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Managing your risk by Michael Kelly

NCACC Risk Management Director Michael Kelly writes a regular column on risk management for CountyLines. With more than 41 years of risk management/ insurance experience, he holds the CPCU - Chartered Property & Casualty Underwriter, ARM-P - Associate in Risk Management for Public Entities, CRM - Certified Risk Manager, ARe - Associate in Reinsurance and CIC - Certified Insurance Counselor Professional Designations. He can be reached at michael.kelly@ncacc.org or (919) 719-1124.  For archives of this column click here.

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Aug 02

Pooling - a form of self-insurance

Posted on August 2, 2012 at 10:33 AM by Chris Baucom

Last month’s Managing Your Risk column addressed the concept of knowing when self-insurance is a viable option and gave general guidelines as to needed size and account composition to be successful. This month we will address one of the most prevalent means of self-insurance utilized by local governments (called Intergovernmental Risk Pools or IRPs) and explain by way of example in simple terms how the concept of pooling works.

To illustrate, let us consider a neighborhood that is comprised of 100 homes, each of which is valued at $100,000. Each family purchases their own homeowners’ insurance policy through a myriad of standard insurance companies, with a per property loss occurrence deductible of $500. The average annual premium per policy through the years has risen to $1,000 because of named storms and a general decline in all carriers’ desire to write insurance in the neighborhood’s geographical coastal area.

With their premiums increasing each year, coupled with fewer insurance companies taking on new business, the member families appeal to their neighborhood homeowners association for help. The solution developed by their board is to collectively put money into a neighborhood “pot” (Pool) and agree to “self-insure” or pay for any loss by any homeowner above the standard $500 deductible, up to $10,000, out of this pot. For anyone with a loss greater than $10,000 up to their respective maximum per occurrence exposure of $100,000 the neighborhood association has negotiated and purchased group property insurance coverage through an excess insurance carrier at a greatly reduced price of $250 per household.

To financially initiate and fund this pool, each member of the neighborhood association individually puts in a one-time $1,000 startup capital fee and then an additional $500 to cover the annual needed fund for paying anyone’s first $10,000 loss. This establishes an annual expected future total cost of $750 per household ($500 to the “Pool” and $250 to the excess carrier) and in low loss years, allows for the accumulation of any unused funds to grow for future losses.

In our fictitious example, if a home burns to the ground, for a total loss of $100,000, even though a single claim check is cut, it is allocated so that the first $10,000 (less a $500 deductible) comes out of the neighborhood “pot” or (Pool) and the next $90,000 comes from the group excess property insurance coverage. This format is similar to a large deductible plan often seen in the insurance industry, with the main differences, being the Pool provides a means to fund or pay for the smaller losses under $10,000 at an annual cost lower than the purchase of individual, traditional insurance. Since the true insurance coverage actually begins at $10,001, the cost for the excess is much less than if it included covering all the way to $0 from $100,000. The ability to fund the much more frequent smaller losses (all those under $10,000) allows the savings and accumulation of funds for future losses and purchase of excess property coverage at a lower overall cost.

As the “Neighborhood Association Risk Pool” gains size in cash reserves, it becomes possible to increase the amount of individual loss to be paid out of the pot from $10,000 to $15,000 and finally $25,000. With every increase in the portion of each loss paid directly out of the Pool, the cost for the excess coverage will decrease.

Eventually a balance will be reached whereby the Pool is funding a high enough per loss deductible (self-funded retention) that there is parity in the financial advantage of risk assumption versus the potential for catastrophic loss, which is to be transferred to the excess property carrier.

As the insurance market conditions continue to turn “harder,” (meaning it favors the standard insurance carriers, also commonly known as a seller’s market) self-insured risk pools tend to grow in size and participation level. It is at this point everyone more readily understands that the “for profit” insurance carriers are in the business with that in mind … to make a profit. When they do not make a profit, the results are either an increase in their pricing, reduction in willingness to continue to write accounts that are not profitable, or both. This is in contrast to the fact that self-insured pools tend to focus on stability and longevity – both from the standpoint of price, as well as coverage availability. It is more important for a Pool to “always be there.” This mindset tends to level out the cost over time, with a Pool being much less expensive when you consider more than just a single year of coverage time. On any given year, the standard insurance carriers can decide to write business at a loss – but it is virtually impossible to sustain over time. Cutting price to gain market share tends to chip away at Members that may not understand that loyalty and the decision to remain true to their own self-insurance pool is the fundamental key to its long-term success.

In our simplistic example, those homeowners that stay in their home for a long period of time will likely remember the problems and reasons their homeowners association formed their pool in the first place - and as such are likely very loyal to their Pool, not wanting to consider going back to the whims of dealing with a standard insurance carrier. Those families that are new to the neighborhood and do not know the previous history are more likely to revert back and purchase a standard policy through a “for profit” carrier. As the new families that make up all the homeowners in our fictitious neighborhood replace the originals, the ability to articulate the Pool’s history becomes most important, as well as how the strength and financial leverage is derived from a strong level of participation of members. Once a new homeowner truly understands how and why their Pool was established, they tend to favor staying in the pool – as long as the coverage and pricing remains steady and reasonably competitive with the “for profit” players.

Such is the case for The NCACC Risk Management Pools. This next policy year 100 percent of the participating counties all opted to renew – either workers’ compensation and/or property and casualty coverage for another year. Several new counties re-joined, bringing the total to 65 counties participating as Members. We began our 32nd year on July 1, and the majority of our Members have been self-insured through the NCACC Pools since inception in 1981. Of these 65 counties, 50 are participating in both pools.

The more counties that participate, the greater the collective control and leverage we have when purchasing our excess coverage. These next few years are likely to be tougher on non-members, with fewer carriers offering to cover local governmental exposures, and those that do opting to charge increasingly higher premiums each year – especially if they experience some sizeable losses. Pooling allows even the smallest of county governments to be self-insured through the advantage of group purchasing for maximum cost savings.

Do not wait until the insurance market gets harder – consider talking with other county pool members for a reference and if your existing coverage is due to renew before July of next year, contact us. We will make the process of joining easy.

Why “rent” when you can “own”?