obvious, such as keeping stairways clear of debris and providing good lighting. Other types of loss prevention may require education in how losses occur. Surprisingly, people often ignore obvious loss potentials. We often hear stories on the news of devastating losses that could have been prevented with simple actions. Fire doors have been locked preventing people from escaping a burning building. Both employees and management have ignored safety procedures. Even at home, we often ignore obvious dangers.
There may be multiple approaches to loss control, but all of these can be grouped under two broad categories: (1) engineering approaches, which deal with the physical aspects of risk, and (2) human approaches, which deal with the actions of people. Certainly loss control is most effective when both approaches are used.
Engineering Approaches
Engineering approaches refers to controlling the physical aspects of loss. This has been the approach of the auto industry, for example. Whether by design or because of regulatory action, the auto industry has utilized such things as air bags, safety lock brakes, and multiple other engineering approaches to safety. Do they guarantee safety? Of course not. A human is still operating the machine, but they do increase the likelihood of loss prevention.
We utilize engineering in all types of loss prevention. Attention is given (usually through building codes) to building structures, nature and location of contents, and protective devices such as alarms and sprinkler systems. Even how a community funds and supplies fire departments will have an effect of loss prevention (and, therefore, the cost of insurance).
A term has become commonly used: “systems safety engineering techniques.” Within an industry, it means specific methods are used to determine the possibility of loss, which results in specific activity to prevent it. This is especially practiced in areas where loss tends to be catastrophic.
Although many of our technological advances have helped reduce human error, we will never totally eliminate it because we are, after all, human. Even so, many of the improved engineering approaches have significantly reduced the amount of loss experienced. If people would follow required safety procedures more closely, loss would be even less. We often know how to prevent loss but fail to do that which is necessary. Drunk driving is an excellent example of this. Virtually everyone knows driving while under the influence of alcohol or drugs is dangerous, yet it is a common occurrence. No amount of engineering approaches will eliminate the possibility of loss when an individual fails to follow simple safety procedures.
People are complex creatures. We tend to believe that rules are made for everyone else. We demand safety in the workplace and in public gathering places, yet fail to follow the very safety procedures that are in place. Safety education is now mandated in schools, in business, and in industry. Education is certainly a good starting point, but most of us do have a grasp of basic safety already. While we certainly want our children to be given safety rules for driving the family vehicle, one must ask how effective it will be if the children see their parents driving after a few beers.
Industry and business is well aware of human failures. They pay the price in their premium costs. A wide range of motivational techniques has been used to help achieve desired safety levels. Awards and recognition is given for specific types of behavior. On construction sites we see signs that state “30 accident free days” for example. Often bonuses are given to specific people (usually management) for specific safety goals. The workers may be given a paid day off. All of these incentives are viewed as productive if it keeps premium costs affordable. Insurers say they can tell in claims which business or industry is actively trying to promote safety and which are not.
Anytime a company or industry works from a prevention perspective the chance of loss is bound to be reduced. This is especially true when it comes to human loss. Failure to recognize the total safety interrelationships of a system’s related person-equipment-material-environment components creates major elements of risk. Failure to recognize the need for safety has brought about most of the regulatory laws now in place (usually after a great loss brought about recognition of the need).
The actual meaning of “accident” has changed and, to some degree, so has the meaning of “safety.” The changes primarily have to do with how the law recognizes these terms, although industry professionals also view them differently today than they did ten or twenty years ago.
The application of the terms reflects application of the law and application of insurance coverage. Safety refers to “freedom from person-equipment-material-environment interactions that result in accidents.” Accident has evolved to “an undesired event resulting in personal physical harm, property damage, or business interruption.” Other terms have also evolved due to law and financial responsibility. Physical harm includes both traumatic injury and disease, including adverse mental, neurologic, or systemic effects resulting from the job. When injury is job-related the laws that govern the related procedures relate to government (state and federal) requirements, insurance requirements, and union requirements.
Some accidents involve what is termed “contact” with a source of energy, such as electrical, chemical, kinetic, thermal, ionizing, radiation, and other elements. The elements involved also change as we become more technical in industry. Some contact elements that are common today were not even imagined a few years ago. Any contact that interferes with normal body function is considered adverse. That would include mental and emotional function as well as physical function.
Since the term “contact” seems to better suit the needs of industry and insurance, it is often used in place of “accident.” The word accident has become more of a descriptive element. The word contact has become the word used to narrow down the actual event that occurred. Insurance agents are accustomed to dealing with terms that describe very narrow meanings. Both insurance companies and legal entities need to have very exact meanings.
Insurance companies desire to minimize accidents. Legal entities desire to make someone or some company pay for them. The legal goals make the insurance goals more aggressive to prevent financial loss. William Haddon, Jr., president of the Insurance Institute of Highway Safety, has been instrumental in systematically identifying hazards and working towards preventing harm to people and property. There are ten general strategies that may be adapted to nearly any type of situation. They are:
1. Prevent the creation of the hazard in the first place.
2. Reduce the amount of the hazard brought into being.
3. Prevent the release of the hazard that already exists.
4. Modify the rate or spatial distribution of release of the hazard from its source.
5. Separate, in time or space, the hazard and what is to be protected. Generally this equates into avoiding human contact with the hazard.
6. Separate the hazard and what is to be protected by interposition of a material barrier of some type, such as safety glasses.
7. Modify relevant basic qualities of the hazard.
8. Make what is to be protected more resistant to damage.
9. Begin to counter damage already done by the environmental hazard.
10. Stabilize, repair, and rehabilitate the object of the damage.
Some of the items listed seem obvious. Number one, for example, seems obvious: prevent the creation of the hazard in the first place. Even though that may seem obvious, people often ignore it. People stack piles of debris on stairways, smoke in bed, and so forth.
Sometimes hazards become the target of laws. Number two is an example of this: reduce the amount of the hazard brought into being. Many states now have seatbelt laws. Those who do not use their seatbelts risk being ticketed by law officials. Seatbelt laws not only save lives, they save money. If fewer people are injured, or injured to a lesser degree, fewer dollars will be spent on medical bills. This may help to keep the cost of our medical insurance down. Everyone benefits.
Number three, preventing the release of the hazard that already exists, might involve many things. It might be as simple as cooking meat long enough to prevent contamination. We all remember the costs and lawsuits connected to the fast food chain that undercooked its hamburger. Not only were people made ill, some died.
A parachute would achieve number four: modify the rate or spatial distribution of release of the hazard from its source. A dam on a river also achieves this by releasing water at a slower pace preventing flooding.
Number five, avoid interaction between people and the hazard, is often seen in industry. Companies try to avoid having their workers exposed to specific types of hazards. Asbestos caused millions of dollars in illness because companies did not try to avoid human contact. Billions of dollars have been paid out in legal claims to the victims. People also died due the exposure. No dollar amount may be attached to the loss of life that occurred.
Creating a barrier between the hazard and people, as stated in number six, is now common. Consider the highways with their concrete barriers between oncoming lanes. The safety equipment used by workers in all types of industry creates barriers between potential harm and the workers, which minimizes exposure to harm. This is not only good for the workers (preventing accidents); it is also good for the companies because it minimizes their financial loss due to lost productivity, medical claims, and lawsuits.
We have tried to lower the relevant basic qualities of risk in many ways, number seven. Freeways, besides using barriers, now have breakaway light poles, which lessens injury to drivers and passengers. The light poles themselves lessen risks by providing light at night.
Number eight, make what is to be protected more resistant to damage, is well known by agents in the property and casualty field. Anyone who works with car insurance knows that some models of cars are more crash-resistant than others.
Countering existing damage, number nine, could include property identification. This helps the insured to recover their loss, but it also helps insurance companies to recover the item that is lost because it is identifiable.
Finally, number ten, stabilize, repair, and rehabilitate the object of the damage, is the last element. The most common example would be the salvage of the damaged item. In the case of a car that has experienced a wreck, it could include repair all the way down to dismantle and part out.
Not surprisingly, it is always best to prevent loss, but loss minimization is also very important. If the loss cannot be totally prevented, it should at least be minimized. Besides preventing human loss it also minimizes financial loss, which affects premium rates. Insurance agents, especially in some fields, have become a loss specialist. Their jobs often include loss consideration not only when the policy is applied for, but even after it has been issued. The modern loss-control specialist will provide information, and make observations to their clients that help prevent or minimize loss.
It should come as no surprise that loss cannot be minimized unless the insured is aware of the risks involved. Risk awareness must be an active pursuit to be most effective. This might include such things as company meetings with employees, a risk manager on staff, and supervisory training. Some types of industry will include premise inspections, job analysis, and engineering controls. When loss does occur it is important to have a follow-up plan that includes immediate medical care, incident investigation, and emergency preparedness.
The type of risk awareness depends greatly upon the types of hazards involved and the business size. Those industries that work with hazardous situations are likely to employ sophisticated methods of risk identification because a single incident can be very costly. Smaller companies whose risks are significantly less are the most likely to loose sight of risk controls. Yet even small companies that seem to have little risk experience lawsuits every day.
The most effective risk management programs use the same aggressiveness used in marketing, production, and cost control. When a clearly defined standard is applied to risk control, employees and all others involved know it is a priority of the company. They know the company expects certain performance and compliance. Many companies utilize auditing techniques to be certain that their safety criteria are followed. It will tell the company not only that their criteria are being followed but also to the extent that it is not. In fact, many audits will provide detailed information regarding the organization as a whole, for divisions of the company, for smaller work units, and even individually. This allows the company to determine specifically where risk control is not being adequately followed. Communication can then be directed to that area so action can be initiated to prevent a possible future loss.
Insurance companies know that aggressive loss prevention works. The problem is getting others to realize this. Financial officers are easy to convince because they see the financial bottom line. Accidents cost money; it’s as simple as that. The more accidents that bring about insurance payouts, the higher the premiums will be down the road. It’s a cause and effect situation. Unfortunately, getting everyone from the top manager down to the lowest paid employee to comply is seldom easy. The vast majority of insureds use only limited risk management techniques. Even state and federal legislation on safety may receive only token compliance.
Both experience and research has proven a direct correlation between the levels of safety programming and losses incurred. Safety auditing has proven to be one of the most effective tools against loss. If we think about it, people use safety auditing every day at home for the protection of their children. We consider what might be harmful and then we act on the “audit” that we have performed. We put plugs in electrical outlets, we use gates at doorways, and we put harmful substances out of their reach to name a few. We even audit our own safety by checking the tires regularly on our cars, replacing brakes as needed, refraining from smoking in bed, taking vitamins, and locking our doors at night. Each of us considers these actions prudent, yet we often fail to follow the safety rules of our employers.
Industry safety audits usually break down the process into specific elements (by department, for example). Doing so makes it easier to identify specific hazards. Think of it as auditing your home for hazards room by room rather than as one entire structure. You are more likely to notice the worn cord on the hairdryer if you are looking at each room individually than you would if you stood on the front porch and just looked at the house. Workers should never be insulted by safety audits. Such audits are for the protection of all. Only by extensive audits have industries been able to reduce some of the dreadful accidents that have occurred in the past. Safety inspections reinforce the strengths that exist in procedures, and identify procedures that need to be introduced.
In some types of industry, the insurance companies require specific evaluations before they will even issue a policy. The insurers want to be sure that the companies are following the safety precautions in place by state and federal agencies. An increasing number of companies are using such evaluations of existing program activities as well as initial physical property inspections and indices of loss in the underwriting considerations. The specific type of business and the related risks will be considered.
Risk control is most likely to be used as it relates to business, but only because the insurance industry has little ability to regulate the risk incurred by individuals. While insurers wish us to use seatbelts in our cars, for example, they have no way to audit us for compliance. In those states that mandate it, insurers will note if tickets have been issued for noncompliance, however.
Although the terms used may vary, nearly all lines of coverage will use the same program application stages: pre-contact, contact, and post-contact. When dealing with loss control, all of these stages apply to an event that produces a loss.
The pre-contact stage is the time element involving elimination or reduction of the possible loss. This is the period of time during which the risk could be entirely eliminated or at least reduced. For example, we can install a sprinkler system prior to a loss. The installation of the system would reduce the amount of loss in the event of a fire. We could also install fire alarms to further aid in reducing loss. Commercially, buildings can be instructed with concrete and steel rather than wood.
Although reducing loss is always desirable, it is even better if the risk of loss can be eliminated entirely. While total elimination is not always possible, it should be the goal. It is a good idea to install fire alarms and sprinkler systems. Removing flammable debris and following safety measures that prevent fires could further reduce the risk.
In our homes, we can reduce the risk of fire by keeping matches and cigarette lighters away from children, not smoking in dangerous areas (such as the bed), and keeping flammable items away from the outside of our house. Many insurance companies recommend, for example, that firewood not be stored next to the house. Rather it should be stacked some distance away.
We can reduce risk from injury by using seatbelts in our cars and helmets on motorcycles. Even horseback riders should consider using helmets. Some types of prevention often end up mandatory because the loss involves more than the one individual that is involved in the accident. Seat belts and helmets have become law in many states because the cost of an accident often impacts more than the single individual. For example, a motorcycle accident may leave the driver permanently impaired which results in state medical aid for an extended period of time, perhaps throughout their remaining life. This impacts the taxpayer who ends up supporting them medically and personally. Laws requiring the use of seatbelts and helmets cannot prevent the accident, but it can reduce the loss (preventing long-term serious injury requiring medical treatment for an extended period).
The contact stage is often referred to as the event stage. It is the actual exchange of energy that is the loss-producing event. That translates into the actual impact of a motor vehicle accident, for example. The goal of loss reduction is to make the loss resulting from the accident less than it would otherwise be. While prevention of the accident is the ideal situation, reducing the amount of the loss is the secondary goal (the first goal being prevention of the loss entirely).
In recent years, we have seen greater efforts at loss prevention on our highways. Such things as concrete lane barriers, additional lighting, and bumper guards lessen the degree of loss.
Following an accident, there are still ways of lessening the amount of loss. Emergency medical care, for example, if supplied quick enough can reduce the amount of time and money required for recovery. According to Property and Liability Insurance by S. S. Huebner, one in every four disabling injuries involves some permanent loss of body part. Obviously this affects the individual, but it also affects society. It means tax dollars may have to help support in part or whole the person affected. It may mean additional tax dollars for rehabilitation and continued medical care.
Although we have always believed that medical care should be prompt, the value of it was especially demonstrated in Vietnam. Death rates were dramatically reduced when medical care was available immediately following the occurrence. This is true whether the injury happens in conflicts such as Vietnam, or on the highways of America. Although it was Vietnam that brought about an initial awareness of the need for trauma centers and federal funding, additional studies have prompted many changes in our healthcare system so that Americans receive care quickly. Since then we have recognized the need for medical speed when treating everything from heart attacks, to accidents.
Thank you,
United Insurance Educators, Inc.
2014