TO:
Honorable Mayor and Members of the City Council
THROUGH:
Mark Danaj, City Manager
FROM:
Teresia Zadroga-Haase, Human Resources Director
Gregory Borboa, Risk Manager
SUBJECT:Title
Risk Pooling Analysis and Options (Human Resources Director Zadroga-Haase).
RECEIVE REPORT AND PROVIDE DIRECTION
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Recommended Action
RECOMMENDATION:
Staff recommends that the City Council receive this report on the status of the City’s current risk pooling membership and provide direction to seek membership in the California State Association of Counties-Excess Insurance Authority (the EIA).
Body
EXECUTIVE SUMMARY:
The City of Manhattan Beach has operated self-insured general liability and workers’ compensation programs since the early 1970’s. The City has accessed pooled excess coverage for these programs through membership in the Independent Cities Risk Management Authority (ICRMA). Other fully insured programs have also been added through this membership over time.
Within the last two years the financial reserves for the excess general liability program with ICRMA have become stressed and assessments have been levied against members for prior claims years. Further funding concerns developed in the excess workers’ compensation program and recapitalization plans have been put in place for both the excess workers’ compensation and the excess general liability programs which are set to begin in fiscal year 2017-18. Negative claims experience and the assessment amount for the current fiscal year resulted in a 50% increase in contributions in the general liability program over the 2015-16 fiscal year contributions. Workers’ compensation experience was also negative and this caused a premium increase of 33% over the 2015-16 premium contribution requirements. The dollar increase for contributions to these two programs was $517,882. An improvement in claims development in the near term is not expected. Due to this erosion in the financial position of ICRMA, Staff evaluated the efficacy of remaining with ICRMA versus seeking an alternate risk pool or traditional insurance option. This evaluation consisted of comparison of four risk pools including the City’s current risk pool. Areas of comparison included: program offerings, coverage limit amounts and types, governance structures, retention of claims administration control, ancillary services, pool fiscal stability, pool diversity and cost.
Pools evaluated included the ICRMA, the EIA, the California Joint Powers Risk Management Authority (CJPRMA), and the California Joint Powers Insurance Authority (CJPIA). Detailed information regarding each of the pool’s programs and structures can be found in Attachments 2 through 4 for reference.
The recommendation is for Council to authorize staff to begin the process to exit ICRMA and to seek membership with the EIA in order to take advantage of a diverse JPA membership and superior marketplace leverage to drive down costs and improve overall risk program stability. The EIA is the recommended choice of alternative risk pools for the following reasons: 1) program offerings cover all City needs; 2) coverage limits and types are more than adequate; 3) the EIA is a sufficiently large and diverse pool (both geographically and in terms of member type) to maximize risk smoothing and reduce volatility in rates; and 4) size and market presence provide significant leverage in the market to ensure competitive rates and fiscal stability.
Traditional fully insured private market options are not recommended nor considered viable for program stability as discussed below.
FISCAL IMPLICATIONS:
The funding needs of the internal service fund for risk management programs will be impacted by the direction given to staff. Based on the indications provided by the alternative JPA options it is anticipated moving to an alternative risk pool will result in net savings (see the Cost Comparison in Attachment 1). The recommended option of the EIA is estimated to save approximately $1.2 Million in the excess workers’ compensation and general liability programs when compared to our budgeted costs for current risk pool coverage.
BACKGROUND:
The City is a founding member of the ICRMA and has maintained membership since 1980. The City maintains a self-insured retention (SIR) of $750,000 per claim for the workers’ compensation program and an SIR of $500,000 per claim for the general liability program. The Human Resources Risk Management staff provides oversight and coordination of the claims administration process and services provided by our third party administrator (TPA) for these programs. The City also accesses fully insured programs through ICRMA for property, cyber liability, and crime bond programs.
Risk pooling became the primary means available to public entities in the late 1970’s and early 1980’s for covering their exposures, particularly in the general liability and workers’ compensation areas at a time when insurers either raised pricing so that it was cost prohibitive or stopped writing public entity business altogether. Risk pooling was a way to structure self-insured programs in an affordable manner while retaining the risk, and associated dollars, that were traditionally transferred to insurance companies.
The term pooling refers to the pooling of risks among a group of entities, generally in a JPA. JPA members typically have an SIR that is the responsibility of an individual entity to pay in the case of a claim or loss. The JPA retains a level of risk for claims in what is referred to as a pooled layer. This means that a portion of the contributions for each member are set aside to pay member losses. If claims experience is positive, the money is retained by the pool as a reserve and helps keep costs down for all members. If losses are negative, claims are paid out of the reserve and the reserve must be replenished by increased member contributions. Member contributions (or premiums) are determined based on a member’s loss experience relative to the other members in the pool. There are layers of excess and reinsurance coverage above the pooled layer for larger, catastrophic losses.
Pools offer excess and first dollar programs. Excess programs are layered. They are structured with a member SIR being the first point of claims liability. Further coverage is provided in a pooled layer retained by the JPA. At a level chosen by the membership, excess coverage is purchased to provide payment of claims above the pooled layer. Members retain claims administration control in excess programs.
First dollar programs require member contributions for a pooled layer and excess coverage above the pooled layer as in the excess program structure discussed above. The key difference is that there is no member SIR level and claims administration control is allocated to the JPA. The key decision point in considering a first dollar pooled program is whether it is more desirable to maintain claims administration and funding control versus the budgetary certainty of set annual premiums.
Benefits of pooling include:
• Member directed organization
• Exposure smoothed across entities
• Greater funding flexibility at the pool and member levels
• Claims savings are retained by the pool and members, not profits for an insurance provider
• Control over claims administration (in excess programs)
• Vested interest in creating programs to prevent losses and create retained savings
None of these advantages are provided under a private insurance model where insurance company profit drives claims decisions and any program savings are retained by the provider.
There are several concerns about exiting a pooled arrangement and entering the private insurance market. When market conditions change and pricing becomes cost prohibitive there is no quick option to resolve budget impacts. Entities can be held hostage or find themselves without coverage at all during the lengthy period of time it takes to find an alternative when the private market becomes cost prohibitive. In considering alternatives below, private insurance is not a recommended option for these reasons.
DISCUSSION:
The City is experiencing significantly increasing costs in the various risk programs primarily for two reasons: 1) increasing claims activity and costs; and 2) the fiscal distress of our current risk pool resulting in higher required contributions; assessments and possible recapitalization charges. The small size and homogeneity of our current risk pool exposes the City to the risk of volatility in rates as any significant single loss has a greater impact on the pool’s financial reserves.
In 2014 unanticipated claims experience began to erode the financial position of ICRMA’s pooled reserves. An extensive evaluation was made by consultants and an ad hoc committee to develop recommendations to the governing board designed to alleviate the negative financial position. At the January 21, 2016 Board of Directors meeting several actions were taken to improve the financial status of the pool in the long term which have a significant impact upon the membership in the form of member assessments for prior year’s liability losses (specific to a member’s claims history) and capitalization charges for both the general liability and workers’ compensation programs.
In evaluating options, ICRMA and three other pools considered to be viable alternatives were assessed. This exercise was initiated with an understanding that it is necessary for the City to consider which pools would be good alternatives and that targeted pools need to consider the City a good potential member. The alternative pools considered expressed interest in pursuing the City as a member. The alternative pools were also considered viable alternatives as they are well capitalized, stable pools with affordable coverage programs. A detailed description of ICRMA and the pools considered can be found in Attachment 3. Once alternative pools were identified and had indicated interest in the City for membership, program alternatives and cost indications were obtained and evaluated. The result of this analysis is summarized in the matrix provided in Attachment 2 and the narrative summary of each pool’s programs in Attachment 4.
The recommendation to leave ICRMA and seek membership in CSAC-EIA is based on member diversity, marketplace leverage, program offerings, the ability to impact program and organizational management through committee participation, and pricing.
PROS:
• Reduced program costs
• Fiscally stable pool
• Large Southern California presence
• Overall improved coverage
• Pool size provides increased market leverage and access to resources
• Significant member type and geographic diversity
• Extensive committee structure for input into programs
CONS:
• Some safety services are a la carte and must be procured separately
• Member board presence is limited
Other Considerations
Homogeneity of the Risk Pool
The issue of homogeneity is a key concept of effective risk allocation. Two key elements of homogeneity, similarity of entities and geographic proximity of entities, are discussed below.
Similarity of Entities
When it comes to risk sharing, the more similar the activities and structure of member entities, the more similar the risks, and the more difficult it is to mitigate similar loss patterns. While each entity may have their own level of loss control and mitigation programs, full service cities, for example, will have a majority of losses related to safety staff. A mix of full service cities, contract cities, and special districts and schools, would create a greater variation in the types of exposures, thus working to smooth the costs of liabilities among the diverse exposures. Varied membership also benefits pools in marketing programs for excess insurance and reinsurance coverage to supplement a pool’s retained risk.
Geographic Proximity of Entities
Many of the pools located in the Southern California area have membership concentrated in the geographic region. If there was a significant seismic event the property and workers’ compensation programs of these pools could be greatly stressed, with increased likelihood that pool members end up in litigation.
Proximity creates exposures to a pool that would not have otherwise occurred had there been less geographic proximity of members. When a pool has members in and out of earthquake areas, in and out of flood areas, or in and out of high wildfire areas, it is more likely that one catastrophic loss will be offset by no catastrophic losses in other areas. In some years there will be members in certain geographic locations that subsidize the losses of members in other locations. That is the nature of pooling, but the focus is that the pool stays financially viable and affordable.
Pool Size
The law of large numbers is of benefit in spreading, thus smoothing, risk. While a larger group brings more losses, it still dilutes the impacts of outliers that inevitably occur. More members also generally leads to a dilution of the negative effects of homogeneity.
Governance Structure
ICRMA is a small, local JPA with 18 members where each member has an equal voting position on the governing board. There are a couple of committees that perform specified functions, but governance is primarily carried out by the full sitting board.
The EIA is a large, diverse JPA with every manner of public entity participating as members. Each member county has one voting board member and public entities are represented by seven elected board members. However, non-county entities can impact the governance of the JPA by serving on the multitude of committees that guide and inform the Board of Directors.
CJPRMA is a medium sized JPA that is made up of 17 cities and 4 small JPA’s. It is the volume of membership in the smaller member JPA’s that differentiates the size in comparison with ICRMA. The member JPA’s are considered one member as if they were an individual city. Each member has one vote on the Board of Directors. There is an executive committee that performs specified functions, but governance is primarily carried out by the full sitting board.
CJPIA is a large JPA made up of cities, most of which are in the Southern California area. CJPIA has a one member, one vote governance structure and the full board only meets once a year. Primary governance is carried out by the Executive Committee with input from the Finance and Managers Committees.
It is important that membership in a JPA offer opportunity to impact decisions and the direction that a JPA takes in terms of financing, program structure, services offerings, and risk management strategies. All of the JPA’s discussed in this report provide those opportunities, just in differing forms.
Cost Summary
The cost comparisons among the four risk pools is summarized in Attachment 1, but based on the information received from the three alternative risk pools, all three would result in a net savings for the City’s risk programs.
POLICY ALTERNATIVES:
This report has provided extensive background on our current JPA membership with ICRMA, concerns and how those concerns are being addressed, and a description of other options for JPA membership to support our self-insurance and fully insured risk management needs. If staff is directed to pursue an option to leave ICRMA, there are requirements to provide notice to ICRMA of intent to withdraw by December 1, 2016 in order to move effective July 1, 2017. A membership application process and new agreement would be required with the selected JPA alternative. These items would be presented at later Council meetings for your approval. If it is directed that the City remain an ICRMA member then no further action will be necessary. Alternatives are set forth below.
ALTERNATIVE #1: Remain as a member of ICRMA, thus maintaining the status quo.
PROS:
• Familiarity of process and programs
• Established long-term relationships with member entities
• One-member, one-vote governance structure
• Proactive new pool management firm
• Safety training services included as part of administrative fees
CONS:
• Financial instability
• Volatility in funding requirements with high and increasing costs
• Recent loss of members with positive claims experience
• Geographic homogeneity
• Relatively small pool size reduces market leverage and risk smoothing
ALTERNATIVE #2: Leave ICRMA and seek membership in one of the other two JPA’s discussed. These are not recommended based on the issues cited below.
PROS:
Both offer cost reductions, financial stability, and a one member/one vote governance structure, but there are shortcomings that make them less attractive than the EIA option.
CONS:
• First dollar coverage only for workers’ compensation program (CJPIA)
• City would be required to pay a TPA to administer legacy claims and would continue to have to fund legacy claims separately (CJPIA)
• There is a lack of geographical diversity in membership (CJPIA)
• No workers’ compensation program requiring a second program participation and results in significantly diluted pool presence (CJPRMA)
• No Southern California presence (CJPRMA)
ALTERNATIVE #3: Leave ICRMA and seek coverage through the private insurance market.
PROS:
There are no positive effects to the City associated with this approach.
CONS:
• Loss of funding flexibility
• Loss of claims administration control
• Loss of claims settlement control
• Vulnerability to market volatility
PUBLIC OUTREACH/INTEREST:
After analysis, staff determined that public outreach was not required for this issue.
LEGAL REVIEW
The City Attorney has reviewed this report and determined that no additional legal analysis is necessary.
Attachments:
1. Program Coverage Cost Summary
2. Program Coverage Matrix
3. Alternative Pool Description Summary
4. Alternative JPA Program Evaluation Summary
5. 9-20-16 Risk Pooling Analysis and Options Presentation