“Insurance and governance in public-private security cooperation”
(Notes prepared for Panel Session 16.30-18.00: Public-Private Cooperation: Challenges and Opportunities in Security Governance , International Security Forum, 30 May 2011, Zurich)
By Rolf Tanner, Swiss Re
Good afternoon, ladies and gentlemen!
After I had agreed to join this panel, I was wondering what I could add here as the reinsurance man I am. What exciting story would I have to tell as a speaker from an industry which usually is perceived as rather dull and boring?
I have to admit that I am a novice when it comes to the topic of Public Private Partnerships (PPP) in the security area and the governance issues around them. Hence, when preparing for this panel, I went through some of the academic literature on the topic. From what I read, it seems to me that those governance issues are mostly about control (of private sector actors, but also about legislative control of contract-awarding executive and administrative agencies in the public sector), clarity of roles and responsibilities, transparency and accountability. As the notion of security keeps expanding, so does logically that of governance of public-private cooperation in the security area, covering ever more ground.
I discovered there is an abundance of contributions when it comes to the challenges and opportunities, the public sector faces in this type of partnerships. There is, however, comparatively little on the other side, i.e., the private sector, the companies. What I would like to do now here is therefore to focus a bit on the company side and there particularly on how the company-company nexus can play role in addressing governance issues.
Financial intermediaries such as banks or insurers take a special role in this interaction because through their financing operations. They actually ‘enable’ other companies to function. Financial intermediaries therefore have quite some leverage over their company customers and can have considerable impact on their behaviour as such financing like banking loans or insurance claims payments after a loss usually is conditional. The conclusion would thus be that the more companies depend on their financiers, the more leverage have the latter over the first, and the more can the financiers influence their customers’ behaviour by setting the right incentives. This implies that the financiers can play an important role in promoting certain desirable outcomes if they wish so. Specifically, I would like to look at a few points in the coming 20 minutes.
1) What role does insurance play with companies involved in security PPPs and, vice versa, how much are these companies a preferred client segment for the insurance industry?
2) How much can insurance actually be a tool to address the governance challenges of security PPPs from a company side?
3) How much NGO pressure is there on the insurance industry to use its leverage – if there is any – over the private security sector and how much is the insurance industry itself self-regulating interactions with companies operating in security?
1. The security sector as an insurance business opportunity
Let’s start with the first point, namely that about the importance of insurance to the security sector and the attractiveness of this sector to the insurance industry as a client segment.
Companies that are cooperating with the government in the security area have physical assets. They also employ staff. They want to protect themselves against the financial consequences of their loss and harm, and they can do so by purchasing insurance. Moreover, they are incorporated under the corporate laws of their respective jurisdictions and this creates legal liabilities for which again they buy insurance. In many instances, there is a legal obligation to buy certain types of insurance against risk contingencies.
The security industry has been growing strongly over the last, say, 20 years. But in business terminology, the private security sector is still a rather unknown term. To my knowledge, there are no stock market indices covering the private security sector, and there are only a few investment funds that focus specifically on private security sector companies, with most of these funds being private equity funds closed to the broad investment public. This is in contrast to, say, the oil and gas sector, the transportation sector, banking and insurance, or the healthcare sectors, when there is a large number of investment opportunities and vehicles from also for retail investors.
Of course, the security sector includes all sorts of different activities and the ignorance of the term may relate to the fact that the security sector actually encompasses a very mixed bag of companies. Moreover, when we are talking about governance challenge in the context of security Public Private Partnerships, I think we must make an important differentiation between those private public interactions where a private sector company is providing the government with hardware and software so that it can perform its security roles, and those interactions where private sector companies solely or together with the government exercise roles that relate directly to sovereign security provision. The first is a rather conventional supplier-customer relationship, with no or relatively little governance implications, and I think these situations should fall out of scope of what we are discussing here. What is important for us here is where companies exercise, or partly exercise roles that can be described as essential to sovereign security provision. Hence, when private companies run prisons, for instance, or protect key parts of national critical infrastructure, they are in such a role and thus they fall in scope of our discussion here.
Admittedly, this differentiation between these two roles is not always easy when it comes to the practical world. There certainly is a large, and probably expanding grey zone between security sector companies as mere suppliers and as sovereign security providers or co-providers. And there are many companies that are involved in both roles and where their revenue would have to be split between these two roles in order to do the right analysis, which, in practical terms, is mostly impossible for outsider observers. Still, I think when we are talking about governance we should much this differentiation in order not to confuse apples and pears.
Having the security sector defined in this way, the estimate of its size does not become easier. I have to done some research into the matter but could not come up with reliable figures. The situation looks slightly – only slightly – better when we look at some sub-segments of the security sector, among them the attention-grabbing private security companies. Are they big business? The Stockholm International Peace Research Institute (SIPRI) estimated in 2005 that the global revenue base for private security companies was US$ 100 bn. Just for comparison: A revenue of US$ 100bn is a bit less of what the largest food company – Nestlé – has. The Washington DC-based Centre for Public Integrity asserted in 2006 that up to this point in time, US private security companies has cumulatively received nearly US$ 50bn for their services in Afghanistan and Iraq. Business week, a business magazine, estimated in the same year that the US had spent almost US$ 104 bn on contracts with security services over the last few years. I checked the figures for the very few security companies that are actually listed on a stock exchange. Dyncorp, first instance, had revenue of a bit more than US$ 3 billion in 2010 and a loss of US$ 5.5 million ; G4S had a turnover of £ 7.4 billion and a profit of £ 527 million. The GEO Group, a leading private prison operator, has total revenue of slightly more than US$ 1bn and a profit of US$ 66 million in 2009. To be sure, some of these companies have healthy margins, so this makes them companies good stocks to invest in. But in terms of size, frankly, they are not huge.
As said, the data situation regarding the entire security sector is deplorable. But I dare to give the preliminary assessment that the private security sector is, at least if compared to other sectors, neither very big nor especially profitable. When talking about commercial opportunities for the insurance industry or any other industry, size does matter, and so does profitability. Hence a first conclusion may be that the security sector does not look like a huge commercial opportunity to the insurance industry, and it does not look like an overly promising client segment either.
There are other elements about security sector companies which we need to bear in mind. Many companies in the security sector, and this also applies to the private sector companies, are small and privately-held. Privately-held companies, however, by nature tend to purchase less insurance than companies that are publicly held. They often do not like the scrutiny and the transparency that go with purchasing insurance. There may be legal requirements for insurance, and where there are such requirements, they will purchase insurance. But private companies normally use insurance much less as a capital management tool than publicly held companies do. Privately held companies prefer self-insurance, i.e., building their own financial reserves to cope with liability and loss scenarios. All this would seem to me adding to the security sector not being a primary client segment for the insurance industry.
The security sector’s reticence to purchase insurance tends to be mirrored by the insurance companies’ reluctance to sell their products to this sector. Insurance companies prefer industries that are transparent and open to sharing information willingly. This is normally not the case with the security sector. Additionally, the high fragmentation of the security sector makes it a difficult target. The relatively small size of companies fits ill with the key account management system prevalent at least with the larger insurance companies when it comes to dealing with corporate clients.
There is one final, important aspect when it comes to the security sector: Many insurers are cautious when it comes to what one could call political risks. In order to be insurable, risks should be subject to as little human agency as possible and they must meet such criteria as randomness of event occurrence, the possibility to calculate an average loss, a relatively high frequency of occurrence of events, manageable moral hazard and others. Business with governments, or with companies that are assuming roles that formerly were exercised by governments, but still are subject to government oversight, seem to come pretty close to what you could label a political risk.
Now, having said this all, of course there is insurance business with the security sector, with the companies operating as the private sector counterpart of governments in security PPPs. Over the last few years, I have seen a number of such cases. There are now specialised brokers and consulting firms that help security sector companies to find insurance coverage and capacity easily. Traditionally, it would seem that the English-speaking world always had a more relaxed attitude when it comes to selling insurance to security sector companies. In the US and the UK, it was always morally and ethically more acceptable to serve the security sector, probably reflecting their pioneering status when it comes to privatisation of former government activities. The general surge of the security business after 9/11 lowered the barriers further. Now selling insurance to private security companies has became pretty normal in the US and UK, though it is still less so in continental Europe. Quantification of the business, however, remains impossible.
 Heiner Hänggi. „Making Sense of Security Sector Governance.” Challenges of Security Sector Governance. Edited by Heiner Hänggi and Theodor H. Winkler. Geneva Centre for the Democratic Control of Armed Forces. Münster, LIT, 2003, pp. 5-7
 Sarah Percy, Regulating the private security industry. Adelphi Paper 384. International Institute of Strategy Studies, 2006; pp. 21f.
 For the criteria of insurability, see “Innovating to insure the insurable.” Sigma 4/2005. Zürich, Swiss Re, 2005; p. 5. Available at: http://media.swissre.com/documents/sigma4_2005_en.pdf