Class Action

Study guides: Exam 6C, Exam 6U

A Class Action is a proceeding in which one representative plaintiff sues on behalf of a class of people with common claims, binding every class member who does not opt out. It converts many individually uneconomic claims into a single action large enough to litigate, and it is the mechanism through which insurers face aggregate exposure to a practice rather than to an event.

• Certification is the gate: a court must find an identifiable class, common issues, a suitable representative, and that a class proceeding is the preferable procedure. Most of the litigation risk is decided here — certification usually forces settlement, and refusal usually ends the matter.
• Insurance-specific subject matter: improper claims-handling practices, systematic underpayment (such as depreciation deducted from replacement cost), premium or fee overcharges, denial of a coverage across a book, and privacy breaches. The common thread is a practice applied uniformly, which is exactly what creates commonality.
• Insurers appear on both sides. As defendants, for their own practices; as liability insurers, defending policyholders facing class actions in product liability, environmental, securities and mass-tort claims.
• Actuarial characteristics that make class actions hard to reserve: aggregate exposure that does not develop like ordinary claims; a binary outcome around certification; a long delay before the size of the class is known; and correlation across the book, since every affected policy is exposed to the same decision at the same time — the antithesis of the independence that ordinary reserving assumes.
• Canadian class actions are governed provincially, with Ontario, Quebec and British Columbia the principal venues, and Quebec's regime historically the most permissive on certification.
• Contingency fees and cost rules make Canada's class-action environment materially less expansive than the American one, but the trend has been toward more filings, not fewer — one of the Tort Litigation trends the syllabus asks candidates to discuss.

Reserving a Certified Class Action An insurer is a defendant in a certified class action alleging it improperly deducted depreciation on 60{,}000 replacement-cost claims over six years. Average alleged underpayment is \$1{,}400. Counsel assesses a 35\% probability of liability being established, and estimates that if liability is found, 70\% of class members would ultimately be paid.

How should this be reserved, and what makes it different from an ordinary reserve?

Answer Expected value:

\begin{align*}
\text{Maximum exposure} &= 60{,}000 \times \$1{,}400 = \$84{,}000{,}000 \\[4pt]
\text{If liable} &= 0.70 \times \$84{,}000{,}000 = \$58{,}800{,}000 \\[4pt]
\text{Expected} &= 0.35 \times \$58{,}800{,}000 \\
&= \$20{,}580{,}000
\end{align*}

Add defence costs, which are payable regardless of outcome and in a class action of this size are themselves material.

What makes it different from a normal reserve:

• The distribution is binary, not smooth. The outcome is approximately \$0 with probability 0.65 and \$59 million with probability 0.35. The expected value of \$20.6 million is a number that will never actually be paid — a fact worth stating explicitly in the actuarial report, because the reader will otherwise treat it as a central estimate in the usual sense.
• No development pattern applies. There is no triangle for this; the estimate is legal judgement quantified, and it should be labelled as such.
• The risk adjustment should be large. A binary \$59 million exposure against the insurer's surplus is exactly the uncertainty a risk adjustment is meant to price, and a confidence-level disclosure derived from a smooth distribution would understate it badly.
• It belongs in FCT as an adverse scenario, not only in the reserve. If \$59 million would threaten the MCT ratio, that is a financial-condition matter for the board.
• It is a conduct problem before it is a reserve problem. If the practice continues, the class keeps growing.