The Pooling Effect

MUNICIPAL INSURANCE ASSOCIATIONof British Columbia

Tom Barnes

Chief Executive Officer & General Counsel

tbarnes@miabc.org

Risk Pools Well established risk financing mechanism

- Mutuals

- Association programs

Not common in the public sector

- Low perceived risk

- Insurance readily available at a reasonable price

Evolution of Public Entity Liability Risk

1960 1965 1970 1975 1980 1985

Public Entities --------Private Entities _____

The Liability Insurance Crisis Insurance industry abandons public entities

○ Dramatic premium increases

○ High deductibles

○ Restricted coverage

○ Constrained availability

Risk pooling was one of the few options available

FOLI Theorem – Market Cycle

Public entities: First Out Last In

The Result

100,000 public entities in North America

○ 85% get some form of coverage from a pool

$13-17 billion in premium

In North America 500 Pools

Liability

Property

Auto

Worker’s Compensation

Specialty Lines

“The greatest success in intergovernmental relations.”

Almost before most pools could begin operation, the market cycle saw:

Crisis end

Prolonged soft market established

The Pooling EffectYet pools have thrived, because of

The Science of the Pooling Effect

-$1,000

-$500

$0

$500

$1,000

$1,500

Coin Toss Bet : 1 Person

Heads: Win $1,150

Tails: Lose $1,000

The Science of the Pooling Effect

• In this simulation by a random number generator, the result is a collective net gain of $7,500 ($75 per person).

• Individual stakes are lower, despite total stakes increasing 100 fold.

54 participants have to get tails to create a loss ($11 per person).

The Science of the Pooling Effect

The tipping point is now when 540,000 people get tails, which is almost impossible with a 50/50 chance on each flip. There is a certain net gain.

Risk Pools apply the science of the Pooling Effect if its risks are:

Analogous

Diversified

Uncorrelated

The Pooling Effect is amplified in practice

Finances

Collegiality

Risk management services

Customized coverage

The Pooling Effect in PracticeFinances

Public Entities value long term cost:

Stability

Predictability

more than the market cycle that can occasionally deliver lower costs.

The Pooling Effect in Practice

FinancesPools inherently moderate the volatility of insurance costs over time

Member commitment

Capital adequacy

Cost allocation

The Pooling Effect in PracticeFinances

The combining of uncorrelated risks always produces the pooling effect

Prudent funding results in surplus funds

Surplus funds result in Financial return to members

Capital accrual

The Pooling Effect in Practice

Finances

Pools cost of capital is relatively low○ No capacity/ROE conflict.

○ Tax exempt investment accelerates accrual.

The Pooling Effect in Practice

Finances

Capital fosters stability.

Financial returns reinforce long-term commitment.

The Pooling Effect in Practice

Collegiality Information and knowledge sharing

Joint initiatives

Pool resources

Not viewed as giving a competitive advantage to an adversary.

The Pooling Effect in Practice

Risk Management Services

Sector-specific knowledge and experience applied for

benefit of all members

Higher risk members can’t be underwritten out of the pool

Risks themselves must be:○ Identified

○ Monitored

○ Mitigated

The Pooling Effect in Practice

Customized Coverage

Goal is to provide members the coverage they need.

○ Risks emerge and evolve, so must coverage

○ Even where there is no market to provide it

The Pooling Effect in Practice

The smallest member has access to the

resources usually available only to the

largest members.

The Pooling Effect in Practice Reinsurance

Pool working layers

Reinsure catastrophe exposure

THANK YOU