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The evolution of a public entity pool.

The Evolution Of a Public Entity Pool

Since the early 1980s cities in Mississippi, like the rest of the United States, have been concerned with the high cost of insurance. Although studies looking into the problem were initiated, no action was taken until the state Supreme Court ruling in Pruitt v. Rosedale eroded the concept of sovereign immunity, which gave the government the right to exclude itself from legal liability. In response, Mississippi proffered legislation regarding immunity and the establishment of a joint insurance program. However, during the state's deliberations, the Mississippi Municipal Association struck out on its own. In 1986 it conducted a study to test the feasibility of a pool for its members; in 1987 it began a liability program.

In the study all 300 member cities were surveyed to determine their approaches to insurance, grasp of the liability situation, exposures and response capabilities. Mississippi is not highly industrialized or populated and has only one major metropolitan area, some medium-size cities and more than 200 small cities and towns. Many of the state's small entities had uneven insurance, coverage gaps or no protection at all. It was obvious from these findings that any insurance program would have to address the lack of protection and the need for simple handling and rating procedures.

Insurance, although considered complex due to the legalities of protection, is really quite simple. In a pool, cities would collect enough premium to pay for the group's losses, thereby spreading the costs equitably among all members. The premium could be increased to pay for handling expense, but it could also be reduced if the funds earned interest. The insurance principles are the same if a professional risk-bearer, such as an insurance company, determined the pooling method and charges.

Setting Fair Rates

The association faced two issues that threatened to set back its program before it even got off the ground. First, what should it do about the lack of good, hard loss data from the cities and, second, how could it determine if the charges would be adequate? Many municipal officials believed that their city had good or better-than-average loss experience. They often referred to the absence of claims or the lack of lawsuits to back up their beliefs. However, without verifiable information these claims could not be readily substantiated.

Any city with insurance has usually been afforded that protection through several companies or agencies. As a result, complete loss data showing number of losses, dollars paid and dollars incurred for each line of insurance by policy year is not available. Furthermore, asking a city for the information is one thing, getting it is another; requesting that information from 300 cities is wholly unrealistic.

The actuarial firm conducting the feasibility study recognized that rating treatments would have to be adjusted to use the amount currently available for losses. This brought up a corollary issue. Although cities pooled together for insurance purposes, it did not improve their loss picture. Changing the method of handling does not change losses, which was another reason for using existing rate levels. This issue of rate adequacy was addressed in part by using current rate levels and was reinforced during the start-up phase by a minimum premium requirement for the pool. This requirement protected the program against large losses that might occur during the first year of operation.

The survey results identified the exposure items in each city, such as number of city employees and vehicles, miles of roads, parks, jails, road construction and utilities. General budget data, population statistics and other information were also added. It was noted that not every city was subject to all exposures or to any specific exposure in the same manner. Each city was a governmental entity providing necessary services to its inhabitants in a specific area within the state.

Many pools have examined the rating question only to give up any attempt to simplify the cumbersome, costly and often inequitable system. Because so many cities in Mississippi have small or limited facilities, a simplified approach had to be found. A single composite rating base was necessary, one that could not be juggled, would not change radically from year to year and would be easily verifiable. As our base, we divided the estimated needed premium for all the state's cities by population to arrive at a rate per person. This assured equanimity among cities and was confirmable by the pool and others so that no favoritism or penalty rating was possible.

It is often assumed that applying a complex formula to exposure rating guarantees accuracy. That is incorrect. The complexity of a false system obscures the faulty reasoning or improper assumptions underlying the system. Simplicity can be powerful because it is understood and verifiable. For those who argue that cities have different exposures, it must be pointed out that such exposures help provide necessary services to citizens under the same state laws, and they secure operating revenues in the same manner.

In the latest Mississippi legislation, pooling coverage requirements did not appear to be satisfied by traditional commercial policies. Indeed, the state did not even separate automobile liability from general, law enforcement or aircraft liability. Because no single policy had ever combined such coverages, a new document had to be written appropriately combining them. In addition, two other coverage features had to be addressed. The state's tort reform legislation did not provide for contractual liability or federal law violations. Both of those areas were insured against by cities in Mississippi, and it was the pool's responsibility to provide protection for them.

The limit to be written had to equal the state tort limit but also provide for non-tort liability. In addition, the limit had to be capped so that no city could make excessive claim demands against the fund. Finally, each city would be written at the same limits so that the risk spread was even across cities. Inasmuch as many cities were partly uninsured prior to the pool, coverage was restricted to wrongful acts or injury occurring and first reported during the policy period. However, a retroactive date was conditionally available to members joining the pool at its inception.

The Pool Makes a Splash

The board and executive staff of the association worked closely with the actuarial firm throughout the feasibility study. However, as enthusiasm grew for creating the pool, a separate board was established which was governed by the association but utilized the executive staff for control and administration. A trust fund was created for fund safety using the trust department of a major financial institution, a third-party administrator was selected to perform marketing, adjusting and loss control services and an accounting firm was appointed to examine banks and records.

The implementation date for the liability plan was Jan. 1, 1987, subject to a minimum of 70 cities. Members were told they might be assessed, but the likelihood was minimal. Reinsurance was not available although provisions were made to consider such protection in the future. Investment funds were to lie in government or governmental agency paper, thus keeping investment risk separate from the insurance risks covered within the pool.

By Jan. 1, more than 100 cities had joined the plan, which had an annualized premium of $2 million. Each member signed an agreement based on approval of their city council or board. The agreement stipulated conditions for individual cities to cooperate in loss control and related matters to the liability pool.

The pool eliminated the so-called we-they approach to insurance by replacing it with a consensus approach. This meant individual cities could no longer blame the inefficiency or poor claims handling of the insurance company for poor loss experience. Cities were part of the "insurance company," which included city representatives elected to boards for administrative oversight of the pool. Claims would be handled according to what was fair and proper for each member. Loss control efforts would be initiated on behalf of the group to help individual members. Statistical and loss information would aid all cities so that practical improvements could be made and future losses minimized.

Each member was provided with the materials to create a citywide loss control program based on group principles. Ongoing training in specific areas is conducted throughout the state and at annual meetings. In addition, the board meets monthly to review all ongoing activity, including new claims, claims handling, investment activity, problem areas and general plan administration. The association's executive staff, legal counsel and actuarial firm participate in these meetings and provide daily management support.

Loss consciousness and the need for identifying and controlling loss exposure became a way of life for the board, staff and even city management. Whereas there were many questions before the program was established about effectively reviewing sister city problems, this soon changed. Board members began to recognize their fiduciary obligations to the entire membership and acted accordingly. One city, for example, after developing unfavorable losses and failing to respond to loss control efforts, was canceled by the board. This action was later rescinded when city management gave satisfactory evidence of change and established a workable safety program. However, the action strengthened board resolution and also impressed the seriousness of cooperative effort.

Four Years and Counting

During the first three years under the plan none of the members withdrew, losses were at an acceptable level and premiums remained stable even though private insurance for the same coverages had increased. During the fourth year members accepted a modest premium increase. Writing two-thirds of the association membership, handling claims promptly and fairly and giving excellent service was cited by members as evidence that the program is successful.

Each year the actuarial firm reports to the board on the pool's operating results, trends, changes, needs and opportunities. During the third year of the liability plan, workers' compensation coverage was made available. This program required the same analysis, preparation, structure, trust fund, loss handling and loss control as the liability plan. The program, now in its second year, is successful, operating without state criticism and providing a cooperative and less costly alternative for city governments.

The association is stronger and more cohesive today than before the introduction of a liability plan. Costs have been reduced and safety has become a major factor in city management. The benefits of learning from individual losses are apparent using statewide training programs, an impossibility with multiple insurance companies. Indeed, the amount of loss control visits and assistance far outweighs what nationwide companies writing diverse business in many states could accomplish.

For example, the pool organized training sessions involving the concept of human error which was based on a study of major losses occurring during a two-year period. In this study, emergency and non-emergency vehicle use and a variety of law enforcement public official and general liability losses were analyzed. Losses involving human error were found to be larger and could not be differentiated by age or city size. Many losses occurred when physical equipment and conditions were safe or capable of compensation. However, in all of the human error incidents it was assumed that others would act properly. It was also believed that no accident would occur. However, the key assumption, which when added to human error resulted in serious loss, was that even if a loss occurred it would be small.

The results of the human error analysis were made available separately for different classes of city employees. This resulted in safety training from real world experience applicable to a specific group, not just the application of general principles. Furthermore, agitation about the quality of protection, rate adequacy or of possible assessments has virtually disappeared. The plan has become accepted throughout Mississippi and is recognized in federal and state courts.

What Are the Dangers?

Many pools fail through disinterest or because of assessment pressure, improper coverage or other factors. Starting and maintaining a successful pool requires clear actuarial and financial assumptions and competent and dedicated staff, counsel and providers. Most important, the board must be committed to the goals of the pool, regularly exercising constraint and judgment on behalf of all members.

Vigilance by competent directors is an absolute. Unattended or left to wander, a fund could become financially unsound in two or three years. The problem might not even be known because patterns were not identified or changes in frequency, severity or types of losses were not perceived as danger signals. The insidious part of liability claims is that payment obligations are fulfilled in the future. If unrecognized, the results can be disastrous. However, with the dangers come rewards that demand that the opportunities available through a pooling mechanism be seized under the right conditions.

Many opportunities are available to cities in Mississippi because of the success of the liability and workers' compensation plans. Certainly, property coverage is one example, but it will not be seriously considered unless a need arises. Providing excess liability in conjunction with other public entity associations is another possibility worth considering.

There are also ways to expand the services provided to the cities themselves or to other public groups, such as school districts, counties and state subdivisions. Education, training, loss control and claims management are additional possibilities. Beyond these traditional approaches are an array of financial and computer services that could be provided by a successful statewide association with a proven track record and qualified personnel. In the future some of these services will be introduced to further the association's goal of fulfilling its public service mission to cities in Mississippi.

Patrick A. Dunne is executive director of the Mississippi Municipal Association in Jackson, MS. Arthur E. Parry, Ph.D., is a consultant for The Wyatt Co. in Dallas.
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Author:Dunne, Patrick A.; Parry, Arthur E.
Publication:Risk Management
Date:Sep 1, 1990
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