What Is a Long-Tail Liability?
Let me explain what a long-tail liability is—it's a type of liability with a prolonged settlement period. You should know that these liabilities often lead to high incurred but not reported (IBNR) claims because it takes so much time for the claims to be resolved.
Understanding a Long-Tail Liability
Whether you consider a settlement period for an insurance claim as long-tail or short-term depends on the type of risk covered. Property insurance claims usually settle quickly, but liability insurance claims are typically long-tail. As a liability insurance provider, I see new claims filed long after the event occurred. This long settlement period happens for several reasons: these claims often involve large sums of money compared to other insurance types, they can lead to settlements plus lengthy court cases, and the insurance company needs to investigate thoroughly to confirm the claim is legitimate and not fraudulent.
Financial Impact of Long-Tail Liabilities
If you're an insurance company offering coverage for long-tail risks, you might have higher investment income ratios— that's net investment income divided by earned premiums—compared to those covering short-term liabilities. This ratio measures profitability, and insurers invest the premiums they collect. With long-tail policies, there's a bigger gap between collecting premiums and paying claims, giving you more time to invest and earn higher returns. However, these policies often come with higher loss ratios (losses incurred divided by earned premiums) and higher combined ratios (losses and loss adjustment expenses divided by earned premiums). The combined ratio shows profitability: below 100% means you're profiting, above 100% means you're paying out more than you're collecting.
Special Considerations
Since claims can take years or even decades to emerge and go through the courts, you must prioritize proper record-keeping. If your company faces potential long-tail liability claims, be careful with old records and keep them until you've checked for insurance policies or evidence of them. If you can't find an old liability policy, you'll have to use secondary evidence to prove it existed and was lost or destroyed without fraudulent intent. This could include corporate minutes, accounting ledgers, annual reports, internal memoranda, transactional records, or even personal appointment calendars—but locating the policy number itself is the most critical step.
Examples of Long-Tail Liability Claims
- Occupational disease claims, such as asbestos and environmental claims involving air pollution exposure over many years.
- Medical malpractice, such as when a patient sues a doctor months after a surgery or procedure.
- Cyber liabilities covered under cyber insurance policies, which help recover monetary damages after a cyber breach.
- Employment discrimination.
- Child abuse.
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