The RMC Advisors

The Cost of Premium Leakage

Quality Planning's (2010), Auto Insurance Industry Leaves Billions on the Table: Failure to Stem Premium Leakage Forces Good Drivers to Pay More reports on the cost of premium leakage and how it can be prevented.  The report includes some staggering facts, notably that auto insurers lost $15.9 billion in 2008 due to premium leakage.  The total loss is comprised of misrepresentations of vehicle, driver, and other rating factors.

Auto premium leakage remained fairly constant from 2007 to 2008. The study notes that the recession affected the rate of premium leakage.  Decreased driving due to high gas prices and job loss decreased the premium leakage caused by underreporting mileage.  However this was mostly offset by an increase in policyholders misreporting garaging addresses and youthful drivers in an attempt to decrease premium rates.

The report lists two main causes of the leakage:

1) Consumer Fraud - Some individuals intentionally misrepresent vehicle or driver rating factors to reduce their premium.  Many websites list ways to reduce a premium which makes it easier for dishonest customers to learn the types of information that will decrease premiums.

2) Change - Policyholders' conditions are constantly changing (i.e. moves, job changes) and many times, they do not notify insurers of changes in a timely manner. Policyholders are more than five times more likely to report mileage changes that will decrease premium rates than changes that would increase rates.

The report also notes negative impacts of rating error:

- Direct Premium Loss - on average every 1% reduction in rating error results in a 20% profit gain.

- Risk Management Costs - rating error leads to failures in risk management.

- Moral Hazard Costs - when controls are not in place, honest agents have a competitive disadvantage to agents willing to rate a policy inaccurately to obtain a cheaper quote and obtain/retain the policyholder.

- Business Management Costs - insurers rely on accurate rating and underwriting data for various functions of the business including marketing, sales, and financial planning.

The report noted a first-year, three-step approach to reducing premium leakage:

1) Step 1 - Get it Right at the Point of Sale - Insurers should have or develop new-business audit checks and data analysis to various rating variables including: commute distance, annual mileage, vehicle garaging territory, unlisted drivers, accidents and violations.

2) Step 2 - Get it Right at Renewal - insurers can achieve customer direct contact rates of 80% - 90% by using a combination of letter, website, and telephone contract to perform renewal reviews.

3) Step 3 - Develop a Long-Term Approach - After completing the one-year clean-up and establishing a baseline of accurate information in steps 1 and 2, insurers should focus on avoiding any lapses that allow rating errors to resume.  Subsequent year reviews can generally be implemented at a lower cost than the first-year review.

If insurers do not perform steps to mitigate the risk, it is likely that auto premium leakage will increase in future years leading to a decrease in profits and higher than necessary premiums for honest policyholders.   

Please respond to the blog or direct questions and comments to Elaine Nissley, MBA, CISA, PMP, CCSA, Principal, McKonly & Asbury, ENissley@macpas.com.

 

Internal Audit – The New Normal: Rewire Your Thinking

During this slow economic recovery, organizations are developing a new normal. The dilemma: the requirement to do more with less, keep up on the trends, and plan to adjust to this new normal. The Internal Audit profession is not exempt from this impact. How are executives and staff dealing with this new normal? Many studies are addressing this issue.

 

To assist you, we developed this series of blog articles to summarize and highlight the key points from the studies conducted by the experts in Internal Audit. The first article is from the Institute of Internal Auditors (IIA) (2010), A Glimpse Ahead: CAEs Look Beyond the Recession.

The report summarizes the discussion at the IIA’s General Audit Management Conference (GAM) attended by 25 CAEs from fortune 250 organizations. The following highlights the forward thinking outcomes of the conference and key items for consideration as Chief Audit Executives (CAE) rewire their thinking to the new normal.

The report provides ten items for forward thinking executives to consider:

1. Recognize that the job market will get better. Stay in tune with your best people and take steps to keep them.
2. Asses the skill needs in your department. Does your team have the skills necessary to provide services in the emerging areas of data mining and enterprise risk management? What other areas are emerging within your organization?
3. Look for affordable ways to meet your team’s training needs. Examples of cost effective training are free or low cost webinars, staff-led training, and business unit mentoring.
4. Obtain the skills you need in various ways such as using guest auditors or staff rotation programs with the business units. Another excellent way to accomplish the audit plan and to train your staff is to co-source with a third party vendor who will do on-the-job training for your staff.
5. Perform dynamic audit planning. Business is changing at a rapid pace and an annual audit plan may go stale quickly. Collaborate with management to develop an agile audit planning process that will respond to the changing business needs.
6. Leverage technology. Look for ways to automate your audits. This is the way of the future; train your staff to recognize automated auditing opportunities. Co-source or train your staff on automated auditing implementation techniques.
7. Add value to your organization by making sure you are proactively involved in strategic initiatives. Correcting control issues is always less expensive during design instead of after implementation.
8. Stay informed.  Are you keeping abreast of legal, public affairs, and regulatory issues? Have you leveraged social media to obtain early alerts versus depending upon others in your organization?
9. Monitor Disclosures. Are you monitoring your organization’s public disclosures? Do you know what is out there in the booming world of social media? Do you or someone in your organization proactively monitor all forms of social media?
10. Maintain open communications with your stakeholders as the economy emerges from this recession. Make sure they understand how Internal Audit is evolving and adapting to the new normal emerging from the economic crisis.

Two of the main items noted at the GAM conference were (1) the social media risks and (2) the opportunities for automation of your audit processes. Making sure you are proactively pursuing these trends will increase the value of the Internal Audit department to your organization.

Please respond to the blog or direct questions and comments to Elaine Nissley, MBA, CISA, PMP, CCSA, Principal, McKonly & Asbury, ENissley@macpas.com.

 

Internal Auditing - An Introduction

Why Internal Audit?

If you could have 5% of your annual revenue rain from the sky would this excite you? Have you ever caught one of your children with their hand in the cookie jar? Or, you know the cookies are disappearing but not why or by whom? Did you ever wonder what Internal Audit (IA) does or why your company needs an IA function?

The 2010 Global Fraud Study by the Association of Fraud Examiners retrieved from http://www.acfe.com/rttn/rttn-2010.pdf. states the typical fraud loss is 5% of annual revenue. When applied to the 2009 Gross World Product, this is a potential fraud loss of $2.9 trillion. (CFE, pg. 4) The report indicates that in 60% of the cases examined, the IA function contributed to detecting or limiting the fraud. (CFE, pg. 44)

Surprise audits conducted by IA can work for you in catching or limiting the impact of the "hand in your cookie jar" effect. The IA function does not even need to be full-time internal staff. Outsourcing the IA function may entail only several hundred hours of work each year. But before we elaborate on how internal audit can help, let's discuss what internal audit is.

What is Internal Audit?

The Institute of Internal Auditors (IIA) is the professional association that provides technical guidance, certification, education, and research in the area of Internal Auditing. The IIA's definition of Internal Auditing retrieved from http://www.theiia.org/theiia/ is as follows:

Internal Auditing is an independent, objective assurance and consulting activity designed to add value and improve an organization's operations. It helps an organization accomplish its objectives by bringing a systematic, disciplined approach to evaluate and improve the effectiveness of risk management, control, and governance processes.

Who doesn't want a specialized group working to improve the organization?

What Does Internal Audit Do?

The two main activities are assurance services and consulting services. Assurance services are:

1. To perform an objective assessment, and
2. To render an independent opinion on systems or operations.

IA does this work on prioritized areas of review based upon the annual risk assessments and areas of greatest concern to management.

IA provides consulting services at the request of management. Consulting services are:

1. Advisory and objective in nature, and
2. Scoped based upon management's objectives.

Management uses these services to support such activities as fraud investigation, due diligence reviews, and preparation for regulatory and compliance reviews.

The optimum use of internal audit structures the audit work to reduce the costs and operational staff time related to external requirements, such as financial audits, Sarbanes-Oxley, Model Audit Rule, Market Conduct, and other external and regulatory reviews.

Conclusion

Having your own objective consultants inside your company working for you to make your operations better will help you close the gap on the 5% you are missing. These objective employees will help you better prevent the "hand in the cookie jar" effect, because after all, if your children know you are checking on them, they are less likely to take cookies from the jar without asking, right?

Internal auditor's must maintain independence and provide assurance or advisory services that include unbiased and impartial opinions. In addition, they must maintain objectivity by avoiding conflict of interest situations and not engaging in activities, such as assuming operational responsibility, which may influence their attitude.

Next Up

In the next article, we will discuss the Institute of Internal Auditor's Code of Ethics and introduce the International Professional Practices Framework (IPPF). The standards that, when followed, provide assurance to management that the IA function is following the highest standards of the profession. The last of the series will cover the External Quality Review process that is necessary for an IA function to state, "Audits are performed in accordance with the professional standards of the Institute of Internal Auditors".

Please respond to the blog or direct questions and comments to Elaine Nissley, MBA, CISA, PMP, CCSA, Principal, McKonly & Asbury at ENissley@macpas.com.