Hampshire Fire and Rescue Authority Item 9

Finance and General Purposes Committee

15/03/200526 October 2006

`Firebuy' proposal to create a fire and rescue services mutual insurance company to procure insurance cover

Report by the Chief Officer

Contact: David Howells Director of Corporate Services Tel: 023 8062 6833

1

Summary

1.1

This report describes a proposal from Firebuy to establish a mutual insurance company controlled by and run solely for the benefit of participating fire and rescue authorities (FRAs). Under this arrangement member fire services will pool their insurance risks and the costs of administration within the company, which would issue policies to its members annually, whilst retaining their own existing levels of self-insurance (excesses) and the range and levels of policy cover provided under existing insurance arrangements. In order to provide financial protection to the members, the Mutual would reinsure high level risk above an agreed sum.

1.2

The Mutual would register with the Financial Services Authority as an insurance company and would need to establish a capital base, partly in the form of a cash advance and partly by financial guarantees against future liabilities which would be provided by the member fire authorities. It would then appoint a board of directors to ensure it is run properly and in accordance with the wishes of the members.

1.3

This proposal is likely to generate significant financial savings as well as other knock-on benefits from improved risk management. Utilising the Mutual model provides solutions to FRAs insurance requirements, meets the key themes of the National Procurement Strategy and eliminates many of the difficulties associated with purchasing insurance from conventional suppliers.

1.4

In developing the proposal to this stage, legal advice from a specialist Queens Counsel has already been received confirming that fire and rescue authorities have the legal power to set up the Mutual and to participate in it. All participating authorities would be full members of the Mutual which would elect a board of directors comprising of appointees from the member authorities and a minority of independent directors with appropriate knowledge and experience of the insurance market. It is recommended that those officers representing the authorities on the board of the company are provided with suitable indemnities against personal liability if these are not already in place.

2

RecommendationError! Bookmark not defined.s

That it be a recommendation to the Authority:

2.1

That the Authority agrees in principle to participate in establishing a Fire and Rescue Authorities Mutual Insurance Company (the Mutual) for the reasons and on the basis set out in this report.

2.2

That, subject to the Clerk, Treasurer and Chief Officer being satisfied with the detailed contractual and governance arrangements for participating in the proposed Mutual and subject to reporting back to this Committee, the Authority becomes a full member of the company and authorises the Chief Officer in consultation with the Clerk and Treasurer to take all necessary steps to achieve this.

2.3

That, subject to the caveat in recommendation 2.2 above, the Authority purchases its corporate property, liability, motor insurance and other miscellaneous insurance requirements for a minimum period of one year through the Mutual with effect from 1 July 2007 [or the expiry date of any Long Term Agreements], but that in the event that the Mutual is unable to assume risk by that date the Chief Officer be authorised to arrange interim insurance cover as detailed in recommendation 2.7.

2.4

That the Director of Corporate Services be nominated as the Authority's representative on the Mutual and be empowered to represent and vote on behalf the Authority at general meetings of the Mutual.

2.5

That the Authority agrees in principle to participate in capitalising the company by way of an initial cash contribution of £26,121 and an additional financial guarantee of no more than £287,333 and authorises the Chief Officer to take all necessary steps to achieve this.

2.6

That the Authority agrees to waive the usual standing orders relating to contracts in view of the fact that the procurement in this case is being pursued through Firebuy.

2.7

That, in anticipation of the Authority potentially participating in the Mutual with effect from 1 July 2007 and if for any reason that the proposed start date for the Mutual is delayed, the Chief Officer be authorised to extend existing insurance cover arrangements (due to expire on 31 March 2007) until 30 June 2007 and on a monthly basis up to 31 March 2008 thereafter.

3

Introduction Error! Bookmark not defined.and background

3.1

A number of fire authorities have had for some time growing concerns over the cost and availability of insurance cover from traditional insurance providers given the changing nature of fire and rescue services' activities. Work has therefore been underway for some months to evaluate the potential for procuring insurance cover other than through conventional insurance arrangements. This activity has been coordinated by Firebuy, the national fire services procurement association, which has funded some of the initial research and feasibility studies. This included collating and analysing data from the initial 5 - and subsequently 15 - English fire and rescue authorities that expressed an interest in the venture.

3.2

The drivers for this investigation were:

_ a lack of competition in the insurance market;

_ fire and rescue authorities being rated as `local authorities' and their unique (favourable) risk profiles not being recognised;

_ current arrangements not representing value for money;

_ to avoid the ups and downs of the insurance cycle;

_ a desire to have more control over obtaining insurance cover;

_ the collaborative endeavour across fire and rescue authorities to maximise cost-effectiveness in line with the aims of the National Procurement Strategy.

3.3

To progress the proposal, a steering committee of officers from participating authorities - assisted by Public Risk Management Limited and Charles Taylor Consulting PLC, with co-ordination undertaken by Firebuy - has been evaluating a proposal to create a mutual insurance company. The project has been supported financially throughout by Firebuy.

3.4

Initially, five authorities sponsored the project: Hampshire, Kent, East Sussex, Royal Berkshire and Essex. Subsequently, a further 10 authorities joined: West Midlands, Hereford/Worcester, Devon, Cambridge, Cheshire, North Yorkshire, Bedfordshire, Nottinghamshire, London and Tyne/Wear. All 15 have provided detailed information to create the financial data contained in this report. Subsequently, a further five authorities have joined: Durham, Leicestershire, Buckinghamshire, Cleveland and Somerset - these have yet to submit their data and this will be incorporated in due course.

3.5

The initial exercise required authorities to provide details of significant 3 year/5 year insurance-related claims and financial data. The results were processed by Graycells Limited (using software provided and owned by Firebuy) which was then validated by Public Risk Management Limited. The initial benchmarking data proved that significant savings would be made by the formation of a fire service mutual insurance company.

3.6

The steering committee - through Firebuy - commissioned Charles Taylor Consulting PLC (CTC) to carry out a feasibility study using the data from the 15 participating authorities. CTC's report indicated that a mutual insurance company, dedicated to fire and rescue services, could offer member authorities savings averaging 15% on current premium spend, plus a share of the potential surplus (profit) once the financial base of the company was established. For the 15 participating authorities this is estimated to be in the order of £1.137m over the first five years of trading. If all 47 fire and rescue authorities eventually agree to join the mutual, then the surplus is estimated to rise to £3.5m, in addition to the 15% premium savings. Once the capital base is established, these surpluses would be available to member authorities and could be used to reduce premiums further. These savings reflect the cost sharing characteristics of a mutual and the weakness of the current market for local authority insurance.

4

The structure and operation of a mutual insurance company

4.1

An insurance mutual is a joint venture controlled by its members. The members insure some or most of their risks with the mutual, instead of with commercial insurers; they pool risks and share costs. A mutual offers its members advantages over and above reductions in annual premium. Underwriting surpluses are retained for the benefit of the members of the mutual and not paid to third party shareholders. The financial incentives to make an underwriting surplus enhance the value of, and rewards good risk management endeavours of each member authority. A mutual also offers authorities the opportunity to determine underwriting appetite and develop policies which are focused their own needs. It can provide the prospect of greater pricing stability. This structure will attract support from sectors of the reinsurance industry that would not normally deal with individual authorities.

4.2

Authorities' current insurance arrangements and contracts typically provide that they will carry the lower level risks in return for lower premiums. These `deductibles' operate just like the `excesses' in many insurance policies. They account for the majority of claims by or against each authority. The proposed Mutual would, at least initially, require member authorities to carry deductibles of at least the same current value.

4.3

The Mutual would only carry risk above these levels. In addition, the Mutual would reinsure - with a commercial insurer - the very highest level risks (catastrophic risks) where the claims are likely to involve very large sums of money. Reinsurance with a commercial insurer would be obtained through a procurement exercise that would benefit from the extra purchasing power of a group of fire and rescue authorities. The Mutual would therefore cover only mid-range claims - above the deductible limits and below the level for reinsurance. These would be met from the premiums paid to the Mutual and the capital held by it; or, if that should prove insufficient, by top-up contributions from the participating authorities. The maximum amount, over and above the guaranteed capital contribution referred to above, that would be levied on a participating authority in respect of any one financial year without a special resolution passed by the authorities at an annual or extraordinary general meeting is 50% of the premium paid by each authority in relation to that financial year. This right by the board of directors to raise additional premium income is considered to be very much a last resort. The intention is that the reinsurance protection afforded to the Mutual covers of the risk of adverse years, therefore this right is not one expected to be exercised in practice. Authorities that have capitalised the Mutual, but have not yet had the benefit of insurance cover from it (because, for example, of existing long term agreements) would not be subject to this provision. The Mutual would also provide claims handling services, where required, to replicate those currently in place.

4.4

The primary advantage for the Authority in participating in a mutual is the economic benefit that would result in the reduction in premiums. An important additional advantage arises from the fact that the mutual can develop specific risk management standards for its members: i.e. to encourage better risk management practice and mitigate unmanaged risk. The Mutual could then offer lower premiums to participating authorities that met these standards. Further benefits accrue from the ability of the Mutual to underwrite specific fire and rescue service related risks that might not be readily available in the conventional insurance market, thus enhancing the protection provided to member authorities.

5

The form of the Mutual

5.1

In their report, CTC reported that a mutual was an economically viable model for fire and rescue authorities. There are two basic mutual models. The first is a `discretionary' mutual, which, although it has tax advantages and need not register with the Financial Services Authority (FSA), it is under no obligation to meet its members' claims if it chooses not to. This option offers authorities insufficient security. The second option is a `guaranteed indemnity' mutual which is obliged to meet valid claims. It is however required to register with the FSA and looses some of the tax advantages as it is required to levy Insurance Premium Tax (IPT) on the premiums it charges, adding (currently) 5% to total premiums. CTC have recommended establishing a guaranteed indemnity mutual, domiciled in the United Kingdom and authorised by the FSA to act as an insurance company for those fire and rescue authorities wishing to participate.

5.2

The Mutual, as yet unnamed, would be set up as a shell company. It could operate only when a sufficient number of authorities agree to participate and when FSA registration has been completed. This report is therefore the critical final part of the establishment process: without sufficient numbers in support of the proposal the Mutual would simply not be established because it would not be financially viable.

5.3

The mutual would be a company limited by guarantee. Authorities that wish to participate in the mutual would become full members. They would have equal voting rights and agree to take part in the mutual set up arrangements, following which they would appoint the board of directors to run the company. Each year, the company would issue policies of insurance to the full members in accordance with their circumstances at the time. The Committee is therefore requested to recommend to the full Authority that it should participate in the proposal to create a fire and rescue services mutual insurance company and to its becoming a full member of the company on the expiry of its current policies.

5.4

The company would be able to underwrite all of the existing insurance policies held by the Authority with the exception of marine hull insurance (which does not apply to Hampshire). In addition, as the company matures, it can be requested to consider underwriting new risks which might currently be difficult to insure through conventional arrangements. Our current policies expire on 31 March 2007 and it is recommended that arrangements be made to extend these until 1 July 2007 - or until the fire mutual is able to underwrite risks - at which point the Authority will be eligible to join the Mutual. Members are therefore requested to agree that the Authority places its insurance cover with the fire mutual with effect from 1 July 2007 for a minimum period of one year.

5.5

It is recommended that the directors should be selected from the financial directors of the full member authorities. The Mutual would indemnify the directors against any personal liability and will place insurance to back up the indemnity. The directors would determine the strategy of the company and monitor performance. Day-to-day management of the company, including administration, issuing annual policies, arranging reinsurance and investing surplus funds will be handled by an experienced firm of mutual managers to be appointed by the directors.

5.6

A minority of directors (initially two) would be independent directors. This is a requirement of the FSA and of the Code of Governance for mutuals of this kind. The non-executive directors would have experience of the insurance industry; their role is to ensure that the company operates properly for the benefit of its members. The independent directors will be paid for performing these duties, but the local authority nominee directors will receive only their reasonable incidental expenses. The Committee is therefore asked to recommend to the Authority that the Director of Corporate Services be nominated as a director of the company.

5.7

The Committee may be aware that Municipal Mutual (MMI) was for many years a major insurer for local authorities. The MMI operated as a mutual but ceased trading in September 1992 and is currently in solvent run-off. Members need to be satisfied that the model of the proposed mutual is different from that of MMI. The key differences are:

_ The MMI Group in its latter period of operation was not focused purely on the public sector whereas the fire and rescue mutual would be constitutionally restricted to providing insurances to fire and rescue authorities only.

_ The influence exercised by local authorities over MMI was diluted in the latter years.

_ The regulatory and compliance regime under which the proposed mutual would operate is more onerous than any under which MMI operated.

_ The structure of the insurances MMI offered did not incentivise the practice of risk management whereas the insurance programmes provided by the proposed mutual would require and reward good risk management practice.

_ MMI's investment portfolio was heavily biased towards commercial property. The proposed mutual would adopt an investment strategy that favours short-term investments and maximises liquidity.

6

Capitalisation of the company

6.1

FSA registration requires the Mutual to be able to access a capital fund sufficient to cover its prospective liabilities. The size of the fund will depend on the number of members, but it is anticipated that the initial fund will be in the region of £3 million. Authorities that become full members will be required to provide an initial working capital of £250,000 plus a further financial guarantee of £2.75m. It is understood that the value of the capitalisation will not impact on the revenue budget of the Authority as guarantee will need to be provided for in the balance sheet of the Authority as a contingent liability and the cash advance as an advance payment. The company would decide the basis on which authorities joining the mutual at a later time contribute their share to the on-going capitalisation requirements of the mutual and such basis will recognise the benefits to the mutual of the initial contributions

6.2

The Committee is asked to recommend that the Authority agrees to contribute its share of the working capital required and makes provision for the additional financial guarantee required upon joining the company.

7

Legal advice

7.1

Queens Counsel, specialising in public sector law, has been engaged to advise on the various issues arising from this proposal. The advice is that it is within the powers of fire and rescue authorities that wish to participate in the Mutual, to do so. As with all its decisions, the Authority needs to ensure that it has taken all relevant factors into account (including its duty to local tax payers to act responsibly with its funds), has ignored irrelevant considerations, and come to a rational conclusion. A copy of the full legal opinion is available if required.

7.2

As the company would be controlled by its constituent authority members, a number of straightforward statutory probity requirements apply. These include: an obligation to provide a participating authority with such information about the company as may reasonably be required for the participation of their duties. The company would be subject to scrutiny with an obligation to keep non-exempt minutes of its general meetings available for public access for four years.

8

Financial evaluation

8.1

The financial modelling contained within CTCs feasibility study based on the data of the 15 participating FRAs shows that a mutual insurance company is financially viable and can offer up-front premium reductions of 15% on 2006 rates on all classes of insurance (other than marine hull), as well as generating a growth in assets of £1.137m at the end of the first 5 years of trading. This equates to an annualised saving of 17.8% on current rates. This is based on a proposed inception date of 1 July 2007 with those authorities with long term agreements (LTAs) expiring before that date joining the mutual at its inception, and all other members joining upon the natural expiry of their existing LTAs.

8.2

It is assumed that the Mutual would be capitalised to £3m, that members retain their existing underlying deductibles and that the Mutual will buy reinsurance protection in excess of £500,000 for any one occurrence in respect of motor cover and £250,000 in respect of all other covers. This financial model has been subject to a number of scenario tests ranging from a very good claims experience to near catastrophic losses. Over 5000 variations of these scenarios over each of the five years of the model have been simulated by a qualified actuary in order to validate the financial viability of the company.

8.3

The financial implications for the Authority can be summarised as producing premium savings of £86,141, anticipated against a current projected cost of £574,272. The anticipated share of any accrued surplus is estimated at £596,523 at the end of the first five years of operation.

9

The next steps

9.1

A commitment in principle is required by each FRA by 31 December 2006. This will enable the financial model to be updated based on those authorities that have agreed to join the Mutual in principle.

9.2

These updated results will be circulated so that a final decision can be made by each fire and rescue authority. If more than the initial 15 join, then the guarantees and shares of working capital from each authority would be scaled down.

9.4

Charles Taylor Consulting have been retained by Firebuy on a variation to the current contract to start work on the formation of the company, and to develop constitutional documentation including a Memorandum and Articles of Association.

9.5

Subject to sufficient members committing by 31 December 2006, Firebuy will start the procurement process to appoint managers of the Mutual. The timetable is critical to achieve a 1 July start and does not allow for any slippage.

10

Contribution to corporate aims and objectives

10.1

The proposed creation of a mutual insurance company for fire and rescue authorities has the potential to provide better value for money than the Authority's current insurance arrangements. The proposal relies completely on the effective collaboration between fire and rescue authorities, and `greater collaboration' is an explicit expectation contained in the Fire and Rescue Service National Framework particularly in relation to procurement.

10.2

The potential efficiency gain will count towards the Annual Efficiency Statement (and `Gershon' savings) which can then be re-deployed towards achieving the Authority's IRMP service delivery objectives.

11

Risk analysis

11.1

The Committee will be particularly concerned to know the potential risks associated in participating in this venture. For this reason a thorough risk assessment has been undertaken by the steering group and its advisers. This is set out in Appendix 1.

12

Equality Impact Assessment

12.1

The proposals within this report are considered compatible with the provisions of the European Convention on Human Rights, the Human Rights Act 1998, and the Race Relations (Amendment) Act 2000.

13

Consultation

13.1

Not applicable.

Background Information (Section 100D of Local Government Act 1972)

The following documents disclose the facts or matters on which this report, or an important part of it, is based and has been relied upon to a material extent in the preparation of the report:

_ Charles Taylor Consulting PLC report on an FRA Mutual

_ Advice from Roger Henderson QC on legal powers.