Slide 1

Professor Michael Mainelli, Executive Chairman, The Z/Yen Group

[An edited version of this article appeared as "Procurement Pretensions Prevent Proper Partnerships" University Business, Procurement Special, Wildfire Comms (March 2012), pages 10-11.]

Procurement processes in many sectors throughout the UK have frustrated Z/Yen, the City of London’s leading commercial think tank. Professional procurement is an important and useful process that should lead to better purchasing decisions, value for money and cleaner, i.e. less corrupt, practices. Yet, sadly, procurement processes are often bureaucratic nightmares of Kafkaesque terror and Catch-22 absurdities.

Some recent work with UK Higher Education Institutions (HEIs) on greater efficiency made us wonder if they were wilfully obstinate about mutual insurance procurement. Mutual insurance is a venerable and widely used form of risk management, constituting for example the vast bulk of marine P&I insurance. Starting a mutual insurer can be problematic, but there are already two significant mutuals among UK HEIs, UMAL (University Mutual Association Limited - general risks) and UMSR (University Mutual Special Risks - terrorism).

At first glance, mutual insurance is alive and well in HEIs. Of 149 HEIs (excluding private and Northern Ireland institutions), 34 belong to UMAL (22%) and 98 belong to UMSR (66%). Oddly though, HEIs that belong to procurement clubs such as LUPC (London Universities Purchasing Consortium) or APUC (Advanced Procurement for Universities and Colleges, Scotland) are far less likely to be members of a mutual, UMAL in particular.

  AUPC – 18 HEIs LUPC – 45 HEIs
UMAL members 0 5 (11%)
UMSR members 6 (33%) 28 (62%)

UMSR membership shows that procurement club HEI members can and do use mutual insurers, but UMSR current membership strength is largely due to historic reasons after 9/11; UMSR stood out for providing terrorism cover HEIs couldn’t get elsewhere. Of the 86 HEIs that do not belong to a procurement club, membership of UMAL is 29 (34%), while procurement club membership is either 0% or 11%. Is there a paradox here that mutual insurance is fine if you have no choice, but otherwise commercial insurance procurement is better?

If commercial insurance procurement is better, that’s a bit strange. For organisations that stay in the same business over long periods of time, mutual insurance is normally a better choice. First, mutual insurance provides much more information sharing leading to better risk management. Second, mutual insurance provides smoother charges and lower charges over the long term. To take some real numbers, let’s look at a not-so-mythical HEI in 2005-2006 with an average claims record. Its declared property value might be £250M; its wage roll might be some £45M. Its mutual contribution might be some £250,000 (0.1% of property or 0.6% of wages). By 2010-2011 its property value might be 80% higher at £450M while its wage roll might be about 30% higher at about £60M. Its mutual contribution would be about £400,000 (less than 0.1% of property or about 0.7% of wages). This looks wonderfully stable but, third, when there is a surplus, over the same period a mutual typically returns that surplus, in this case about £225,000 over the five years, i.e. enough to drop the annual headline rate by about 15%. And in this particular case, the reserve surplus was an additional £500,000 still undistributed, or just over a year’s worth of contribution in reserve. So how can savvy procurement clubs be avoiding UMAL?

Sadly, procurement processes seem to be part of the problem rather than the solution. In Z/Yen’s work we emphasise that good procurement should, “set criteria for procurement, but in most cases ‘window shop up front’ so that valid criteria can evolve and emerge.” [Harris, Mainelli & Jones, 2008] The HEI procurement clubs we’ve seen in action do the opposite. Aware that there are brokers and underwriters, they tender for insurance brokers and underwriters, rather than look at risk management. Let’s look at seven criteria they miss by issuing invitations to tender without ‘shopping’:

Where do profits go?Commercial shareholdersMembersHow do we learn about risk management?Little evidence of shared learningMutuals are incentivised to raise membership knowledge and standardsIs there discretionary cover?Claims not covered by the policy can be declinedClaims not included in the cover wording can be adjudicated by the Board and are often paidWhat is included in the price, e.g. risk surveys or claims handling?Additional charges payableSuch services included in price

Evaluation Criteria Insurance Company/Broker Mutual
Is data released by brokers? Insurers buy information Information held by the mutual for members’ benefit only
Who owns the reserves? Commercial shareholders Members
Who gets commission? Purchasing consortia often take a percentage of premiums payable Institutions join mutuals directly without commission or joining fees

There are numerous other ways in which procurement clubs unthinkingly discriminate against mutuals, for instance insisting on a local office or asking for the pricing of separate lots as part of tendering and failing to look at the aggregate value for money, but three particular problems are worth noting. First, invitations to tender often insist that applicants be authorised by the Financial Services Authority in accordance with the provisions of the Insurance Companies Act – sounds great, but not necessary for mutuals. Second, applicants must have a credit agency rating – leaving aside cheap shots about the value of these ratings in the first place, it’s not the mutual that matters, but the underwriters they in turn use for the catastrophe losses. Third, mutuality is about long-term partnership, collegiality, things that HEIs should treasure. But in reality these values, sharing information and learning, are not valued in scoring criteria.

Procurement needs to be well-run, providing value-for-money through above-board processes. Poor thinking turns any process into one that drives out innovation and learning – procurement is no different. The challenge is for UK HEIs to look more critically at why their own procurement processes let them down, all too professionally, and start to learn through shopping rather than buying. Why not start with a critical look at discrimination against the mutual solution?

Further Reading

Professor Michael Mainelli PhD FCCA FCSI, originally undertook aerospace and computing research, followed by seven years as a partner in a large international accountancy practice before a spell as Corporate Development Director of Europe’s largest R&D organisation, the UK’s Defence Evaluation and Research Agency, and becoming a director of Z/Yen, the City of London’s leading commercial think-tank. Michael is Emeritus Professor of Commerce at Gresham College and a Visiting Professor at the London School of Economics & Political Science. “The Price of Fish”, Michael’s recent book on solving the world’s wicked problems, including procurement, has been widely acclaimed.