GAD support for government management of uncertain liabilities

The government has faced unprecedented financial exposure due to the COVID-19 pandemic. This highlights the need to understand and, to the extent possible, mitigate the risks to which taxpayers are exposed at all levels.

As a risk management specialist and actuarial advisor to government, the Department of the Government Actuary (GAD) has a key role to play. This article discusses GAD’s support for ongoing government work to plan, monitor, and manage risk.

The government as the insurer of last resort

The government will often use guarantees and insurance to protect citizens against unexpected risks and to support the economy. This may involve stepping in when private insurance is unavailable or unaffordable and filling the void.

At the individual level, this may be necessary to ensure the financial security of those affected. Or on a macro scale, the government can intervene to ensure the stability of the economy in times of stress.

Management of contingent liabilities

One type of key risk is contingent liability. These are defined as expenses that may or may not need to be covered at some point in the future, depending on the outcome of uncertain events.

According to Her Majesty’s Treasury Guidelines for the Management of Public Money, departments must obtain approval before making commitments that could lead to future expenses, such as assuming contingent liabilities. As part of the HM Treasury Contingent Liability Approval Framework departments are required to complete and submit a checklist for certain contingent liabilities.

GAD has helped several departments assess the risks and costs of contingent liabilities considered since the framework was introduced in 2017, including:

• help the Department of Business, Energy and Industrial Strategy understand the potential costs of the trade credit reinsurance program that was introduced to ensure that trade credit insurance coverage and credit limits are maintained for the COVID-19 pandemic

• help the Department of Digital, Culture, Media and Sports model and understand the potential costs of the film and television production restart program, which was introduced to support production companies struggling to gain insurance for costs related to COVID-19

• advise the Cabinet Office on the potential costs of compensating designers and manufacturers of fast-manufacturing ventilation systems, which were purchased as part of the government’s response to the COVID-19 pandemic

Plans to improve the management of contingent liabilities

In an ever-changing world, it is important for government to monitor and understand the evolving nature of the risks to which it is exposed.

Her Majesty’s Treasury has long recognized the importance of improving the management of contingent liabilities. In March 2020, they released the The State as insurer of last resort: management of contingent liabilities in the public sector report which contains proposals to improve the management of guarantees and insurance provided by the government. GAD played a key role in developing the proposals, with the objectives of:

1. improve expertise in government quantify and price the risk
2. improve pay that the government receives for the risks it assumes
3. establish incentives reduce both the likelihood of the risk occurring and the cost when it occurs
4. clarify ownership of risks provide more certainty as to how costs will be shared between ministries, the Exchequer and the private sector

At the heart of these proposals is the creation of the new “Core Contingent Liability Capability” (PLC), which was approved and funded as part of the 2020 Expenditure Review.

The CLCC will support ministries in the assessment, pricing and management of guarantees and insurance, and will monitor and report on the government’s overall risk portfolio related to contingent liabilities.

GAD is proud to have been selected by HM Treasury to partner with UK Government Investments to establish the CLCC in 2021 – read more here.

Set up incentives

A pervasive concern when offering compensation is the danger of “moral hazard”. This is the danger that people or organizations will be more willing to engage in riskier behaviors because they feel safe knowing that someone else, like the central government, will cover the cost.

Therefore, the challenge of managing contingent liabilities within the public sector is not only to ensure that adequate compensation is provided at a fair cost to the taxpayer, but also to ensure that there is adequate incentives to encourage prudent behavior.

Public / private and property risk sharing

As the term “insurer of last resort” suggests, risks should be covered by the private sector to the extent possible. The report “Government as insurer of last resort” suggests that when full commercial coverage is not viable, public / private risk sharing may be a solution. GAD has extensive experience working under such agreements, including:

• Support HM Treasury in its oversight of Pool Re. This is a private sector solution founded in cooperation with HM Treasury. Pool Re seeks to enable the UK insurance market to underwrite terrorism risks at rates reflecting the risk.
• Assist the Ministry of Environment, Food and Rural Affairs in monitoring floods. Flood Re is a joint initiative between the insurance industry and the government that makes flood coverage more widely available and affordable as part of home insurance protection.

In each example, the scheme offers a guaranteed reinsurance option to insurers, allowing the private insurance sector to continue to take risks.

Evolutionary risks

While 2020 hasn’t taught us anything else, it has shown the importance of managing risk nationally.

This highlights the need for those responsible for the national purse strings to have as clear an understanding as possible of the potential financial impacts of the risks and contingent liabilities facing the government. GAD risk management experts will continue to help the government achieve this goal.

(For more on this topic, see our blog on The Changing Face of Public Sector Insurance)