Treasure Hunt.

Regardless of whether insurers pursue salvage and subrogation, recovery often depends more on the characteristics of the company than on its management.

One of the byproducts of the increasingly competitive auto insurance marketplace is an increased interest in improving performance in the claims-recovery area. Insurers have an opportunity to improve claims performance by focusing more closely on their salvage and subrogation efforts.

To determine why some companies are not inclined to take advantage of these salvage and subrogation opportunities, we conducted a study that focused on identifying factors that could affect how aggressively firms pursue their salvage and/or subrogation opportunities. This study was conducted with an understanding that there might be legitimate reasons for the existence of disparities in insurer recovery efforts.

With analysis of financial statement data from 833 property/liability insurers, the study confirmed that there is a wide range of recovery levels among insurers. For example, the mean value of the average recovery measure of the sample firms was $108.96. However, almost 25% of the companies had an average recovery value of more than $134.

Size and Organization

One possible explanation for varying claims-recovery efforts, besides management performance, is that some insurers enjoy cost advantages due to their size. If economies of scale exist in the salvage and subrogation area, then a larger insurer should have better claims-recovery performance. Not surprisingly, other academic studies have found support for scale economies in the claims area.

Another potential explanation is that the insurer's organizational form makes it more or less likely to manage its costs aggressively. There are several studies that support the hypothesis that the managers of stock companies are more closely monitored than the managers of mutual companies. This is because stockholders (when voting shares can be accumulated) are in a better position to hold management accountable for their activities than are policyholders, who are limited by a mutual in their ability to accumulate voting shares. If differences in recovery exist due to the insurer's organizational form, it is likely that stock insurers would exhibit better recovery performance.

Two other potential explanations of these recovery-level differences are related to the insurer's degree of specialization and the amount of resources that it devotes to recovery efforts. As an insurer devotes more of its resources to a particular line of business, it is expected to give an increased amount of attention to that line and enjoy a comparative advantage over insurers with less focus in that line. Given that a firm writes a significant percentage of its business in auto physical damage coverage, it is likely to manage its claims in this area more aggressively than would a firm writing only a small percentage of its business in that line. From a resource perspective, firms that are found to spend more per dollar of loss for loss expenses are expected to use a portion of this money in the pursuit of salvage and subrogation recoveries. As a result, these firms are likely to experience more significant salvage and subrogation recoveries.

An insurer's participation as a member of an insurance group also might affect its recovery efforts. There are reasons that insurers that are members of an insurer group might have significantly different claims recovery than firms with no such affiliations. First, in the event that a member of an insurer group is involved in a claim with another member of the same group, it is possible that the subrogation process would be circumvented. In addition, given that unaffiliated insurers do not have the benefits of access to capital on an intragroup basis, it may be that these insurers are more aggressive in their recovery efforts because of this increased difficulty in raising capital.

Finally, the average size of the claim itself would likely affect significantly the firm's decision to pursue recovery efforts. Given that the ratio of time, effort and expense to dollar of recovery is decreasing with an increase in claim size, firms with greater average claim size are more likely to pursue recovery efforts than those firms with lower average claim size. This is because the potential returns per case are greater for firms with greater average claim size.

The potential validity of these hypotheses was determined by analyzing the data from the 833 insurers, using an ordinary least-squares regression. The benefit of using this methodology is that it allows researchers to examine variables of interest while controlling for the effects of other factors.

Results of the analysis indicated that larger insurers are more likely to have higher recovery levels than smaller insurers. This suggests that economies of scale do exist in the salvage and subrogation area and are likely a contributing factor to an insurer's recovery efforts. Additionally, we found that the organizational form of the insurer is related to the firm's recovery levels and that stock insurers are more likely to experience higher recovery levels than are mutual insurers. As previously stated, this is presumably due to the increased monitoring of management by the owners of the stock firm.

As expected, unaffiliated companies were found to be more likely to experience higher recovery levels than were insurers that are members of insurance groups, presumably because of having more subrogation opportunities and less access to intragroup capital. In addition, the results indicate that insurers that write more of their total business in the auto physical damage area are more likely to achieve higher recovery levels. Likewise, we found a positive relationship between recovery and the amount of resources that the firm devotes to the processing and settlement of claims. Finally, the size of the insurer's average claim is positively related to its recovery levels. This result is not at all surprising, given that the potential "reward" to the insurer increases with an increase in the size of the claim.

More Than Good Management

Although it's likely that many in claims management should be pursuing salvage and subrogation recovery efforts more aggressively, this study suggests some reasons--other than mismanagement--why some companies are more aggressive in these areas than other companies. The results of this study are consistent with other articles that point to the differences that exist with regard to the salvage and subrogation recovery efforts among insurers. But this study attempts to explain why these differences might exist.

The results of the analysis suggest that there are several reasons--some of which are economically sound--why the management of one insurer might not pursue salvage and subrogation opportunities to the same extent as the management of another insurer. The study found that some of the reasons for the differences in salvage and subrogation activity found between insurers have more to do with the characteristics of the insurers and the environment in which they operate than they do with the abilities or efforts of the management.

L. Lee Colquitt is the associate professor of risk and insurance in the Finance Department at Auburn University. Randy E. Dumm is an assistant professor of insurance at Florida State University.

Average Recovery Levels of Auto Physical Damage

An analysis of financial statement data from 833 property/liability insurers showed a wide range of recovery levels through salvage and subrogation.

                  [less than] $134 $135-$268 $269-$402 $403-$536
Number of Firms                629       167        17        11
Percent of Sample           75.51%    20.05%     2.04%     1.32%
                  [greater than] $536
Number of Firms                     9
Percent of Sample               1.08%
Mean = $108.96
Standard Deviation = $90.08