Guidance

GAD support for government’s management of uncertain liabilities

Published 18 December 2020

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This publication is available at https://www.gov.uk/government/publications/gad-support-for-governments-management-of-uncertain-liabilities/gad-support-for-governments-management-of-uncertain-liabilities

The government has faced unprecedented financial exposure as a result of the COVID-19 pandemic. This brings into sharp focus the need to understand and where possible mitigate the risks taxpayers are exposed to across the board.

As risk management specialists, and actuarial advisers to government, the Government Actuary’s Department (GAD) has a key role to play. This article discusses GAD’s support for government work being done to plan for, monitor and manage risks.

Government as insurer of last resort

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

On an individual level, this may be necessary to provide financial security for those affected. Or on a macro scale, government may step in to provide stability for the economy in times of stress.

Stack of coins in the centre of a toy life belt

Managing contingent liabilities

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

Under HM Treasury’s guidance for managing public money departments must obtain approval before making commitments which could lead to future expenditure, such as taking on contingent liabilities. As part of HM Treasury’s Contingent Liability Approval Framework departments are required to complete and submit a checklist for certain contingent liabilities.

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

  • helping the Department for Business, Energy and Industrial Strategy to understand the potential costs of the Trade Credit Reinsurance Scheme which was introduced to ensure that trade credit insurance coverage and credit limits are maintained during the COVID-19 pandemic

  • assisting the Department for Digital, Culture, Media and Sport to model and understand the potential costs of the Film and TV Production Restart Scheme, which was introduced to support production companies struggling to secure insurance for COVID-19 related costs

  • advising the Cabinet Office about the potential costs of providing an indemnity to designers and manufacturers of Rapidly Manufactured Ventilator Systems, which were procured as part of the government’s response to the COVID-19 pandemic

Image shows several rows of medical ventilators.

Plans to improve contingent liability management

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

HM Treasury has long recognised the importance of improving the management of contingent liabilities. In March 2020 they published the Government as insurer of last resort: managing contingent liabilities in the public sector report that contains proposals to improve the management of guarantees and insurance provided by government. GAD played a key role in developing the proposals, with objectives to:

  1. improve the expertise within government to quantify and price risk
  2. improve compensation which government receives for risks it takes on
  3. establish incentives to reduce both the probability of the risk materialising and the cost when it does
  4. clarify risk ownership to provide more certainty surrounding how the costs will be shared between government departments, the Exchequer and the private sector
Blurred image of a man facing the camera as he ticks a vertical row of boxes

Central to these proposals is the establishment of the new ‘Contingent Liability Central Capability’ (CLCC), which gained approval and funding in Spending Review 2020.

The CLCC will support government departments in the evaluation, pricing, and management of guarantees and insurance, and monitor and report on the government’s overall portfolio of risk from contingent liabilities.

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

Establishing incentives

An ever-present concern when offering indemnity is the danger of ‘moral hazard’. This is the danger that people, or organisations, will be more willing to engage in riskier behaviour because they feel safe in the knowledge that someone else, such as central government, will cover the cost.

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

Public / private risk sharing and ownership

As the term ‘insurer of last resort’ suggests, risks should be covered within the private sector wherever possible. The ‘Government as insurer of last resort’ report proposes that where full commercial coverage is not viable, public / private risk sharing can be a solution. GAD has extensive experience working within such arrangements including:

  • Supporting HM Treasury in its oversight of Pool Re. This is a private sector solution founded in co-operation with HM Treasury. Pool Re seeks to enable the UK insurance market to underwrite terrorism risks at risk reflective rates.
  • Assisting the Department for Environment, Food and Rural Affairs in monitoring Flood Re. Flood Re is a joint initiative between the insurance industry and the government that makes flood cover more widely available and affordable as part of home insurance protection.
Flooded lounge. The TV, chair and sideboard are all in the water and a plastic duck is floating on the floodwater.

In each example the scheme provides a guaranteed reinsurance option to insurers, enabling the private insurance sector to continue taking on risk.

Evolving risks

If 2020 has taught us nothing else, it has shown the importance of managing risk on a national scale.

This drives home the need for those in charge of the national purse strings to have as clear an understanding as possible of the potential financial impacts of risks and contingent liabilities faced by government. GAD risk management experts will continue to support government to achieve this.

(For more on this topic see our blog on the Changing face of public sector insurance)

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