Judge before jumping in
It is well known that one way companies can achieve cost savings with their employee benefits coverage is to implement a multinational pooling arrangement. Economies of scale could lead to improved underwriting term and conditions as well as direct cost savings. But a recent study by Mercer Human Resource Consulting has confirmed that these arrangements need to be actively managed in order to achieve the best results.
As the report forthrightly states: “Our research studies suggest that many of the pools … are not managed as cost-effectively as they could be. Multinational pooling does not automatically eliminate unnecessary insurance costs. In fact, it is highly probable that the majority of pools in existence are not appropriately constructed to achieve optimal economic efficiency in terms of a multinational company’s benefits risk financing requirements.”
The annual reporting provided by a multinational pooling arrangement can – and should – be used as a management tool and subject to regular and thorough review. Data provided by the Mercer study can make comparative analysis possible.
Mercer began its annual surveys of multinational pooling in 2000. For the third year running, it has compiled an extensive database on multinational pooling on a global basis. It obtained 925 multinational pooling reports from a total of 158 companies worldwide, representing 91 countries. In this study, 316 pools are represented, an average of two pools for each participating company, and representing total premium volume in excess of $2bn (E2bn). Because the study has been going on for long enough, it is now possible to draw some historical comparisons and identify key trends in multinational pooling.
On an individual basis, the average pool size is reasonably small, coming in at $2.25m. Further consolidation would lead to greater cost savings because retentions will reduce as premium volume increases.
One important result of the Mercer study is that the savings to be achieved from multinational pooling arrangements are often over-estimated. “Dividends of the order of 10-15% of pooled premiums are often given as a reasonable estimate of the savings that can be expected from multinational pooling. Our research indicates that this is an over-estimation when looking at a large, average sample,” maintains the report. However, Mercer also points out that this kind of savings can be achieved if the pool is proactively managed.
To reach this conclusion, Mercer aggregated the data for all pools and all years and built a single cash flow statement, treating the data as though it was for a single pool for one year.
The average pooling surplus across all countries and contracts as a percentage of premium was: 3.6% for loss carry forward pools; and 0.2% for stop loss pools.
The differential between loss carry forward pools and stop loss pools suggests that it is prudent to review the risk management technique utilised by the pool, with an eye to considering either a change in strategy, or possibly adopting a risk management method that combines the two approaches. Of the 316 pools covered in the survey, 188 operate on a loss carry forward basis and 128 on a stop loss basis. Over the three years of the study, loss carry forward has continuously been the predominant method, although stop loss has been showing a gradual and steady increase.
The study uncovered a continuing but gradual reduction in the average surplus. There are several possible explanations for this, including: continuing increased competitiveness of many local insurance markets has resulted in lower up-front premiums; tariff premiums have continued to be removed in some countries; contracts that provide local dividends have increased; and some insurance companies have been increasing their reserves.
The increase in local dividends suggests one area of possible cost savings, because local dividends remain high as a percentage of premium.
One approach suggested by the study would be to include only non-participating contracts, which have no local dividend, into the pool. As Mercer points out, “These will cost less, as there is no need to load the premium for the local dividend. The local experience will still, however, continue to contribute to the overall experience of the pool.”
When Mercer studied the pools individually, it found that some very large pools are operating in a deficit position. There is an ‘acceptable’ corridor of deficits of –25% to surpluses of +30% of premiums, and the number of pools that fall outside this corridor is on the increase. In a few rare cases, surpluses have been greater than 100% of premium, and deficits have been as low as 200%. The study points out that “this must surely demonstrate the need for hands-on active management for such arrangements”.
One way to do this is to judge carefully which contracts to pool, and to consider removing those that are expected to be loss-making or that may unbalance the pool. In order to facilitate this process, Mercer studied the profitability both of individual contracts and of individual countries.
Some countries are clearly more profitable than others. On a country specific level, those countries generating the best surpluses – between 15 to 20% as a percentage of premium – include South Korea, Ireland, Greece, Argentina, and the US. Those with the largest deficits – from –10% to more than –20% – include the UK, Chile and Australia.
The Mercer study also considers the use of existing captives for employee benefits. In the Marsh Mercer Captives Survey, which was conducted in June 2001, only three out of 112 respondent reported that they used their existing captives for employee benefits – although 29% of the respondents did state that they would be likely to do so within the next two years. In general, they were attracted by the possible cost savings that could be achieved.
There are a number of routes to achieve savings through the use of captives, according to the Mercer report.
The pool insurers make a risk charge, which includes a profit loading, and this profit loading may be reduced by linkage to a captive.
The risk charge may be reduced or eliminated if the captive reinsures the pool.
If the insurance companies in the pool transfer reserves to the captive, higher investment earners might be possible.
Companies with US parents may achieve tax advantages because pooled insurance linked to the captive is generally considered to be third-party business.
By using the composite pool devised for the study, Mercer found additional cost savings through moving to a treaty reinsurance method, whereby a captive takes the risk and receives premiums, and the captive pays the claims. This brings about increased cash-flow income, as well as tax efficiencies. Under this arrangement, the composite pool would see pool surplus increase by more than 10%, including additional costs for network administration and reinsurance.