Fragmented Coverage Widens Knowledge Gap Among Consumers

There’s a classic line with claims management implications in the 1967 movie “Cool Hand Luke,” starring Paul Newman as an obstinate inmate in a brutal rural prison chain gang. His refusal to stop trying to escape prompts the exasperated warden to exclaim, “What we’ve got here is failure to communicate.”

A similar “failure to communicate” is one potentially negative result of what’s being referred to as “risk fragmentation.” This occurs when carriers unbundle coverages via exclusions, narrowed definitions, or other policy limitations.

In some respects, fragmentation has benefited the industry by allowing insurers to exclude coverage for correlated risk where potential losses are high—flood being a prime example. But fragmentation also might lead to a breakdown in communication, thus leaving policyholders uninsured for risks they thought were covered, bewildered to learn this after the fact, and angry toward the industry for leaving them bare. This is particularly the case following natural disaster losses such as the recent Superstorm Sandy.

The relative merits and drawbacks of fragmentation for the industry and its policyholders were discussed among academics, industry professionals, lawyers, and regulators during a recent conference hosted by the Rutgers Center for Risk and Responsibility. (Last year, this same group put on a fascinating conference about bad-faith claims against insurers, covered in my May 2012 column, “When Does Aggressive Claims Management Become Bad Faith?”)

In some cases, the industry still bundles a variety of coverages, such as with business owners’ policies (better known as BOPs). But on the other side of the equation, the industry’s signature comprehensive general liability policy was fragmented years ago after multiple waves of long-tail claims.

One attendee at the conference noted that the “golden goose got cooked” when CGL carriers were overwhelmed by pollution, asbestos, and product liability losses. The industry moved to a far more fragmented commercial (rather than comprehensive) general liability form, with many of the problematic exposures excluded, thereafter available only by endorsement or under separate cover.

The same goes for homeowners’ policies, particularly when it comes to flood, which was excluded decades ago and is now covered on a primary basis under the National Flood Insurance Program. Indeed, flood risk is further fragmented by the fact that, while coverage is supplied by the federal government, private insurance companies administer the policies (which, some say, could result in a conflict of interest if wind damage is present in addition to flood). Independent insurance agents sell the coverage.

Other exclusions generally apply as well for homeowners’ policies, including mold, pollution, earth movement, and concurrent causation. One plaintiff’s attorney in attendance complained that homeowners’ policies have so many exclusions that the industry has turned standard coverage into “Swiss cheese.”

A number of those in attendance asserted that fragmented coverage tends to leave policyholders in the lurch, as many often learn only after a loss, much to their chagrin, that they lack insurance for an exposure they thought was included in their policies. As a result, more litigation likely takes place—not just over coverage disputes but also to hold someone (usually the agent who sold the policy) responsible for the gap via an errors and omissions claim. 

In a broader sense, fragmentation also may serve to undermine the industry’s credibility, tarnish its reputation, and draw the ire of regulators and legislators faced with demands for “reform” from angry, uninsured constituents.

But whether coverages are bundled or fragmented, some at the conference argued, most buyers still need to understand better the risks that are insured in their policies and the ones that are not. Many require advice as to what they should buy given their particular exposure, balanced against their risk tolerance and budget constraints. Indeed, a bigger problem, some at the conference suggested, is policyholders who understand their coverage quite well yet buy lower limits to save on premiums—only to complain (and perhaps sue) when claims payments end up being inadequate to cover a loss. 

This is where the aforementioned failure to communicate angle comes in. A good part of the discussion at Rutgers focused on the need for more transparency on the part of the industry and greater financial literacy on the part of consumers so that buyers are more aware of what their policies cover—thus avoiding claims management complications and litigation, as well as moves by harried government policymakers to “fix” the problem.

Some at the conference said consumers not only have to cope with a fragmented policy structure, but also with fragmented regulation. One attendee, referring to the state-based regulatory system as “Balkanization,” recommended that one way to protect policyholders better might be to give the federal Consumer Financial Protection Bureau preemptive authority to move into market conduct regulation if state insurance departments don’t improve coverage disclosure standards. 

A number of speakers on the program cited the need for better education of young people about finance in general and insurance in particular so they are more likely to be informed consumers. This sounds like a logical suggestion, but some at the conference insisted that “educating” high school students about insurance is a utopian idea doomed to fail because discussing such topics years before people actually have to buy insurance is likely to go in one ear and out the other. 

Instead, one participant asserted that the buying public would benefit more from “just in time” education during the sales process, when people are focused on understanding the product. But who will do the educating? Will it be the agent alone, the carrier on its own, or the two working together? And what if there is no agent involved—as occurs when the consumer is buying direct over the Web?

One attendee said that direct contact by carriers might actually be preferable because, while buyers often don’t want to take the time to review coverage details when they are sitting down with an agent, they might do so if they can learn about policy options at their own pace and if a carrier’s software does a good job taking an applicant intuitively through a policy’s terms and conditions.

Some at the conference urged adoption of the UK model, where carriers generally post their standard policies online for prospects to ponder at their leisure prior to purchase. One participant conceded that, while it’s unlikely that many individual shoppers will spend much time studying policies in detail, such a level of disclosure would allow other interested parties—such as consumer advocates and journalists—to compare and contrast coverage and offer opinions to the public about what to look for and what to avoid.

I then tossed out my idea (raised in my April 2013 column) that perhaps it might be beneficial to include federal flood insurance automatically with all property policies—at least in certain storm-prone areas—while forcing consumers to opt out if they don’t want the additional coverage. An opt-out model might work with other lines of coverage, as well.

But such efforts were characterized by some at the conference as a futile gesture—the equivalent of throwing more paperwork at people and asking them to “check the box and sign here” without confirming that they actually read the explanations offered or understand what they are signing away in terms of optional coverage. One attendee said behavioral economics suggests that providing too many choices can paralyze a consumer and make matters worse.

In the end, many at the conference were skeptical that enhanced disclosure efforts would make much of a difference in giving consumers a better grasp of the perils they face and the fragmented insurance policies available to cover them. But others offered ideas on how insurers might help consumers make more informed decisions and, thus, perhaps avoid misunderstandings about coverage at the point of purchase as well as associated claims management problems later on.

One intriguing suggestion was to structure insurance policies along the lines of target-date mutual funds, with insurance “experts” making the choices as to what coverage should be included based on an individual’s exposure, goals, risk tolerance, and budget.

Another suggestion was to mandate the purchase of more lines of coverage within a standard policy (with flood cited as a prime example), although I imagine that could make insurance unaffordable for many lower-income buyers.

A third proposal was to write coverage in plain English rather than legalese, which resonated with me. If you recall from my September 2012 column, “Small Businesses Expect No Disguises on Claims Management,” the inability to make heads or tails of policy language was a particular complaint among small-business consumers discussing their customer experience in a pair of focus groups last summer run by the Deloitte Center for Financial Services. Since the industry’s goal should be to demystify coverage options, I second that motion.

At the end of “Cool Hand Luke,” Paul Newman is fatally shot during yet another escape attempt after taunting his pursuers with the film’s signature line, “What we have here is failure to communicate.” Are insurers shooting themselves in the foot by making their policy terms and conditions too difficult for consumers to understand and by failing to communicate coverage details more effectively? Or is this miscommunication mainly the fault of consumers, who owe it to themselves to pay closer attention to their insurance needs and coverage options?

Frankly, I think both sides need to step up and be better prepared to communicate more clearly with one another. But since insurance, fragmented or not, is such a complex issue and consumers don’t deal with the subject very often, the burden primarily rests with the industry to make itself more transparent and comprehensible. That’s certainly a better option than having to explain coverage terms to a jury of their “peers” that’s not likely to be up to speed about the latest insurance terms and conditions.