3.10 THE FUTURE IN THE UK IN 2013 A FORM OF MINIMAL PUBLIC-PRIVAT...

6.3.10  The  Future  

In the UK in 2013 a form of minimal public-private partnership has been agreed that will be based on

the concept of insurance pools. These are relatively new frameworks and are increasingly popular

approach to reducing the systemic risk of insuring high impact, low probability events. One of the first

insurance pools, called ‘Pool Re’, was designed to ensure that the UK insurance industry would

continue to be able to offer cover for damage caused by the increasing number of acts of terrorism in

the UK during the 80s and 90s. During those years, losses from terrorism like those from catastrophic

flooding were becoming seen as an open ended and, therefore, an uninsurable risk. There are

therefore parallels with the challenges of providing flood insurance. This theme is discussed in more

detail in Box 2.

There are many concerns, however, with this trend towards insurance pools. Many in the industry worry

that insurance pool as a sort of public-private ‘fudge’ used when no one can decide what to do with

commercially unattractive bad risks. Putting a ‘very large number’ as the capital in the risk pool gives a

patina reassurance to the public. Given the high costs of setting-up and running a new risk pool

company, and the unknown nature of many of the risks that are included in them, how successful a

pool such as ‘Flood Re’ will be in the medium term is questioned (EP, 2013) Whether they will properly

serve well any of the stakeholders - the government, the insurers and the insured – is doubtful as the

high risks they contain will still have to be financially underwritten and paid by one entity or another

either publicly or privately.

Pool Reinsurance Company Limited (Pool Re) was formed in 1993 following a series of terrorist

incidents in the UK related to the situation in Northern Ireland. Like the problem of insuring floods, the

high potential cost of terrorism losses and the lack of any reliable method of estimating the future loss

made it difficult to insure commercially. In the UK, insurers rely on reinsurers for financial cover

should very large claims occur. Consequently insurers and reinsurers alike came to the conclusion

they could not continue to offer terrorism cover using traditional underwriting methods.

Retraction of terrorism insurance would have potentially had severe consequences for the UK

economy. A new mechanism was required for providing this type of insurance while at the same time

not exposing both insurers and reinsurers to potentially huge losses for which there was no reliable

method of accurately pricing premiums. It became clear that any new approach would require the

involvement of both government and insurance sector. Following a lengthy consultation period, Pool

Re was brought into been operation and has already covered substantial incidents of terrorism. For

example, it paid out £234m after the centre of Manchester was destroyed by a huge terrorist bomb

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attack. Its success rests on several innovations that - given similarities with the problems covering

natural disaster insurance, (also high impact and low probability) - may offer guidelines for designing

a national flood insurance system, perhaps based also on a public-private insurance pool.

The first innovation for the UK insurance industry was the legal commitment from the government that

if losses from terrorism exceeded the substantial reserves (paid for by premiums) held by Pool Re,

the British Treasury would cover the shortfall. The transfer would, however, have to be repaid from

future income.

A second novel part of the approach was to limit cover to only commercial property. Domestic cover

is excluded. Direct and indirect losses (for example lost business days) are included in the indemnity.

The cover may be bundled as part of an existing property policy or as a separate policy. This

provides brokers flexibility to structure the contract optimally for each client.

Third, while each insurer must pay losses up to a threshold, when losses exceed that threshold,

which differs for each member, the insurer can claim upon reserves accumulated by the insurance

industry on a mutual basis within a separate company. Pool Re asks its members to reimburse them

the cost of claims they pay to their policyholders under the terrorism cover they chose to provide. This

is subject to a loss retention (a type of reinsurance deductible) that they must pay themselves. The

Pool Re company is financed by the premium paid to it for the cover insurers received. The retention

differs between members depending upon the size of their terrorism insurance portfolio.

Fourth, as Pool Re involves rules within its arrangements that could be construed as working counter

to principles of a competitive market i.e. might restrict or distort competition within the United

Kingdom, the rules gained an individual exemption from the Chapter I prohibition of the Competition

Act 1998 (Office of Fair Trading, 2004).

Source: Adapted from a history of Pool Re (2013)