Risk pooling: is the time up?

Frank Randall asks whether international risk pools are reaching the end of their usefulness in Europe

In Europe, the idea of cross border risk pooling dates back 45 years. Originally, the pools provided companies operating in two or more countries with a way of circumventing artificially high insurance costs, caused usually by a mix of local legislation, insurance company ‘cartels’, tariffs or other legal and commercial obstacles.

By linking together subsidiaries’ insurance contracts, claims experiences could be combined, resulting in advantages such as cost savings, improved management information, better underwriting terms and expatriate facilities.
For their part, insurers accepted the idea of smaller profits in order to secure larger volumes on offer from
a rapidly growing number of multinational companies.

For almost five decades, the trade-off worked well enough. Today, there are nine separate risk pooling networks, offering increasingly sophisticated arrangements and handling an estimated USD7bn in premiums, covering hundreds
of countries across the globe.

Now, however, it seems risk pooling might be under threat. There are signs that insurers in Europe are reconsidering the whole system and maybe using the potential of current EU legislation over the next five to ten years to remove the need for risk pooling altogether. As they do, Europe’s vision of a more integrated, single market for both life insurance and pensions could come a step closer to reality.

But why change a system that has proved such a success? Much of the impetus is coming – directly and indirectly – from globalisation. Recent years have seen an explosion in the number of genuinely global companies, with the centralised management required to adopt a truly global approach to the provision of pensions and employee benefits.
If anything, in the coming years, the pace of globalisation is likely to increase rather than slow down, particularly with the emergence of economic powers such as India and China. Nowhere is this trend more visible than in Europe: here,
as part of broader efforts to create a genuine single market economy, national governments have approved legislation that supports cross-border operations, not least in the financial sector. It is precisely this trend that is allowing European insurance companies to rethink the old risk pooling set-up.

That said, much of the push away from risk pooling and toward a new system is coming from multinational companies themselves. As they become more international, they need to be able to provide employee benefits – pensions in particular – in several countries simultaneously. Moreover, as the world economy becomes ever more competitive, there is constant pressure to improve efficiency and find new ways of saving money and a more integrated, harmonised approach offers that.

In the past few years, these factors have spawned a new market for asset pooling. So far, only Europe’s corporate giants, the likes of Unilever, Shell and BP, have been able to take advantage. But, the coming years will undoubtedly see further developments in this area.

For multinational companies, asset pooling offers similar benefits to risk pooling, giving them greater visibility and control over their financial risks and more transparent management of their administrative costs. But, it has one additional advantage: while risk pooling deals with a ‘known’ expense – insurance premiums – asset pooling gives the multinational CFO a way of managing an unknown, by matching up their pension assets with their pension liabilities. This is a very considerable advantage. With rapidly ageing workforces and volatile share prices, recent years have shown how quickly pension liabilities at leading corporations in Europe can mount.

For years, Europe’s insurers have had at their disposal legislation that allows a more pan-European approach to pension and life insurance provision, but it is only now that they are waking up to its potential. Under the EU’s Third Life Directive, insurance companies can sell products and services – including pensions – throughout the 27-member EU from a base in one single country; something that would obviate the need for risk pooling in the future. This is an important step beyond previous legislation, particularly the First and Second Directives which didn’t specifically encourage pan-European risk or pension products.

With national governments also pushing for greater uniformity, some insurers are already using the possibilities of the Third Life Directive to work on just such a pan-European risk product which could be sold from a single country. As demand grows, other insurers are sure to follow suit.

Of course, the process is still in its infancy. Some very real obstacles still need to be navigated, not least how to arrive at a single price for the whole of Europe and how to rate varying levels of morbidity or mortality across the board. If the concept of a single-priced life insurance contract takes off, however, expect to see more pan-European products come onto the market in the years ahead, and an increasingly sophisticated and tailored approach to pan-European solutions on the part of leading insurers. Gradually, then, the need for risk pooling would fade and while the practice would continue for other parts of the world, in Europe risk pooling could wither away entirely.

It is clear that the significance of what is currently happening could well reach beyond risk pooling itself. For years, Europe has been striving for a single market in pensions, as part of broader efforts, of course, to create a single market in financial services as a whole. For Europe’s insurers and pension providers, the Third Life Directive may offer a way forward.

For Europe’s employers, the advantages of a ‘pan-European pension’ are obvious: more transparent management of risks and liabilities, the possibility of greater cost control and enhanced employee mobility. For insurers, too, there are benefits, not least regaining the profit margin implicitly lost when risks are pooled and the risk premium reduced to the lowest common level.

So far, however, progress toward pan-European pensions has proved tricky. Thanks to a mix of national sensibilities, concerns over tax legislation, the difficulties associated with translating reform into change on the ground and the unavoidable realities of politics, change has been far from straightforward.

However, there are now signs of very real movement. Asset pooling, certainly, is one possible route to a pan-European pension. As more multinational companies follow the example of Unilever and its peers, it seems reasonable to expect these companies will begin to cluster together their pension assets and liabilities in Europe. Eventually, that could lead to an ‘end game’ in which companies are increasingly willing to bring everything under one roof, making the final transition to genuine, pan-European pension plans for their employees. If all went well, the result would be a structure that would allow companies to pursue pan-European investment policies but still cater to employees’ local needs and requirements.

The EU already has legislation in place to help multinationals that have already started to think along these lines: the Occupational Pensions Directive which provides for the establishment of pan-European pension funds, known as Institutions for Occupational Retirement Provisions, or IORPs. The problem is that the Directive hasn’t proved universally popular. It carries with it additional social and labour charges, especially for those EU member states that currently have lower than average employment costs. As an alternative, insurers are finding they can turn back to the Third Life Directive. By allowing insurance companies to provide not only a single-priced pan-European life product, but also insured pensions and group insurance cover from a single location within the EU, the Third Life Directive could prove, for employers, a more logical route to a pan-European pension plan for their workforces.

Naturally, there is a long way to go before any of this happens. The idea of providing risk product or pension product across Europe has still to be tested – both commercially and legally. Nevertheless, the trend is clear enough. Increasingly, Europe’s insurers and its leading multinationals are thinking pan-European and looking for ways – and legislation – to put their pan-Europeanism into practice.

Written by Frank Randall, Global Sales Director, AEGON Pension Network