Local government finance has come under extreme pressure this year, with organisations seeing their operating expenses increase significantly, and unexpectedly, as a result of inflation. Peter Grocock, public sector practice leader, South West, Wales & Central at Aon, explains how to ensure insurance excesses are set at the optimum level.
Public sector organisations continue to face significant challenges in 2022, balancing local budgets with decreased revenues, increased service demands and the costs of new government initiatives such as levelling up. And, with inflation adding further financial pressures, organisations must ensure they get maximum value from their insurance spend.
As every penny of local government spend comes under careful scrutiny, it’s more important than ever to ensure insurance funds are properly structured and self-insured retentions, or excesses, are set at the right level. This should ensure that organisations are able to meet their liabilities while not inadvertently tying up unnecessarily large amounts of capital.
Analysing the total cost of risk is a valuable exercise when setting excesses. By overlaying historical claims data on different insurance programmes, with varying deductibles, limits and aggregates, it’s possible to see how the different programme structures would have performed and what the optimum structure would have been. This is known as the ‘burning cost’ approach to programme valuation.
The drawback of this approach is that it can only tell you what would have been the best option. As an example, running this exercise on a portfolio with limited historical claims activity may indicate that a larger deductible – and lower premium – is the best option. But this does not take into account the associated volatility of the loss experience and the potential for losses that have not occurred to date. An ‘unexpected’ loss or series of losses could leave the organisation picking up claims costs it never anticipated.
Data driven decisions
At Aon, we have developed a tool – the Risk Financing Decision Platform (RFDP) – to remove some of the potentially costly uncertainty from insurance programme structure analysis. This builds on available historical data to form a view on the distribution and associated volatility of claims that factors in potential outcomes.
The starting point for the analysis is the organisation’s own data, with the size of each claim modified in line with experience and market benchmarks to allow for inflation and anticipated development. Historical claims count is also modified to take account of the expected change in exposure for the new policy year.
The next step in this analysis is to fit statistical distributions to the updated claims information. This allows us to construct a mathematical model that closely replicates claims experience seen to date while also providing a measure of the potential for claims that have not occurred to date.
This mathematical model is then used to simulate hundreds of thousands of versions of loss experience for the policy year. These can then be used to test different insurance programmes and determine which is the optimum structure.
By adopting an actuarial approach supported by the latest tools and techniques available it is possible to ensure excess levels are set at a prudent level. Looking to protect the authority from both large losses and a high volume of smaller losses, while ensuring as much capital as possible is left available to invest in the provision of services.
To find out more about how RFDP can support your organisation, speak to your Aon account manager or contact Peter Grocock at firstname.lastname@example.org.