Managing Your Risk
Pooling vs. private insurance

By Michael Kelly
Property and Casualty Program Specialist

As a risk manager, one of your typical responsibilities is marketing and securing the insurance program for your county or entity. Ultimately the chosen path and solution is one or a combination of three possibilities. These three primary choices for coverage are pure self-insurance, private "for-profit" insurance and self-funded pooling.

Since even the largest North Carolina counties likely purchase some level of excess coverage above a self-insured retention (similar in this instance to a very large deductible), your insurance program boils down to being comprised of private primary/excess insurance, self-insurance through pooling, or a combination of the two.

Private "for-profit" insurance carriers are normally much larger in size and territorial presence than what is found in a pool. Their primary focus is to provide insurance products at a pricing level that produces a profit for their stockholders by collecting more in premiums than they sustain in losses. Because most are generalists in their insurance products, providing coverage for a wide array of business types, they can change the desired class of customers and/or shift to emphasize those less likely to have losses depending upon the client's profitability, legal environment and geographical location (for example, refraining from insuring coastal properties due to the exposure from hurricanes). Over a timeline longer than one or two years, for-profit carriers tend to be less consistent in their sustained appetite for local governmental clients, as it varies with their bottom line underwriting results.

On the plus side, private carriers often are international in scope, and as such, have financial assets much larger than normally found in a pool. Occasionally, depending on their marketing strategy, they may intentionally write coverage at rates statistically below what is needed to secure a profit in hopes of broadening market share. This can be leveraged through having the ability to "make it up" in other types of client businesses where there is less competition. Unfortunately, this can result in a significant increase in renewal costs, and sometimes they may even decline to offer a renewal at all. The ability to operate on a "take it or leave it" basis is often the stimulus necessary for organizations to form their own self-funded risk pools when conditions for buying insurance coverage are difficult.

Such is the case for the NCACC Risk Management Pools, which were created in 1981 – a time that many counties learned they could not purchase workers' compensation coverage at any cost. It just was not available in the "for-profit" insurance market in North Carolina. County officials asked the Association for help in forming their own risk management pool.

Pooling, in simple terms, occurs when a group of organizations band together to collectively share in each other's loss exposures in an effort to secure better insurance rates and coverage design by virtue of their increased buying power as a large, similarly comprised group (Foundation of Risk Management Insurance – AICPCU Second Edition).

A pool operates akin to a "for-profit" insurance carrier by collecting premiums, paying losses and purchasing reinsurance. The pool normally provides other important services such as loss/risk consulting. A pool will typically achieve savings through an economy of scale in its administration, claims handling and purchase of excess reinsurance.

Normally, a pool's marketing is on a direct basis to their members, eliminating the cost of commissions paid to agents and or brokers. A pool's coverage and service focus tends to be more specific and likely more responsive to its members since the "customers" are in fact themselves. As pools do not have the luxury to flip-flop in and out of a given insurance market, they tend to take a longer viewing perspective and strive to provide rate and coverage stability – with consistency being one of the primary goals.

It is easy to understand how and why a pool's coverage design and general product delivery is likely to be more commensurate with the needs of its members. A pool's entire existence is by and for its members. When you have a single class/type of "customer" it becomes more possible to tailor coverage designed to fit squarely with the exposures facing those members. Pool insurance policies contain far less exclusions that eliminate or restrict coverage because they exist to spread the cost of risk among all pool members – not make a profit for stockholders. After reserving for losses based on actuarial projections, any excess premiums are typically plowed back into the member base through lower or less fluctuating rates, coupled with broader coverage when possible.

At year-end, normally a pool's legal department will revisit losses that were not covered and – if deemed to be a real exposure for its members – attempt to amend policy language to provide coverage if actuarially possible for the future. Again, the main focus is spreading this cost of risk among all members. Obviously the more members a pool has, the wider the arena the risk can be shared. The results should be a lower cost per exposure unit with less premium fluctuation.

Similar to "for-profit" insurance companies, a potential downside to risk management pools is the possibility for financial hardship through negative claim case loss development, unfavorable asset investment results or even radical unfavorable changes in the reinsurance market. For this reason it is important for a pool's management board to be comprised of a wide range of representatives from its membership and be supported by a skilled professional staff. Board members should fully understand and exhibit the same "ownership" characteristics as the membership, and function with a conservative posture in its management style with long-term stability being a primary focus.

Although standard insurance carriers can spend much more money advertising, marketing or promoting their products in an effort to generate new clients, a pool normally has a finite number of potential members and as such, often has a loyal following by its membership due to those members' ownership of their "insurance company."

Both "for-profit" insurance carriers and risk pools have their position and needed functions in the insurance marketplace. Generally one contractually transfers the responsibility of risk while the other spreads it among its members and then transfers it above a specific loss limit. Each has its plusses and minuses – but given an insurance market absent the existence of pools, there is often little to temper the whim of an insurance carrier's pricing, or even impact a carrier's willingness to offer coverage at all. Insurance pools typically set the coverage standards and establish reasonable premium thresholds in the market. Simply stated, similar organizations (counties and entities) that for whatever reasons are not members of their industry's pools will still realize substantial cost benefits from their industry pool's existence.

Suffice to say with the fundamental goals being radically different – one being profit, the other being stability – it is important to consider carefully the overall characteristics of each in order to choose the option that best suits your county's game-plan for handling risk. Collectively, the existence of both standard and pooling insurance mechanisms provides a needed parity in the marketplace, resulting in a wider array of risk handling options.

NCACC Property and Casualty Program Specialist Michael Kelly writes a regular column on risk management for CountyLines. With more than 32 years of risk management/insurance experience, he holds the Associate in Risk Management for Public Entities, Certified Risk Managers and Certified Insurance Counselors professional designations. He can be reached at michael.kelly@ncacc.org or (919) 719-1124. Archived versions of the column can be found online at www.ncacc.org/managingyourrisk.html.