Managerial use of debt to fund municipal government risks

In recent years, managers of municipalities have been forced to reevaluate the cost-effectiveness of their risk management strategy. In many cases, individual or groups of municipalities (pools) finance a self-insurance plan through the issuance of debt. However, no decision-making methodology for cost-effectively structuring the debt issue presently exists. Utilizing a math programming model, we examine a self-insurance alternative to conventional insurance that uses tax-exempt debt supplemented by taxable borrowing to finance a municipality's or pool's liability exposure. We implement our optimization model with actuarial and financial data from an intergovernmental risk pool in the state of California, and simulate the effect of the trade-offs important to sound managerial decision making. We find that significant savings are realized by using a self-insurance plan rather than purchasing conventional insurance. We also find that managerial goals and risk preferences impact the decision when revenue flows are insufficient by themselves to reasonably fund expected losses.