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Shared-Risk Insurance Pools for Transit Agencies: A Guide (2023)

Chapter: Chapter 2 - Transit Insurance Basics

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Suggested Citation:"Chapter 2 - Transit Insurance Basics." National Research Council. 2023. Shared-Risk Insurance Pools for Transit Agencies: A Guide. Washington, DC: The National Academies Press. doi: 10.17226/27419.
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Suggested Citation:"Chapter 2 - Transit Insurance Basics." National Research Council. 2023. Shared-Risk Insurance Pools for Transit Agencies: A Guide. Washington, DC: The National Academies Press. doi: 10.17226/27419.
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Suggested Citation:"Chapter 2 - Transit Insurance Basics." National Research Council. 2023. Shared-Risk Insurance Pools for Transit Agencies: A Guide. Washington, DC: The National Academies Press. doi: 10.17226/27419.
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3   2.1 Why Transit Insurance? Insurance is essential to transit agencies because it protects them against the risk of unusu- ally large losses (e.g., from a series of accidents or a single catastrophic accident) that would impose unacceptable costs on the organization. Imagine the impact if 2 years of large payouts for a multimillion-dollar accident resulted in a reduction of bus frequency and abandonment of route sections to avoid borrowing cash for the upcoming year’s operations. The extent of these unpredictable swings in liability expenses requires either the purchase of insurance or the sharing of risk. In states with strong and effective sovereign immunity laws, the need for insurance may not be as great because such laws provide for the sovereign status of state governments to limit an operating agency’s maximum liability for an accident. 2.2 What Is a Transit Shared-Risk Pool? In this Guide, a shared-risk insurance pool is a group of government entities that provide transit service in a state (organizations) with the shared goal of improving how they manage their exposures to risk of loss and lowering their total cost of risk. For organizations not large enough to feasibly self-insure (by setting aside cash to cover potential losses individually), the pooling of risk (by pooling cash to cover potential losses among multiple organizations) can be an effective alternative to commercial insurance to achieve these goals. Risk-sharing means that the contri- butions and losses of each member of the pool are allocated based on a predetermined formula and subject to certain operating conditions such as implementing programs to limit individual exposure [bus driver training, human resources (HR) support, closed-circuit television on the buses to record accidents, and so forth]. 2.3 What Are the Alternatives to Transit Shared-Risk Pools? The principal alternatives to a pool are as follows: • Commercial insurance: The purchase of commercial insurance through a broker or agent for all losses above a retained amount [self-insured retention (SIR)]. SIRs for transit organizations range from $0 to $1,000,000+. The primary insurer may purchase additional insurance to obtain higher limits (excess insurance) or to spread its risk of loss (reinsurance). The primary insurer pays the cost for excess or reinsurance beyond the initial premium paid by the transit organization; the cost of insurance to the transit organization is not affected by the excess insurance or reinsurance. C H A P T E R 2 Transit Insurance Basics

4 Shared-Risk Insurance Pools for Transit Agencies: A Guide • Captive insurance: A captive insurer is a legal organization whose insurance business is pri- marily supplied and controlled by its owner and affiliates, who are its principal beneficiaries. A captive insurer has the same legal restraints and limitations as a commercial insurer. Municipal risk pools exemplify captive insurers that may be available to transit agencies. • Self-insurance: Self-insurance involves setting aside reserves large enough to provide confi- dence to the agency that it will be able to cover most upward swings in loss expenses; these self-insurance reserves are generally supplemented by the purchase of excess coverage insur- ance policies to stop the losses when they exceed the agency’s reserve capacity. These excess coverage policies typically cover losses between $2,000,000 and $10,000,000 annually with upper coverage limits of $10,000,000 to $50,000,000 annually. 2.4 How Do Pools Operate? Pools are funded through contributions (called premiums in commercial insurance) that pro- vide insurance-like coverage. Pools generally issue coverage documents tailored to the specific needs of their members. Coverage documents rely on contract law, while standard insurance industry forms rely on insurance law. Contract law is more widely understood, which helps streamline claims management. Unless state law requires it, this Guide recommends pools issue coverage documents rather than standard insurance industry forms of coverage. This Guide will use the term “coverage documents” in place of “insurance policy.” Pooling of risk allows pool members to confidently replace commercial insurance coverage with pool coverage when commercial insurance is not consistently or economically available. Figure 2 represents how pool contributions are used in combination with commercial insurance covering the highest risks. In general, risk pooling does not replace, but supplements, com- mercial insurance. Contributions are used to pay claims and claim-related expenses and do not constitute an equity interest. The pool generally does not materially reduce the total losses (such as the payouts to claimants.) Also, the pool does not materially improve interest earnings on reserves held to protect against risk. However, as the Guide sets out in Section 3.1.3, the pool can reduce overhead costs, such as marketing expenses and administrative costs (underwriting expense) when compared to each agency purchasing its own commercial insurance. Figure 2. How contributions are used.

Transit Insurance Basics 5   2.5 Why Is the Insurance Cost Cycle Important? Insurance industry pricing cycles between soft and hard market conditions (see Figure 3). A controlling factor in the insurance cycle is competition within the industry. In the cycle’s down phase (soft market conditions), premium rates drop as insurance companies compete to increase market share. In the up phase (hard market conditions), competition is less and the availability of commercial insurance is limited by the deletion of capital, with premiums rising as a result. The prospect of higher profits draws more money into the marketplace, leading to more competition and the inevitable down phase of the cycle. The insurance cost cycle has a significant impact on the availability and cost of transit insurance, reducing the stability and predictability required by the budgeting process of most government entities. Figure 3. Insurance industry cycle between hard and soft markets.

Next: Chapter 3 - Phases to Create and Operate a Transit Pool »
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Transit agencies are finding it increasingly difficult to find, purchase, and maintain adequate and affordable insurance coverage for public transit vehicles. The number of smaller insurance providers is decreasing due to the volatile nature and demands of the insurance industry and insurance coverage requirements in general.

NCHRP Research Report 1079: Shared-Risk Insurance Pools for Transit Agencies: A Guide, from TRB's National Cooperative Highway Research Program, explains how insurance pools function, how to evaluate the feasibility of a shared-risk insurance pool, and how to establish and manage this type of pool.

Supplemental to report is a presentation and NCHRP Web-Only Document 374: Developing a Guide to Shared-Risk Insurance Pools for Transit Agencies: Conduct of Research Report.

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