Cities Sharing the Risk--and the Premium : Pooling Is Creative Approach to Beating High Cost of Insurance

It is called “going bare,” and for cities, it is the equivalent of streaking through a congested thoroughfare.

Torrance has been doing it since last October, El Segundo since November, Rolling Hills since January and Hawthorne since February. Hermosa Beach flirted with the idea several months ago, but prudence prevailed.

In the municipal liability insurance industry, going bare means going uninsured. For cities, that translates into having no outside protection against the hundreds of claims filed against them each year.

‘We Are Vulnerable’

“We think it is very serious,” said Jose Sanchez, finance director in El Segundo. “We are very vulnerable.”

If a resident who falls off a broken swing in a city park wins a suit against the city, for example, an uninsured city must pay the award with money from its reserves or general fund. Cities with liability insurance, by contrast, usually must pay small claims, but the larger ones are picked up by insurance companies.

Frustrated by their inability to get coverage or affordable premiums from major insurance carriers, eight South Bay cities and 26 other cities in the Los Angeles area have joined in hopes of creating a self-financed insurance pool--a cities-run insurance business of sorts.

The insurance companies say they are losing money on policies with cities and other public agencies because they are exposed to high risks. They say the municipal liability insurance business has become too expensive, forcing them to drop out of the market.

A major cause, both cities and insurance carriers say, is the so-called “deep pockets” principle. Accident victims have collected large sums from cities whose degree of fault was minor when individuals principally at fault did not have the ability to pay the damages awarded by the court.

Torrance, El Segundo, Rolling Hills and Hawthorne have all been dropped by their insurance companies, and no other carrier has been willing to take on their coverage. Redondo Beach was able to renew its policy last October with Planet Insurance Co., but only after officials accepted one-third of the coverage they had the year before and agreed to pay six times as much for it.

“We are better off than many others in that we have insurance,” said Redondo Beach City Manager Timothy Casey. “But we have no guarantee that Planet will renew us when we come due in October, and we have no guarantee that Planet won’t cancel us tomorrow because they’ve decided to get out of the business.”

In the pool, member cities would pay annual premiums that would be used to establish reserves, pay claims awarded against cities and pay the debt service on “certificates of participation,” which are similar to bonds.

The pool would sell up to $25 million in the tax-exempt certificates to serve as an interest-bearing reserve, which could be tapped if cities are hit with multimillion-dollar awards.

In addition, pool members would have a self-insured retention--meaning that claims below a certain amount would be paid by the city rather than the pool--but above the retention level all risks would be shared by all members. Premiums paid by Inglewood, for example, would help pay for claims made against Manhattan Beach, and vice versa.

The self-insured retention is similar to a deductible, except that the city is also responsible for legal and other costs associated with awards that fall within the retention level.

Premiums Would Vary

Preliminary estimates show that premiums through the pool would be much cheaper than those cities are now paying. In the case of Redondo Beach, the city would pay an estimated $198,000 for $10 million in coverage with a $500,000 self-insured retention. The city now pays $482,000 for $5-million coverage with a $400,000 self-insured retention.

The actual pool premiums, however, would depend on how many cities join and what level of coverage those cities want.

The pool, which is scheduled to be in operation late next month, is being set up by the Independent Cities Risk Management Authority, 12 cities that organized in 1980 to buy municipal liability insurance as a group. Since then, the cities have also joined to buy property insurance, health insurance and workers compensation, according to David Smith, a management consultant for the authority.

Other Pools Forming

Marsh & McLennan Inc., brokers based in San Francisco who have been setting up the self-financing pool, are organizing similar pools in Northern California.

El Segundo, Gardena, Hawthorne, Hermosa Beach, Inglewood, Manhattan Beach, Redondo Beach and Torrance have participated in the study phase of the pool.

The city of Los Angeles is self-insured and basically too large to join a pool with so many small cities--some not even one-hundredth its size, said Richard Welch, Los Angeles’ risk manager.

The authority has requested that the cities give at least conceptual approval to participation in the pool by April 26. Cities that delay will be assessed a penalty on their premium or be denied entry for one year, officials said. The pool is tentatively scheduled to begin May 20.

As a result, city councils from all over Los Angeles County are being briefed this month by city managers, risk managers, city attorneys and brokers about the risks and benefits of joining the pool. Redondo Beach, for example, has set aside most of Tuesday’s City Council meeting for a presentation by Marsh & McLennan, Casey said.

Only Option

To many cities, the proposed Independent Cities Risk Management Authority pool is the only insurance option available if they choose not to go bare. In El Segundo, Sanchez, the finance director, said the city’s broker is seeking premium quotes from insurance carriers outside the state, but so far with no success.

“If we get a claim against the city, and we don’t have enough money in the self-insurance fund, then the difference comes out of the general fund,” Sanchez said. “I have heard that we would have to dispose of assets if necessary to satisfy judgments.”

Cities like El Segundo, which has been without insurance since November, have been stepping up so-called risk management loss-prevention programs in hopes of averting claims that might bankrupt the city.

Barbara Lansberg, a legal assistant in the El Segundo city attorney’s office who has been handling liability claims, said the city has put on seminars for employees to help increase awareness about potential liability problems.

“We are trying to show people what to watch for,” Lansberg said. “When anyone in the city gets a phone call or drives into town and sees an emergency or hazardous condition, we want them to report it. Things like tree limbs in the street, a street light burnt out, a blind intersection or faulty playground equipment.”

In January, the Rolling Hills Community Assn., which controls the private community’s horse trails, was forced to close the trails when liability insurance for the association and the city lapsed and they were unable to obtain other coverage.

Checking Another Pool

The tiny city of 2,000, however, has not applied to the Independent Cities Risk Management Authority pool, but has looked to a pool in the Coachella Valley that consists of smaller cities with low risk, City Manager Terrence L. Belanger said.

Cities are also tightening up liability insurance requirements for groups that use public parks, streets and other city property for special events. In Torrance, the city has required some groups to buy up to $5 million in coverage for functions that previously required only $1 million in coverage, said Kathy Keane, assistant to the city manager. Torrance has been without liability insurance since October.

“We are looking at things very carefully,” Keane said. “We are also letting employees know that we don’t have insurance, so they are being more careful. When you sit down and explain that the money will come out of the taxpayers’ dollars, it makes a difference.”

Cities that join the pool will be required to implement risk-prevention programs and other risk-management practices similar to those in Torrance, El Segundo and other cities. Gary J. Martin, risk manager for Manhattan Beach who has been active in setting up the program, said the risk-management requirements are essential because all members will be sharing losses.

With strict risk-management requirements, the risk-sharing principle can only help cities like Manhattan Beach, which might not be able to absorb a major claim on its own, he said.

Spreading the Risk

“Risk sharing spreads the risk so that no one city faces the consequences of unpredictable losses,” Martin said in a report to the City Council. “If a catastrophic loss occurs, rather than being at the mercy of an insurance company for the increased premium or cancellation, the risk-sharing principle of the pool spreads this risk so the city’s financial viability would not be devastated and it would be able to amortize its loss over a reasonable period of time.”

The proposed Independent Cities Risk Management Authority pool, however, is not without its skeptics and detractors. Mike Bell, risk manager of Carson, said his city has steered clear of the program because officials there would prefer to renew the city’s liability insurance policy with Planet, which expires in July.

Bell said Carson has an advanced risk-management program that is geared toward loss prevention, and that he fears that a pool like the Independent Cities Risk Management Authority program, even with its risk-management requirements, would expose Carson to unnecessary risks from other cities.

“Loss-prevention techniques we use here are not available in most cities because they don’t have full-time risk managers,” he said. “Most of these cities look at risk management as a way of reducing costs and they have forgot about loss prevention. The idea of loss prevention is you are pro-active rather than reactive.”

Idea Being Reviewed

In Gardena, City Manager Kenneth Landau said city officials are reviewing the pool idea very carefully because of concerns about the financing plan and the risk-sharing provision. Gardena has liability insurance at least until September, so Landau said the city has the luxury of scrutinizing the proposal more than cities who are bare or facing immediate cancellation.

Landau said officials there are concerned that the pool might run into a cash-flow problem because premiums would not be sufficient to cover debt service and claims. He said the city also opposes sharing risks with all members of the pool.

“It is a question of home rule,” Landau said. “If we go into risk sharing, we don’t have control over our own destiny. . . . We are not ready to jump in yet.”

And there are other concerns. To join the pool, cities must commit themselves for at least three years. Also, if a city or several cities are suddenly hit by a series of catastrophic losses, the reserve for all the cities could be entirely depleted before the certificates are even paid off.

And then there is politics. How much pressure will there be on officials to settle claims within each city’s self-insured retention so the pool’s reserve won’t be drawn upon?

“With an insurance company, you expect to get pressure from them to settle,” said Casey, the city manager in Redondo Beach. “But when you have to look into the blue or brown eyes of the mayor next door, who is saying, ‘Settle this thing,’ that could lead to a little bit of strain.

“If we get into the insurance business we are going to have to act as insurance men. I don’t think that is a problem so long as the players recognize there will be some degree of oversight by political officials.”

51-City Pool

Five South Bay cities--Lawndale, Lomita, Palos Verdes Estates, Rancho Palos Verdes and Rolling Hills Estates--belong to the Southern California Joint Powers Insurance Authority. The 51-city authority pools its losses for claims up to $500,000 and purchases excess insurance for $10 million in coverage, according to George Anast, manager of the authority.

The joint-powers authority, however, is unlike the Independent Cities Risk Management Authority pool in that its pool coverage is paid for by annual deposits from its members rather than through borrowing. Martin, risk manager in Manhattan Beach, said the authority rejected that form of financing because it would have required exorbitant annual payments by member cities.

Anast, however, said his authority opposes floating certificates of participation to finance insurance pools.

“I consider it the least desirable solution to the problem under almost any set of circumstances,” Anast said. “I consider it unethical, impractical and completely unnecessary.”

Anast said using tax-exempt financing such as certificates of participation to raise money “ahead of any proven need for that money,” amounts to “a raid on the U.S. Treasury.”

‘Unconscionable Cost’

“In effect you are asking the taxpayers as a whole to fund a sum of money for you to have available to pay your liability losses,” he said. “It appears as if there is an unconscionable cost to the creation of that program.”

Casey and others, however, defend the use of the certificates.

“It is unconventional, but it is certainly a public entity issue and a legitimate use of tax-exempt financing,” Casey said. “It bothers me less than when some cities use tax-exempt instruments for the primary benefit of private entities.”

Martin said legal opinions for Independent Cities Risk Management Authority by a firm experienced in bond counsel work determined that the sale of certificates of participation for raising money for the insurance pool is legal.

Smith, management consultant for the authority, said formation of the pool has been a careful process that has included representatives from all poor members and other interested cities. Complaints and suggestions have been incorporated along the way, he said.

“From Day 1, all participants in the pool have been mandated to become involved with the organization, so no one can say, ‘Hey, you guys made a bad decision,’ but rather, ‘Hey, we made a bad decision,” said Smith, the management consultant for the authority. “The organization is not an insurance company going out to make money. It is a group of cities helping themselves.”

MUNICIPAL LIABILITY INSURANCE RATES

Self- insured Expiration retention date City Year Premium & coverage per claim of coverage CARSON 1984-’85 $55,000 for $20 million $50,000 1985-’86 $230,000 for $10 million $100,000 July 1986 EL 1984 $35,500 for $10 million $50,000 SEGUNDO 1985 $74,500 for $10 million $100,000 Expired GARDENA 1984-’85 $49,000 for $10 million $100,000 1985-’86 $230,000 for $5 million $500,000 Sept. 1986 HAWTHORNE 1984 $40,000 for $10 million $100,000 1985 $117,500 for $10 million $250,000 Expired HERMOSA 1985 $96,000 for $10 million 25,000 BEACH 1986 $147,000 for $1 million $100,000 Dec. 1986 INGLEWOOD 1984-’85 $49,000 for $10 million $500,000 1985-’86 $216,000 for $10 million $500,000 May 1986 MANHATTAN 1984-’85 $17,500 for $10 million $250,000 BEACH 1985-’86 $153,000 for $10 million $250,000 May 1986 REDONDO 1984-’85 $82,000 for $15 million $100,000 BEACH 1985-’86 $482,000 for $5 million $400,000 Oct. 1986 ROLLING 1984 $17,400 for $20 million $2,500 HILLS 1985 $28,500 for $10 million $5,000 Expired TORRANCE 1983-’84 $42,000 for $20 million $250,000 1984-’85 $158,000 for $20 million $500,000 Expired

The self-insured retention is similar to a deductible, except that the city is also responsible for legal and other costs associated with awards that fall within the retention level.

Note: Lawndale, Lomita, Palos Verdes Estates, Rancho Palos Verdes and Rolling Hills Estates are members of the Southern California Joint Powers Insurance Authority. The cities pay varying deposits each year to the authority and receive $10 million coverage. The city of Los Angeles is self-insured.