The Who, the What, and the Why of Allocation

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.
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The Who

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:

• Crafting responses to settlement demands.
• Evaluating the exhaustion of underlying policies.
• Facilitating the preparation of settlement or coverage-in-place agreement payments across numerous policies and claims.
• Forecasting future exposure to claims stemming from one or multiple policyholders.

2. Outside Counsel

Legal representatives may utilize allocations to:

• Offer recommendations for settlements to their clients.
• Evaluate demands presented by opposing counsel.
• Strategically test their approaches and theories.

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.

The What

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.
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The Why

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:

• A policyholder’s basis for their demand.
• The past and future projected liabilities.
• The appropriate allocation methodology in a given jurisdiction.

Even if the allocation methodology is well-established, the exposure to each policy can vary greatly depending on other uncertainties, such as:

• Facts related to the claim.
• Jurisdiction-specific characteristics.
• Policy language nuances— whether common to certain policy years, or otherwise.

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!