In an ever-evolving world, risk exists across all departments and levels of an organization. Managing these risks is paramount to the long-term health and well-being of both public and private entities. For many organizations, procuring insurance is a big, if not the biggest, component of risk management. This article will explore several considerations for entities when procuring insurance.
Consideration #1: The Insurance Market is Cyclical
The global insurance market is typically defined as a soft market or a hard market. During a soft market, there is greater capacity, and insurers are willing to take on more risk. This results in greater competition for risk which typically leads to lower premiums and deductible offerings, greater coverage and fewer exclusions to the policy. During a hard market, there is less capacity, and insurers are looking for the best risks. This typically results in higher premiums and deductible offerings, contracted coverage and more exclusions.
Many public sector entities generally procure insurance every three to five years but the insurance policies procured must be renewed annually. This means that there is the potential for changes in rates or coverage. The cyclical nature of insurance can impact annual renewals and make it critical that an entity understands the state of the market before going out to RFP. Where possible, flexibility should be built into the procurement cycle to account for market changes. Let’s explore this further in consideration #2.
Consideration #2: Insurance Policies Renew Annually
While RFPs for insurance services are generally issued every few years, insurance providers are not offering multi-year renewals in current market conditions. That means entities must manage annual premium increases by budgeting for risk. Gathering a full analysis and understanding of your risk profile is the best way to build resilience into the budgeting process.
First, entities need to know that changes to annual premiums depend on two factors:
– Growth – For example, how many vehicles were added to the fleet, the value of new buildings or pieces of equipment added to the asset list.
– Rates – Insurers determine how much they will charge per vehicle, per $100 of insured property value and what the liability rate will be based on their rating standards. Most will consider previous claim experience, full-time employee count and operations in this rate. To gather this information, insurers are requiring significantly more information, with more applications that contain more questions.
Traditionally, entities have used a projection (also referred to as an indication) provided by their insurance provider and apply it to the previous years premium. The challenge with indications is that they are only a best estimate, and the timing is off for most budget cycles. Insurers typically won’t provide a projection more than 60 or 90 days out from renewal. For entities looking to budget in June with a January 1 renewal, the timelines simply don’t line up. As well, these indications don’t address unknowns, such as growth or inflation.
Consideration #3: Claims have a Long Tail
The cost of risk is largely influenced by claims. Claims can take up to two years to be reported and can take up to 15 years to settle. Claims vary widely and don’t incur expenses at the same rate or even at a predictable rate. This makes them a large unknown when attempting to budget for future years.
Consideration #4: Historical vs. Future Perspective
In addition to claims and premiums, there are additional budget pressures related to risk, such as expenses that fall below the deductible or uninsured losses.
If an entity is increasing deductibles or reducing coverage, the budget needs to recognize that those costs may deliver short-term relief on premiums but will begin to build year over year on all other below-deductible budget line items. Looking historically at below deductible expenses will not provide the full picture and will leave the affected line items short. Reserve funds should be considered for future costs of increased deductible expenses.
What can help? Entities can engage an actuarial firm to prepare for both annual renewals and budgeting. It can be helpful for the firm to conduct a review of the expected and ultimate claim amounts attributable to the entity based on current coverage and deductibles. There are several reports you can request – Deductible Study, Reserve Study and Technical Premium Study. These reports are especially helpful in a hard market. This work gives entities access to data that insurers also use in their calculations.
A New Approach?
Entities may want to reconsider how they procure insurance coverage. One approach is to review the current procurement policy. Can you remove insurance procurement from your main procurement by law? By categorizing insurance as an excluded financial professional service, entities can pull insurance services out from a typical RFP process. While this does not reduce staff work in terms of due diligence, a more flexible approach to procurement can be more suited to the tight insurance market. It can allow an entity to do the research and analysis needed to make sure it is getting the insurance that best fit its needs.
For example, the Canadian Free Trade Agreement defines insurance as a financial service, making it exempt. If you had a corresponding by-law, you could build in some room for your insurance procurement staff to seek quotes from insurers that your current broker might not have access to.
This approach also addresses the reality of a significant increase in premium, policy changes or coverage cancellation close to renewal. Staff would have flexibility to seek a quote from other providers.
In lieu of issuing an RFP, staff would be able to approach targeted providers to request a competitive quote for the missing coverage or the entire program. This helps staff find solutions that meet their unique needs more efficiently. It removes the need for an emergency procurement or a move to a self-insurance model before the municipality is ready. This is especially critical when the next years budget has already been set and the funds required for self insurance or significant increases are not available.
If insurance remains within the procurement program, entities will need to find alternative ways to finance sudden premium increases and/or loss of coverage.
Conclusion:
Public sector risk management and risk financing requires specific considerations to ensure that the risks your entities face are well managed. It is critical to consider how insurance designed for the public sector works and how to best operate within that eco system.
The Canadian Free Trade Agreement (CFTA) definition of Financial Services
financial service means any service or product of a financial nature, and a service incidental or auxiliary to a service of a financial nature, and includes:
(a) deposit-taking;
(b) loan and investment services;
(c) insurance;
(d) estate, trust, and agency services;
(e) securities; and
(f) all forms of financial or market intermediation including the distribution of financial products;
Section 11 Non- Application notes that:
Non-Application
11. This Chapter does not apply to:
(h) procurement of:
(i) financial services respecting the management of government financial assets and liabilities (i.e., treasury operations), including ancillary advisory and information services, whether or not delivered by a financial institution;