ALC-Executive Subcommittee

This so 3A and 3B are similar presentations for the um public public school insurance trust and again this did show that um public public school insurance trust and again this did show that this program is also taking minimal risk in that in a bad year, the losses don't go up by very much more than um that we would expect them to be in an average year, so we can go to for. To the next page, please. And then the next page is for the school boards association. This one is a little bit different because the structures a bit more complex um in that the program takes the 1st $500,000 of each claim with no aggregate retention and then the next $750,000 they take that too, but each $750,000 claim erodes a $3 million retention. But it turns out that the 1st $500,000 of loss accounts for a lot of the loss in the program, so, um. The um the, their, uh, If you look at the difference between what's retained on an expected value basis and a 85% confidence level, um, the difference isn't it's, it's going up, um, it's the difference is bigger than in the other two programs, but not appreciably bigger to the next page, so really this part of the report is to um uh prove. The case that very little risk is being transferred, and here's another example. This is a graphical depiction of what we just talked about, so you've got expected losses at the top. The blue ones are the losses retained by the um the public the multi-agency insurance trust, Orange is what goes to the insurer and the gray is the total in an. here you'll see that the retained losses don't change very much. The orange losses shoot up quite a bit, as do the total losses and then the difference between those two, that's really what we're looking at here to measure um risk transfer and here you can see in a in a bad year, nearly all the risk is transferred to the insurance companies and only a small sliver of additional risk is retained by the program. Under its current structure. And um go to the next page, please. So these are graphical depictions of really the same concept that you can see down at the Arkansas School Board Association that the difference at the bottom, the blue bar is bigger than it is for both the um insurance trusts, so that's what I was getting to a minute ago where there is some risk transfer in ASBA, um, but it's not, um, a very significant. amount of risk transfer, um, we can go to the next page. If that's OK, great. And the top bar chart is all three programs combined. And then the table under that is the data underlying all these bar charts and so the point that I was making that very little risk is being taken in the insurance trusts. If you look at those two diagonals, um, the one on um section 1 and the 1 and Section 2, those are the retained loss amounts under the current programs on an expected value basis and A 85% confidence level and you could see the increase which has shown down at the 2nd row from the bottom, you've got $558,000 of an increase for um the multi-agency insurance trust and almost no risk transfer for the um uh public school insurance trust and Reasonably large one for the uh school boards association, but in total you could see in that adverse year you've got $14 million 14.7 million dollars of additional loss overall to the programs. 2 million is being retained and 12.7 is being picked up by the insurance companies and it is because the program has um losses have increased during a time when the retentions have remained fixed. This mismatch has grown, and that's the reason for the big premium increases. The insurance companies are taking the lion's share of the additional risk due to the higher level of losses and they've increased their premiums in response to that. Any questions so far? All right, if we go to the next page, so this gets us to the first recommendation, and that is that we think it would be wise for the programs to take more risk, and there are a lot of different ways that that can look, but I think just the general idea of taking more risk will pay off for the programs and um the next section of the report talks about Um, some of the pluses and minuses of doing exactly that of taking more risk in by whatever means, um, the subcommittee ultimately decides it wants to. So the first advantage is. A reduction in risk transfer inefficiencies and Really this is talking about the your insurance companies's expenses. The insurance companies, a large insurance companies tend to have high expenses and your premium. Um, that you pay includes a large portion of those expenses and to the extent that you take risk away from them and keep it yourself, you are taking premium away from them and some of those expenses, um, are, are saved because for instance, um, commission and premium tax are charged on the basis of the premium charged if the premium. down the expenses go down and you don't have to pay those, so there are significant um expense gains that can be made by taking more risk, um, and you know, we, we haven't quantified those specifically but can can do that if, if asked to, um. The next two items are really the crux of the whole argument of why it's a good idea to take more risk, um, so item number 2 is reduced risk premium. So, um, the If you and we saw this when we were looking at table one and if you look at the losses year to year, you'll see some low years and then they'll just be a really high year that's much higher than the adjacent years and then a couple lower years we have had a few bad years in a row, which is not typical, but that's typical of a property in all risk property insurance program and what insurance companies do is they base their premium on long-term expected losses, so they'll take an average over a 10 or a 20-year period, however they look at it, um, adjusted to, you know, current inflation levels and exposure levels and that will be the basis of their premium and to that they'll add all of their expenses and then they'll also add um what they call a profit and contingency load and that is a um A provision that ensures that they're covering their risk and that gives them a reasonable chance of earning a profit over the term of the policy to which the premium applies and um if the Arkansas programs took a significant share of the risk back and depending on the mechanism they choose for self-insurance, they could keep that Um, profit profit and contingency load and not only can they keep it and this gets me to item 3 here, um, money in the bank until you need to pay claims, so the the risk charge is a long-term risk charge. It's generally an amount that you charge every year and it's meant to accrue over time to provide sufficient funds to pay for that bad year when it happens and so um property insurers tend to accrue significant amounts of capital over time and they have Asset management teams that invest those assets and make sure that they have sufficient liquidity to pay the claims when the claims need to be paid, um, they're all as soon as you pay your insurance premium to an insurance company, they set up a portion of that premium in loss reserve for what they expect to pay out during that year in losses and they're earning investment income on those reserve funds as well, so The idea, take more risk and particularly if you do it in a captive insurance company where um um you would keep any underwriting profits that you earn year would be the ones investing those funds. You would keep the profit in contingency load for one thing, rather than paying it, and then you would keep the investment earnings on those funds, and those, if you, if you look at the balance sheet of of the large insurers that are insurers on Arkansas's program and look at the assets they've got in the asset side of their balance sheet. These are big numbers we're talking about, and Arkansas's program is big and it could have a big asset um balance on its balance sheet as well, and I would just argue better for Arkansas to have it than for an insurance company to have it, um. Which isn't to say that you don't need the insurance companies, you need the insurance companies. They have capital that is going to be greater than than what the program's ever going to have, and they'll be taking the the really big risks, you know, the the major flood risks and the major windstorm risks. I don't not suggesting you take a significant share of that, but you still can take a large part of the risk of claims that are more likely to happen. Um, and then before we move on from these two topics of keeping risk premium, um, accruing capital and, and earning investment income on those capital uh on those capital funds, um. If if you have a stable program over time and you've a cumulative amount of um of capital in the program, you may have more capital than you need for the program. You could have excess capital, and that's a very, you know, good position to be in, and it gives you um lots of freedom as what you as to what you can do with it and I'll just mention a couple of um excess capital will be put to in property insurance. Programs of um other clients that I've worked with, um, excess rate increase fund and what that, how that functions is um a certain amount of money of excess capital would go into this fund and it would be available for those times in the insurance market when the market turns hard and say you've had 35% increases. In a row, each of the last 3 years and then all of a sudden your insurance company wants a 40% increase this year if you've set up a um uh rate increase fund, you could reduce that 40% by using some of your capital to buy that down and make the increase more palatable to the end buyers of the insurance, the school districts and the and the public agencies. Um, I've also seen excess capital or deferred maintenance programs where um a program is funded and um funds are available to any insured in the program through an application process and you could design the program any way you want. It could be based on need. It could be based on some measure of performance of a particular school, any any way you want to do it, um, And the advantage there is, you know, one of the criteria for qualifying would of course be that there is maintenance that needs to be done that hasn't been done, but it would award funds for getting maintenance done, and that can be a really, a really, um. Good morale booster, um, is, as much as anything else. Now there are some disadvantages to going this route. One is if you were to set up a captive insurance company, for example, um, you would have, um, your the financial statements would be subject to audit, so you'd have to have, you know, an audit firm, be part of the captive, um, a attorney to be part of the captive, um, to, um, sign off on policy documents. And so on. Um, you would need an actual opine on the balance sheet loss reserves at fiscal year end, um, you would need a claims administration outfit, and that claims administration outfit, it doesn't need, you don't need to go to a third party with that you could do it in house as long as you got approval from the captive regulator. Um, and there's some general bookkeeping expenses, but um the expenses for captives are generally thought of, oh I left one out. You need a captive manager, and that's generally somebody, a CPA with experience, um, running captives that, you know, keep the whole thing together. They're, they kind of run the captive show. Um, and that's also you could. Do that from within as well if you have the skill. Um, but the, the expenses tend to be low. There's there's a captive premium tax, but generally less than 1% whereas the taxes you're paying on the premium that you pay in the commercial insurance market are going to be in the 3 to 4% range, um, and commissions would be minimal if any if you were going direct to reinsurance markets, you'd have to pay some commissions, but if you kept your current Broker structure then that that would, that would be a separate negotiation. Um, but presumably that would be a net gain because you would be placing less insurance than you um uh would under a fully insured program and then. I'm sorry, this is on the next page. If you don't, so what I was talking about was administrative cost number 4 under disadvantages. Um, and number 5, and this is really the, the big risk is that you you're putting your own capital at risk, so you're doing what the insurance company does and um risk is the greatest in the earlier days of the captive because generally, um, when you form a captive, each captives. I will have a minimum captive requirement, but for um risks of this size that the um the captive requirement would be a negotiation. The representatives of the captive and the captive regulators that they would get to by looking at pro forma financial statements and stress testing those and seeing what happens under an adverse scenario. That's the usual method that they would go about um coming to A reasonable starting capital, but at the beginning, capital is low, you, you, uh, tend to accrue it over time and if you get unlucky and get hit with a large loss in the first year, it could, you know, it could wipe out all your capital. So that's the risk, but there are ways of dealing with that by taking lesser risk in year one and ramping the risk up over time as capital accrues and so. There are other ways of mitigating risk, um, that can be put to put to use in the early life of a captive. So, um. The the last part of my presentation has to do with program retentions. And um and deductibles, so. This table 6 shows what the agency and school district retentions and deductibles are. That's the first row. So if there's a loss, these are paid directly by the public agency or the school district before a um any lost dollars go into the insurance program and then the program retention retentions are below that, so for the multi-agency insurance trust, um, There is no per occurrence self-insured retention. There is only a $8.5 million aggregate retention unless that went up to 10,000 at the 7124 renewal. I didn't hear that it did, but I know that was an option considered. Um, then for the public school insurance trusts, um, they have a $2 million per occurrence retention and losses within their retention erode a $6 million aggregate and once that aggregate is exhausted all of the losses go to the insurance companies. And then for ASBA there are district deductibles that range in size from 5000 to 250,000 and then there is a program deductible of 500,000 that is not subject to an aggregate and then on top of that, there's a $750,000 per occurrence retention. Any losses above $500,000 in that $750,000 layer erode a $30 million. This is a little bit more complicated of a program, um, you really have on a given claim $1.250,000 of retention but only $750,000 of it erodes the aggregate and any number of $500,000 claims would be insured by the program, which means that there's quite a high frequency risk that is retained by the program, but the severity risk is well managed and nothing wrong with this program. It it at all, it's a different program and I like it because it retains more risk than the other two. Um. That's just a little bit of history before we go and talk about um where the losses have been historically, um, in the what layers they've been in and what we recommend as possible retention changes and if you can go to the next page, the first two tables, and I apologize for the size of the print here. This did get a little small. Um, Thank you. So on the top table again we're going in the order um multi-agency insurance trust, public school insurance trust and then school board, uh, association. So if you look at the top table, you can see that. Um, that row 1000 to $2 million if you go all the way over to the right, you could see that accounts for 47 losses, $2 million and below accounts for losses 47% of all the losses in the program and if we were to have adjusted those lost dollars for inflation, it'd be higher than that. It'd be in the 50s, um. So, you know, we recommend that the program increases it actually increases it too is, you know, I don't, we can't say this retention is better than that retention because we're not privy to all the considerations that go into determining what the retentions are, um, there could be considerations that that we just don't know anything about it and I wouldn't want to. You know, pretend I've got better institutional knowledge of these programs, then the risk managers that work with them on a day to day basis, but, um, the upshot of this is that I would suggest. Um, A probably taking a per occurrence retention with or without an aggregate and um perhaps starting at 1,000,000 with a $100 million dollars aggregate, um, next year and seeing how that works and um maybe adjusting it upwards and Before I continue on with um additional comments on this. I did want to say and I, I, I sort of alluded to this earlier that uh Part of the programs aren't taking much risk is that the program designs did not evolve as the property claim environment evolved and what I mean by that is right now we expect property claims in a given year to be double what they were 5 years ago and um in order to retain the same percentage of losses as you did 5 years ago, you would have needed to increase your Tensions by double in those five years and that did not happen and it's not, you know, it's was a decision made based on, you know, what the quotes were, what the best deals were to be gotten what was available in the in the marketplace and again, I'm not privy to that, but um I think just given the inflation of claim values and the generally higher frequency of severe events that we've seen over the past 6 or 7 years that um higher retentions are a very good idea and it might even be a good idea to index retentions to inflation in some way so that they go up on a regular basis without having to make a decision about it. You could, you, you could index it to the CPI for the for the state, for instance, or you could index it to the construction cost index that um the Bureau of Labor Statistics publishes for the state of Arkansas. There are a lot of of options indexing options, but I would recommend some sort of indexing while we're in an inflationary environment. So, um, getting down to table 8, which is the um public school insurance trust, um, similar situation. I will note that there are 3 claims that were over $111 million that are all in that bottom row. Number of claims too is incorrect. That should read 3. I don't know what happened there. Uh, bear that in mind and looking at these numbers you've got a lot of dollars at the very top that, you know, it's going to be outside of what would be retained. Those are, those are the kinds of losses the $16 million fire loss in the 2 $11 million wind hail losses that happened in 1920. Those are the kind of losses that you don't want to retain that you that you have insurance for. And um so when we're suggesting a retention program, um, for the, excuse me, public schools insurance trusts, we wouldn't suggest a retention that high something right now they're at 2 million current, 6 million aggregate maybe. Doing away with the aggregate maybe increasing the aggregate maybe um increasing the per occurrence retention and the aggregate. Um, there are a lot of possibilities and Again, items that are listed as suggested in the structure boxes to the right. These are just thoughts on what might be good choices. Um, I'm not recommending one over the other, I think that that sort of recommendation can't happen in a value um needs to take into consideration, um, uh, risk management objectives and also um you know, the. Market circumstances what the carriers are willing to write and um and where their pricing may be more favorable and I'll Just stop here and um with with an aside, one of the directions that we're going in with this and one of the reasons why we are suggesting multiple options to um. Put a bug in the ear of the people that go to the brokers at and I'm talking about next year's renewal to ask for quotes because it would be wise to ask for a variety of quotes at 3 or 4 different structures. They won't like it. They won't want to have to do the extra work to provide it, but the advantage that it gives you can overlay. The results of the actuarial analysis on that and actually do a total cost of risk analysis and find out what in what layers their premium is expensive in what layers it looks like a bargain and actually choose the right structure that has the lowest cost to the, um, Arkansas programs, so that that's something I'd like to just get out there in people's ears now because it would be, I would Love to be able to to model a half a dozen scenarios for each of the programs next year, next year and see if there's a clear winner among those because sometimes there is, um, other times they're modeling and our modeling are so much in sync that a lot of the scenarios will come up looking the same in terms of total cost or the differences just won't be material, but sometimes they're really far off, and that can have to do. With, you know, what's the appetite that the particular insurer in this particular layer has in this part of the United States right now. It could be in this renewal process they've written as much Arkansas as they can already write and for additional capacity they're going to charge way too much for it. So that's those are the sort of things you don't know until you're in the negotiating process, but if you have alternate, if you've got um. Various quotes, it puts you in a much more powerful position to negotiate favorable terms for yourself. So if we can go to the next page, please, and this is the final table this one for the school boards association, and again, the structure on the right looks a little more um a little messier because it is, um, but that's not a bad thing. It's it's a good structure. Um, and we suggested a few alternatives that would increase the retentions there as well, and as I was getting at earlier that I, I think the amount of adjustment in this program is that's warranted is less than the other programs because they're already taking a decent amount of risk with that $500,000 retention not being subject to an aggregate, but I think some movement up words to reflect the higher levels of expected losses makes sense. Um, so I have one more item I want to talk about, but before I move on to that, does anybody have any questions? No OK. Um, so the next and final subject is the actual deductible, so remember when I talked about the structures of these programs there are deductibles and deductible and retention are often used interchangeably. Um, but there is the deductible that is paid by the school district or the public agency and then there is the retention that is paid by the program and so if you've got $1000 of loss in the um uh public schools insurance trust and a 500, say $250,000 school, um, district retention. than the school district itself will pay the $250,000 and then the next $750,000 will flow into the um the um public school insurance trust program and would be subject to their retentions. Well, um, This came up in a discussion that we had when we visited on June 20th, there was a concern specifically over roof damage claims and we were asked to take a look at them. And what we um. It's the first thing to say is the claims data that we have, it's good claims data, it's comprehensive, but it did not have the detail necessary to tell us if the claim involved roof damage, but we've worked long enough in property insurance to know that water damage claims and roof damage claims are closely tied together and so we use water damage claims as a proxy. For roof claims here and what we wanted to do is look at the current deductible structure and look at the actual water damage claims that have been filed in each of the programs and see how much of um those claims are actually getting picked up by the deductible and how much is not and going into the insurance program. And the way to um OK yep to do just uh I Share the results, uh, so in uh in combination with the actuarial analysis we also did a. Uh, it's essentially kind of a research project I'll I'll I'll call it that ultimately it's gonna, it's gonna be a restructure type project where in essence, we did some research to see what other neighboring states have done so, um. I just kind of skip to this pretty quickly here and get to this table. In essence, we look at 6 states all the neighboring states of Arkansas, and kind of two main pieces that we saw one of them is their agencies like they they split their insurance kind of into, you know, very similar to Arkansas they have schools are looked at different than public buildings, uh, K through 12 is different than higher education and that and so again that's very similar to what they've done in Arkansas. Um, so what we've done with these different states is kind of look to see how they structured their models and essentially what they're retaining in that and you'll see here on this, on this table one, which is really kind of just a summary of all the research and stuff like that that we've done. It's, you know, you know, it's fairly similar on an overall basis it's just probably maybe an aggregate retaining a little bit more and um you know the touch on may be a couple of things that Charlie had mentioned before, the work that we've done up until this point is a draft. We are next month going to put together a, you know, some suggestions and recommendations in terms of what we think, you know, potentially the best course of action is going to be to Charlie's point from earlier, we probably will need to look at this. In conjunction with some of the reinsurance quotes that we're getting, but at least at a minimum we could go through and make some suggestions on some uh folks in that that would, uh, you know, that the reinsurers would uh you know that we would like to see from the reinsurers in order to kind of fill the missing pieces uh there and then one other final piece that will research and again we'll have this complete next month is. We're gonna look into the size of some of these programs in the other states. So again, we know what the retaining in that and that's that's on this table here, but what we don't know is how many assets do they have? What is their balance sheet look like? What is your income statement look like on year over year basis and so we'll put that in for comparison purposes, and again that will be another data point that we go through and kind of make some suggestions in terms of the best course of action. So with that I'll pause. I don't know if anyone has any questions for either Charlie or myself. Representative Brooks, you're recognized for a question. Thank you, Mr. Chairman. Charlie and, and, uh, Kyle I appreciate you guys. I've done a tremendous amount of work, just a couple of questions, uh, Kyle went back and watched the initial presentation back in April kind of looking at what the scope was going to be and one thing that you mentioned was that you're gonna look at uh the policies prior to the huge increase and after the huge increase to kind of see if there's anything to change, is that something that's being done or not a part of the scope of it, and then One more follow up. Um, so in terms of like did the prices go up because of the retentions were higher, is that I don't know, you just the, the, and I just wrote this down because I went back to look at it yesterday. It just you'd said, you know, we look, we're going to look at what did the policy look like before the price increase and what did it look like after, so I'm not sure. I don't know exactly what that meant. I don't know if I was looking at like policy forms and specific coverages if things have changed, uh, or, and that may not be. You know, prevalent to what we're doing anyways, but I just wanted to clarify that. Yeah, I, and again, Charlie, you might have a better answer here, but to my knowledge, the rate didn't go up or the total premium didn't go up because the the insurance companies are so that wasn't the reason it went up because the assumption of market for Charlie, I don't know if you. Yeah, I, I, I agree with what you said, but I still think there may be an outstanding question, and that is whether when the carriers increased their premiums, they have also decreased their coverage. And that would, you know, coverage comparison I think might get us there, um, just to know if, if, if, if terms changed a lot that's kind of that's, that was my impression of what, what you're saying you're going to be doing, so I wanted to clarify if maybe that could be coming. So, and then one follow up, Mr. Chair, um, this on the last page of, uh, Charlie of your presentation the discussion of page 22, um, and I wanted to see if maybe you just comment on it real quick. Last line. gives me a little bit of pause, so it says, given the factors discussed above, it's more than likely that actual results will vary from projected estimates perhaps substantially. So what do, what do we, as we're looking at, you know, what we're obviously thinking about building something out of all this, right? And as we look at that, we say, OK, we're going to take the recommendations and what these numbers are, but oh by the way, one quick little caveat we may be way off so help me understand a little bit better what I'll say about That is that is That that is sort of standard qualifications, language in reports where you're making estimates and the estimates are um the, the actual outcomes are subject to events like where you know you could have, you know, a year that has uh a $70 million or you can have a year that has no win losses, and it's just the nature of the of the. closure we have to say I mean you for the, the 24, 25 year, I think we're estimating $48 million of loss that could ultimately end up being one of the years that that looks like and this is on page 6 of the report. It could be one of the years that looks like, say, 1213, which had $3.6 million of loss and if you were to adjust that today's dollars would be maybe $8 million. That's possible. Not likely, but it's possible, and that's the reason why that caveat is there. Thank you, Mr. Chair. Representative Timel, do you recognize? Thank you, Mr. Chair. Um, when y'all are going to be doing the research on these, uh, other states that have the same programs obviously Tennessee is a captive agency. I would like to see a focus on that captive agency because if, uh, their risk retention is going to be close to what we have, you know, I'd really appreciate a deeper dive into that and probably a little more resources spent on, on, on trying to mirror something there. You know, just have a quick call with them and. All right, excellent. Thank you. Any other questions from the members? I remind the committee of the same things I reminded reminded the members in here the same things I reminded the committee of earlier today, uh, as we move forward, we're going to have to determine a, um, Point in which we want to see the insurance to be headed, whether that's a captive, whether that's the same position we're in today with a higher retention rate, whatever that looks like, we're going to need to have that decided in the next 30 to 45 days for the consultants to be able to run the actuaries, run the feasibility studies, do the performance, all the things it's going to take to set this up for the January session. So just be mindful as you leave here today, that it's very important to come back with good ideas. In August because we're going to be headed forward in a certain direction by the end of the September council meeting. So any questions? See you no other business on our agenda. We stand adjourned. Thanks everyone.