Insurance Game Theory
Insurance Company Concerns
Insurance companies face unique challenges in the optimum financial management of claim portfolios. In addition to the usual questions involved in the management of legal disputes, insurance firms also face very similar economic issues in regard to disputed insurance claims.
More than any other type of company or financial institution, insurance companies are exposed to claim settlement issues on a truly enormous scale, raising unique challenges and opportunities in the areas of risk and portfolio management.
Insurance Game Theory
Our approach provides a unique economic perspective of litigation and disputed claims, which can facilitate valuable insights for insurance companies. These methods establish a new analytical discipline, which can be incorporated into claim management operations as an additional quantitative step. Drawing upon ideas from game theory, information economics, financial economic analysis and Monte Carlo simulation, SettlementAnalytics has developed a suite of game theoretic models of dispute, which can now be applied using our game theory analytics software platform to individual claims or entire claim portfolios.
Game Theory Analytics
Game theory models, methods and software developed by SettlementAnalytics enable insurance companies — for the first time — to examine claims in a settlement bargaining framework — factoring both the expectations of the parties and their strategic interaction. This analysis goes beyond the traditional, unilateral, financial evaluation of possible trial outcomes to make an explicit consideration of claim settlement, its theoretical probability and its impact on the value of dispute as a whole. In essence, our approach enables insurance companies to better analyze their claim portfolios from a liability management perspective.
Central to this perspective is the examination of litigation and disputed insurance claims across the dyad of both trial and settlement — understanding the important contribution of settlement and its likelihood.
This view of dispute, as a liability driven by value contributions from trial and settlement, characterises our approach. The chart above (just one of the 32 charts in our game theory analytics platform) illustrates how our models examine the value of a claim as the probabilistic combination of ‘wealth components’ — having regard to the different modes of claim resolution.
The real economics of dispute are quite mathematically complex. However, conventional approaches to the analysis of litigation and disputed insurance claims can fail to capture this complexity. By focusing on economics of trail outcomes, much of this complexity and its economic influence is lost or assumed away using conventional methods of the analysis. For example, traditional litigation analysis generally fails to accurately factor the following key economic considerations:
- the influence of strategic interaction between the parties
- the contingent nature of claim liabilities
- the rational discounting effect of uncertainty on claim settlement bargaining
- the opportunity for quantitative optimisation
Using a game theoretic framework, SettlementAnalytics is able to address these limitations, allowing insurance companies to explore the whole value of the claim liabilities more accurately. Using a proprietary economic model of dispute which combines game theory, information economics and Monte Carlo simulation, our analytics platform enables insurance companies to capture and reflect the real economic complexity of claims.
Controlling for Risk
Yet, as important as it is for insurance companies to examine potential liability in terms of both trial and settlement, it is also vital to assess the impact of risk attached to projected cash flows. Using conventional methods, this has been a difficult task for two reasons: a) because trial risk is not the same as claim risk, and b) because the financial dispersion associated trial is a much more complex animal than it at first appears. In addition to the direct contribution to risk of the uncertainty of trial outcomes, our research shows that trial risk has a complex secondary effect on settlement optimization, the value of claims as a whole and the settlement bargaining process as a result.
Legal Dynamics Chart
Pricing Trial Risk - Award (Df)
Award Uncertainty ±: 100 $M
Insurance companies recognise this complex contribution of trial risk intuitively, but historically, it has been difficult to measure, and therefore difficult to know how it will affect claim portfolio risk. A significant advantage of our game theoretic approach is its ability to quantify and visualise the complete impact of trial uncertainty on the entire claim.
Using the game theoretic framework pioneered by SettlementAnalytics, we are able to derive and demonstrate the tangible cost impact caused by trial risk. Our interactive Legal Dynamics™ app [right] illustrates this relationship, and shows how settlement decision-making is also affected.
Using the blue control button at the bottom of the chart, the reader can adjust the input level of trial uncertainty about the damages award and examine its impact on the litigant’s wealth outcomes across a range of different settlement offers. Our game theory litigation analytics platform (OptiSettle™) also provides graphic illustration of this economic relationship between risk and the measure of liability.
Benefits of Our Approach
The benefits of our approach are significant and numerous. Using claim analysis techniques developed by SettlementAnalytics, insurance companies can:
- Quantitatively optimise claim settlement decision-making
- Avoid expensive settlement decision errors
- Achieve greater realism in claim portfolio valuation
- Use quantitative methods to better control litigation spend
- Minimise the cost of claims management in general
Insurance Company Services
In addition to consultation on individual high value insurance and legal claim management issues, SettlementAnalytics can work collaboratively with large insurance companies to:
- Introduce our more quantitative claim settlement analytic framework to the organisation (see QSBA)
- Provide in-house training in the use of our OptiSettle™ litigation analytics software platform (see OptiSettle)
- Develop an alternative claim portfolio valuation and risk management system based on game theoretic principles
At SettlementAnalytics our models and software provide a more complete and rigorous approach to the economic analysis of claims than the traditional approach to litigation analysis. But more importantly, our process results in an evaluation of claims and claim risk that is quantitative, documented, auditable, defensible, highly visual and open to scrutiny.
To learn more about our software applications, click here.
To learn more about our models and methods, please click here.
To see our range of consulting services, please click here.
 This sample Litigation Dynamics analysis is just one of a whole library of analyses we have developed to illustrate the real economic sensitivity of disputes when examined in a more realistic, bilateral, game theoretic framework. To examine other game theory demonstrations, visit our Legal Dynamics Library.
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