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Will nationwide risk management work?

RISKY BUSINESS: Is collaboration possible and necessary? Featured Image

The devil is in the detail when it comes to setting up a nationwide local government risk management model. David Robson and Colleen Rigby delve into where current thinking could be leading.

The Christchurch earthquakes of 2011 prompted a shakeup of insurance products and services to New Zealand local government. Existing sector mechanisms such as Civic Assurance, the Local Authority Protection Programme (LAPP) disaster fund and Riskpool were severely tested but managed to survive the reinsurance arbitration process.

Two years later, Craig Stobo prepared a report for Local Government New Zealand (LGNZ). Published in December 2013, Insurance Market Review considered the crafting of economic sustainability and the notion of a nationwide local government risk management model.

In his report, Craig espoused a vision of a way forward with likely economies of scale… if the local government sector could find a way to work together.

In order to achieve this, three recommendations were offered:

  • First: rather than simply purchasing insurance there is a need to access and acquire skills and expertise to think critically about, and to manage, risk.
  • Second: local authorities share similar asset and liability risks which, coupled with the sheer size of the sector, present substantial buying power and the opportunity of economies of scale.
  • Third: a review of the 60/40 insurance arrangement whereby central government financially contributes 60 percent to underground infrastructure damage caused by a greater than 1:1000 year natural disaster event, is essential.
David Robson
David Robson

Craig wrote in the report that the current arrangement arguably “incentivises councils to avoid self-reliant risk management outcomes [through insuring up to 40 percent] and creates funding uncertainties for both parties”.

The Insurance Market Review found that: “Twenty-five percent of authorities don’t have a risk register or risk framework, 30 percent that have risk registers don’t review them at least annually, 50 percent of authorities don’t have business continuity plans, and there is very little understanding and documentation of event impacts and potential liability.”

These findings bring into consideration the potential for variable capability and capacity of service levels and mismatched risk and resilience investment on a national level. Working and technical advisory groups have since been created to review the matters raised in the report and undertake the business case to test the idea of creating a Local Government Risk Agency (LGRA).

However, is the implementation of a sector-wide model the correct thing to do? By all accounts, it appears so. The benefits that a LGRA would bring include better informed risk management decisions, increased community resilience and the opportunity to improve sector risk management practice through knowledge and resource sharing.

Dr Colleen Rigby
Dr Colleen Rigby

Fast forward to 2016, and professional management consulting firm Gravelroad has brought out a new report: Benefits of working with the LGRA from the perspective of a local council. The report suggests some collaboration for risk could start with grouping councils into high, medium and low risk exposure to natural disasters. The idea makes sense from a cost perspective, but how would these groups be defined? And by whom?

A council may be subject to high flood risk and low earthquake risk. The decision of whether it is then high, medium or low risk would need to be made and by some credible organisation. In an insurance sense this is not simply linked to exposure, but also claims history and the value or loss potential.

For instance, floods are attritional and frequent enough to influence the premium rating in individual locations. However, earthquakes and tsunamis can be attritional too, but such large loss events can affect regional and individual council limits.

Risk grouping could be difficult to apply in reality with significant potential of over-simplification. For instance, a council in a low risk environment would understandably seek to pay less for insurance without subsidising a higher risk council in a current regional cluster arrangement.

However, if a low risk council suffers a loss through a natural disaster event and begins to make claims then at some point it would logically move up to the next risk category. The higher pool would then increase in size, somewhat improving that economy of scale, but would likely have the opposite effect on the lower risk group that has now shrunk in size.

Conversely, if a higher risk council makes no claims over a protracted period of time, does this provide the ability to move down a level, downgrade its cover and realise some savings? Some of these events are 1:1000 after all.

Consider Craig Stobo’s issue of incentivising – raised in his 2013 report. A ‘high risk’ council is likely to spend money to lower some of its risk with the probable contention of moving to a lower claim category. However, there would likely be little motivation for a ‘low risk’ council to invest in further mitigation when they are paying the lowest amount based on their current arrangements.

Research conducted at a New Zealand university in 2016 yielded a similar response rate as LGNZ’s survey and the responses showed uniform alignment to the AS/NZS ISO 31000:2009 standards.

This could suggest that although the look, the feel and the sophistication may differ from council to council, the same risk philosophy is being employed by others and this could provide a platform for the basis of a sector-wide template.

The university research went one stage further and sought to find the reasons why some councils did not employ a risk register and this was claimed to be largely due to a lack of time, money and resources. Building a risk management framework can be a time-consuming and costly exercise.

But a sector-wide approach could be what, certainly the smaller councils, have been waiting for; a ready-made system that only needs to be adopted and populated with a national knowledge bank from which to draw data.

However, a ‘one size fits all’ model will need assurance of consistency of standards and quality. If the LGRA expects a central function visiting all councils, unless this is centrally funded the simple geographic separation between similar ‘risk’ councils could mean any potential cost savings could be swallowed in administration costs. The question of consistency also applies if local representatives are utilised.

This then raises the possibility of every council self-insuring or purchasing commercial insurance via a brokerage arrangement. Both these options have merits. The theme of the AS/NZS 4360:2004 –which preceded the ISO 31000 standards – advises the user firstly to take a wider view of the organisation and decide what is at risk.

In its 2013 report, LGNZ suggested there is little understanding of the potential impacts of events in the respective environments and Craig Stobo urged local government to acquire this knowledge.

The approach should therefore be to take this collective advice and obtain expert opinion to establish what really is at risk, test the current assumptions that insurance is based on and then address how risk transfer arrangements are procured.

In the meantime, it could be that councils are over- or underinsured and the latter will likely only be discovered after an event. This could be mitigated by better valuations (based on insurance reinstatement), combined with understanding around what would be reinstated and where. This may help to better define the loss expectancy and drive risk transfer options.

Regional collective insurance arrangements are already established and arguably largely utilising this type of service but without a national standard being in place.

If the LGRA is planning to take over the largely outsourced functions of loss modelling, valuations, risk engineering and consulting, the set up cost to do this is likely to be high and, if transferred, could ultimately lead to increased costs to the councils. Two other issues exist:

  • What drives evolution? The private sector has commercial drivers which force insurers / brokers to innovate in order to maintain position and customers. With a government monopoly the outcome may be stagnation and inflexibility through limited options.
  • How does the risk agency interact with the risk transfer market for the purchase of insurance? The best outcome is one where risk transfer is directly linked to the risk understanding and modelling. One argument is that brokers have links to the market and can influence premiums claims. Seventy eight councils together is a big programme but it’s still small when put into a global market.

Outsourcing could be a logical solution, but this would require whichever party is used to be held accountable. This could be achieved with a board of impartial experts who could gauge adequacy and suitability of the supplier without political influence.

It is questionable whether local government currently has the expertise to do this effectively and in-house. An officer may be responsible for the renewal of council insurance policies, but that does not necessarily make them an ‘expert’. However, the utilisation of a multi-party approach could ensure the most rounded view achievable.

Self-insurance is always an option but should be considered with an understanding of exposure and cost of capital from the insurance markets or banking sector if there is reliance on borrowing. However, consider costs of loss snowballing following a major event. Is it prudent to rely on significant borrowing that subsequent generations may have to pay off?

Whatever approach is adopted, understanding risk and developing an insurance strategy that drives risk transfer is a sensible approach. The precise design of LGRA is yet to be learned, but what is known is that it will need to create a centre of excellence for local government risk management delivering much-needed education, guidelines, templates and support.

  • David Robson is risk and internal manager at The University of Waikato. He was previously senior 
risk manager at Hamilton City Council. drobson@waikato.ac.nz
  • Dr Colleen Rigby is the MBA director at Corporate and Executive Education, Waikato Management School at 
The University of Waikato. crigby@waikato.ac.nz

Keys to collaboration

Large-scale collaboration is a significant undertaking and should follow logical steps in order to succeed. This includes:

  1. Collaborate in areas where there is already a solid footing. 
In practice, the most successful collaborations build on strengths rather than compensating for weaknesses. All councils need insurance – this is one area in which some will have strengths that can form the basis for sharing.
  2. Invest in the right infrastructure and people. The resources required to make collaborations work are frequently underestimated with assumptions that it can be left to staff to do what is required in addition to their other responsibilities.
  3. Establish a robust, joint evaluation system. An effective agreed evaluation system will help local government ensure that this long-term project is on track and delivering the results it should.
  4. Collaborate for the long term. Successful collaboration requires stamina. It may take time and effort to overcome the initial hurdles and make a new collaboration work. All parties need to recognise this and build an appropriately long-term perspective into their goals and expectations for the collaboration. This means including metrics that review performance beyond the first year, as well as conducting joint, long-term planning.

This article was first published in the July 2016 issue of NZ Local Government Magazine.

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