December 20, 2023
If you have ever found yourself looking at an insurance claim that potentially spans multiple years, you may have heard the term “allocation.” Admittedly, oftentimes this word will be met with puzzled expressions or even the occasional eye roll. Don’t worry, we don’t take it personally! Instead, we at Alan Gray, view this as a perfect opportunity to educate the uninformed and convert the skeptics on the value of an allocation analysis.
In this blog post, we aim to lay the foundation on the basics of allocation, focusing on the Who, the What, and the Why of Allocation.
Allocations find utility among various stakeholders within the insurance claims arena.
1. Insurance Claims Organizations
These entities can employ an allocation analysis for a multitude of purposes, such as:
2. Outside Counsel
Legal representatives may utilize allocations to:
3. Mediators
In the right situation, mediators can also utilize an allocation analysis as a tool to understand the dollar impacts to policies of the arguments presented by both sides.
Allocation analysis does not eliminate uncertainties, but it provides decision-makers with a means to assess their implications from a financial standpoint.
What exactly constitutes an allocation? An allocation in the context of complex insurance claims is at its core a giant calculation. It aims to determine each insurance policy’s share of a policyholder’s liabilities based on a set of assumptions related to methodology, claim-specific factors, and policy or coverage details.
There are three main allocation methodologies:
1. Pro Rata Allocation
In general, a pro rata allocation is meant to "spread the loss" proportionally amongst all applicable policies using either time, limits, or some other measure as the basis for the assignment of liabilities.
2. All Sums Allocation
In this approach, the entire loss is assigned to one specific policy, policy year, or insurance carrier. This assignment of the loss can also be referred to as a “spike”. That’s the easy part. The more complicated questions are a) whether that policy can receive contributions from other applicable policies; and b) if so, what is the underlying methodology for determining each policy’s contributing share, if any.
3. Carter-Wallace Allocation
This method allocates liabilities based on a combination of time and policy limits across the various insurance policies within a designated coverage block.
Dealing with uncertainty inherent in complex claims spanning multiple policy years is the main reason to perform an allocation analysis.
Uncertainty can surround numerous aspects of a “claim”, including:
Even if the allocation methodology is well-established, the exposure to each policy can vary greatly depending on other uncertainties, such as:
To be clear, an allocation analysis does not eliminate these uncertainties, but it does provide decision-makers with a means to comprehensively understand the implications of these uncertainties from a financial perspective. Essentially, it empowers decision-makers to make informed decisions through a purposeful, numbers-driven process.
While the intricacies of allocations may not ignite enthusiasm in everyone, we hope this blog has shed light on their significance. Stay tuned for our forthcoming blogs, where we will explore “The Where,” “The When,” and “The How” of allocation analysis. We assure you, it’s not as complicated as it may sound!