When multinational pooling pays off
Risk benefit pooling remains a key management tool for multinational companies, as confirmed by our recent study which examined both the financial and non-financial benefits of this approach.
The results of the study demonstrate the various factors that must come together to achieve significant profits from multinational pooling:
❏ There must be sufficient overall premium volume, which means there should be a reasonable level of underlying benefits;
❏ Overall experience must be good relative to the premiums charged;
❏ The local dividend and reserving policy must not conflict with the policy for pooling.
Low benefits (in central currency terms) will only have low premiums and therefore little potential for profit. This is typically the case in developing countries; in Europe salaries and therefore benefit levels tend to be higher, giving reasonably high premiums. Our 2006 study shows that the main pooling premium resides in European countries*.
Chart 1 is distorted somewhat by significant contracts in Scandinavia, but Belgium remains a key country for pooling (as illustrated in previous equivalent studies).
Claims v premiums
Experience relative to premium rates is, of course, key. In the past, tariff premium rates have given room for significant profits, including investment profits. Now, premiums can more often be derived directly from the underlying elements of cost, as shown in pooling reports: claims, expenses, commission, etc.
Evidence suggests there are two areas where the potential for pooling profit is limited: the largest contracts, particularly in the headquarters
country, and in the mature insurance markets.
Our study shows the most and least profitable countries for pooling are as follows (represented by profits as a percentage of premiums for all contracts in the country)(see Chart 2).
Here, countries with smaller operations and less sophisticated markets for insurance are mostly represented. Insurers appear to be putting significant investment into these countries.
By contrast, the least profitable countries are typically those with highly developed markets and/or significant contracts (see Chart 3).
The charts suggest margins have been reduced in these large insurance markets and, therefore, the potential for profitability from pooling is limited. Of course, these percentages vary by type of contract and, as in previous studies, claims as a percentage of premiums are lower in life insurance than in other key risk areas.
This shows the key impact of reserving on profitability and highlights a challenge in pooling: where local contracts are established on terms that may lead to pooling losses. This may occur if local reserving is at a different level to the reserving for pooling purposes, ie higher reserves are established for pooling than for the local terms, resulting in loss-making contracts.
Local dividends may also be payable based on terms that can result in pooling losses, for example if the measurement period is out of step with the pooling year. Our study revealed a large number of contracts that are loss-making for pooling purposes, but are still paying local dividends. In total, some $35m (€26m)was paid out in local dividends on contracts that contributed losses of $41m to pools.
Of course, overall, local dividends still represent a positive return from the premiums paid, but the result is a distortion of the pooling process and could represent a significant cross-subsidy between different subsidiaries, with some countries profiting at the expense of others. Some companies have taken the view that all local dividends should be removed to avoid this effect, but this can be difficult when they are built into local contracts and have been in place for a number of years.
Freedom of Services Directive
The impact of legislation continues to be felt across Europe, with localised examples such as the new laws around medical and disability in the Netherlands and France, and at a European level. Here the implications of the Freedom of Services Directive continue to be examined.
Broadly, the directive allows an insurer licensed in one EU member state to write business freely in another state, provided it satisfies the local requirements. This means that, theoretically, an Irish firm can buy insurance from any EU-based insurer.
We have seen two instances of this in practice in the employee benefits insurance world:
❏ The development of EU-based captive insurers writing business direct for their subsidiaries in the region, contrasting with the captive approach used previously of establishing a multinational pool and using the captive for reinsurance purposes. The direct writing approach relies on a number of factors: a suitably flexible domicile for the captive (in this case Malta), the availability of suitable claims handling, actuarial and other expertise and a preparedness to establish insurance contracts for all the risks being taken on;
❏ The establishment of insurers who have obtained licences for all countries looking to write single contracts across the region. Only a small number of insurers have gone down this route.
While the captive route will only be suitable for some larger multinationals, the availability of contracts across Europe may have a significant advantage for smaller and growing multinationals, reducing the administrative burden. We await with interest the bedding down of this new market.
Network coverage can become an
issue in trying to cover the entire region. The networks are typically well-represented for EU member states, though there are variations, particularly in the ability to pool medical risk:
A similar chart can be created including EU accession countries and other Western and Eastern European countries, which only serves to exaggerate the contrasts and shows the push that some insurers and networks have made into Russia, for example.
The biggest challenge we see for European multinationals is the decentralised nature of their operations. We asked our study participants how they went about pooling, and then matched this against the profits on their pools, with the following stark results (see Chart 5).
This suggests that European companies that typically give a lot of autonomy to their subsidiaries may achieve better results through a more centralised approach to managing pooling. We have seen a number of companies, particularly those based in Germany, taking this step by using a global broker approach.
For such firms, the financial advantages remain a key driver (nearly three-quarters of study participants cited this as the primary reason for pooling), but the delivery of annual pooling reports and central advice gives significant governance benefits, with further information on local contracts and greater opportunity to influence the pricing and terms and conditions.
For many companies, a pooling policy can be central to developing a more co-ordinated benefit strategy, leading to greater cost control and understanding, and helping to achieve business objectives.
Jeremy Hill is a principal at Mercer Human Resource Consulting
* Mercer Human Resources Consulting