DMF feasible, but scale a must
Business ManagementManaging apple and pear industry business risks through a Discretionary Mutual Fund (DMF) is feasible but will need broader industry commitment to achieve the scale required, a preliminary study has shown.
Justin Niven from KJ Risk Group, which conducted the feasibility study, told attendees at a DMF workshop preceding the January APAL Post-harvest Seminar in Shepparton that a DMF offered industry the long-term opportunity to both reduce costs through the sharing of risk and to incentivise better risk management across industry. But he said it would need at least $20 million in annual premiums to be viable.
(lt) Basic DMF aggregate structure. (rt) An example of the apple and pear industry DMF based on the data collected during the feasibility study, the claim amount is $1.4m therefore a surplus would be expected with the amount totalling $2.8m.
“We would need five times the number of growers who participated in the feasibility study to get it off the ground,” he said. “The final deal would then have to be agreed with the insurance market and that process has been slowed down by the bushfires.”
He estimated that if sufficient scale is achieved, it could take 12 months to establish the fund. In the short-term Justin said opportunities already existed for significant savings on several insurance categories through group buying (see below).
The DMF feasibility study highlighted the 44 businesses that
provided meaningful data paid $4,176,736 in insurance premiums in 2018, with their five-year claim average sitting at $1.4 million. It’s important to note the claim data included one large bushfire, a catastrophic loss. Actual working losses are a much lower average.
The 44 businesses that took part in the feasibility study collectively pay more than $4 million a year in premiums. Their five-year claim average is just over $1 million.
Justin said a DMF was essentially the creation of an insurance company owned by and operating for the apple and pear industry. It would replace traditional property and liability insurance –property premiums have been escalating due, in part, to concerns over the fire risk of commonly used expanded polystyrene (EPS) insulation panels.
“Your [the apple and pear industry’s] EPS risk is not well understood,” Justin said.
A DMF would not necessarily mean lower premiums initially. Premiums, or contributions, not paid out as claims would accrue in the fund as a surplus and could be used at the discretion of the fund to benefit industry through driving improved risk management, reduced future premiums or development of complementary products. The fund would not bear all the risk however as it would insure against catastrophic or excess of loss (XOL) beyond a pre-determined limit with an external underwriter.
Justin said interest in partnering with industry on a DMF had already been received from an international insurance underwriter.
“We need to purchase catastrophic risk protection, or excess of loss cover, which is where the underwriter comes into play,” he said.
But he said the need to demonstrate responsible risk management to underwriters meant potential fund members would also need to demonstrate risk management.
“For it to succeed the initial structure needs to be managed which will help give the XOL insurer confidence that the DMF will drive risk management,” he said.
“There is a strong need to develop a relationship with the XOL insurer, reassuring them that not just anybody would be admitted into the DMF.
“It wouldn’t be a ‘no’ [to applicants], it would be a pathway,” he said.
When structured correctly, Justin said the XOL model created a situation where everybody wins.
“Members control their risk, capture underwriting profit and reduce costs,” he said. “And the insurers attach at a point above the majority of losses – making the business more profitable as less administration is required.
“Additionally, you might expect the DMF to breach the aggregate and make an XOL claim once in five years, so the insurer can make a return on their XOL in the good years, while the industry is covered for the years with a greater incidence of claims.”
Layers of risk in insurance
In general, insurance works by spreading the cost of unexpected risks among a large number of people in the same region who share similar risks. The money paid on an insurance policy is pooled
with the premiums paid by other policy holders. Once a claim is made by those policy holders, the pool of funds is used to pay the person claiming up to the limit selected on their policy. Purchasing insurance means that in times of damage or loss, the policy holder is less likely to be left to pay the full cost on their own, which could create a financial crisis. The website understandinsurance.com.au states there are more than 120 insurers licensed to do business in Australia. Each of those insurers purchase reinsurance to transfer catastrophic risk, the same way the XOL operates for a DMF.
These diagrams show the layers of risk in insurance and highlight which layer the Discretionary Mutual Fund (DMF) would specifically cover.
Group buying opportunities
While property, liability, machinery and potentially crop protection can be covered under a DMF, some products are better suited to group purchasing arrangements, such as:
- management liability (including directors’ and officers’ insurance),
- motor vehicle,
- travel
- cyber
The feasibility study has outlined that businesses are paying a range of rates – some higher and others lower. Group buying would involve appointing a single insurer to cover the group for specific categories. Justin said while individually each business needed full cover, the risk of every business claiming in the same year was minimal, so the aggregate sum insured as a group could be less than the sum of each individual cover, reducing premiums.
Group buying could proceed before, or regardless of whether, a DMF is set up. And a central administrator would manage invoicing and claims for all policies held by a business, including the DMF, enabling a simple, single invoice and claim management process.
Workers compensation
There is an additional opportunity for businesses in Tasmania, Western Australia and the Australian Capital Territory to negotiate better terms on workers compensation premiums as workers compensation is underwritten in these states/territories (and in Northern Territory). This means a broker can negotiate terms for the businesses in these areas. The Government still controls workers compensation in the remaining states, ruling out negotiation at this time.
KJ Risk Group has completed a case study for one of their clients, a large WA-based buying group, to highlight the savings they’ve made through their workers compensation program within the last two years.
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Next steps:
Phase 2: Any business seriously interested in participating in the DMF who haven’t provided their information, or would like to update the data already provided, please do so now by submitting an expression of interest or contacting Alan Limpyer, AB Phillips: 03 8586 9333 or [email protected].
Phase 3: Once additional data is received, KJ Risk Group will complete negotiations with the XOL insurer.
Phase 4: Financial modelling and sign off completed with accountant and lawyer input.
Phase 5: Implementation – the DMF will be created , guidelines and entry requirements set, Board selection and membership process completed.
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New podcast series
To continue exploring risk factors in the industry, following the Risk Management workshops last year, APAL has developed a five-part podcast series on a range of business-related issues. The series of ultra-short podcasts covers five key topics:
Crisis Management 101: Rachel Mackenzie, Berries Australia
Managing Change: Rob Blakey, Stemilt
Traceability: David Ironside, Australian Government Department of Agriculture and Water Resource
Embracing Energy Efficiency: Justin McFarlane, Rethink Sustainability
Netting: Jeremy Griffith, APAL
