PARTNERSHIP CAN HELP MEASURE TOTAL COST OF RISKPosted On: Jan. 12, 1997 12:00 AM CST
If you're not looking at the big picture of managing your total cost of risk, you can get lulled into thinking you're getting valuable service from your outside providers, including brokers, insurers and vendors, when in fact the service may have little to do with your strategic or financial needs.
What is total cost of risk?
The world has changed from the days when an organization's total cost of risk was calculated based solely on an analysis of its cost of premiums, losses and broker/service provider fees.
Traditionally, this approach led to recommendations for insurance products. And when the existing insurance products didn't work, more expensive, so-called advanced or state-of-the-art insurance products were recommended.
While these solutions may have helped reduce some of your risk-related cost, they might not have attacked your most pressing cost drivers.
Unfortunately, many insurance brokers are continuing to focus on building a better mousetrap. That's not to say insurance products don't help manage total cost of risk; if used properly, they can help a great deal.
Today, a total cost-of-risk approach can enable your organization to address its entire spectrum of risk: pure risk; financial risk; and speculative risk such as market, liquidity, credit risk, legal and regulatory risk, as well as the risk of damage to its reputation.
This approach often calls for a broad-based partnership of key employees involved in understanding and managing risk, outside vendors, suppliers and service providers and insurance brokers/consultants that can focus on your business strategies and the impact of your risks on your bottom line.
Organizational gridlock results when departments, vendors, suppliers, service providers and all other entities that intersect with the organization cause congestion by behaving independently.
On the surface these entities act as if they all work toward the same goal but at the same time pull in different directions.
A decision one department makes in an effort to manage the total cost of risk may have a significant impact on another department's cost-and, therefore, the organization's total cost of risk.
For instance, if the operations department proposes to relocate the company's Florida factory to New Jersey, it may seem to be an effective way to reduce the company's total cost of risk, i.e., losses due to hurricanes are reduced.
However, the operations department may not be aware of other costs associated with the move that ultimately could increase the organization's overall total cost of risk.
Some of these potential costs include: potentially higher workers compensation classification rates, potentially higher premium taxes and increased payroll as salaries in New Jersey may be substantially higher than in Florida.
To make sure a move to New Jersey makes the most sense, the operations department should consult all affected parties, i.e., risk management, human resources, insurance brokers, etc.
Thus, avoiding organizational gridlock on cost-of-risk issues calls for improving the quality and frequency of communication among all involved internal departments as well as with insurance brokers, consultants and other outside service providers and vendors.
And all of the outside providers helping you reduce your corporation's cost of risk must understand your current business strategies as well as any plans that will affect your operations three to five years into the future.
Senior management knows the direction their firm is taking-what it plans to buy, sell, whether it foresees downsizing or right-sizing, or even outsourcing various functions, and what's necessary to maintain competitive strength and meet strategic goals.
The providers who will be your partners in addressing your cost-of-risk issues need that information to help you determine your insured, uninsured and uninsurable risks and gauge the potential for significant loss due to either frequency or severity of a claim, injury or potential for financial and strategic loss.
What to expect from your
brokers and consultants
When children discover the usefulness of a hammer, they quickly find many things around the house that need "hammering," e.g., toys, the dining room table, the dog.
Service providers, including insurance brokers, often fall into the trap of using a new "tool" or insurance product everywhere they can, hoping that if they "hammer" enough things, something positive will result.
The attribute most needed by insurance brokers/consultants for successful reduction of total cost of risk, though, is systemic understanding. Your insurance broker/consultant must be absolutely literate not only in your corporation's business, goals and strategies but also your corporation's systems and interrelationships.
Addressing a corporation's risk from a total cost of risk perspective involves these steps:
Discovery. The insurance broker/consultant must ask questions to understand your corporation, the interrelationships among various departments or operations, and with their suppliers, buyers and distribution channels. This will enable it to recognize all cost components within your organization.
Analyze and measure impact. The insurance broker/consultant then must acquire a thorough understanding of how various risks affect your corporation. This calls for analyzing all pure, speculative, insurable and non-insurable risks/exposures identified through the discovery process to determine how well they currently are controlled; to uncover opportunities for reduction; and to measure their impact on the corporation's overall financial condition.
This work can't be done in a vacuum but requires a working partnership with your operations, divisions, service providers, suppliers and all others who interact with the corporation to identify the most serious exposures.
Propose solutions. Recommendations to address your risks must relate to your corporation's overall business strategy and financial goals. The broker/consultant should describe how the risks affect your corporation's financial picture and explain how its recommendations will control the cost of risk and support your business strategy.
In cooperation with your accounting/CPA firms, investment bankers and outside counsel, the broker/consultant may also be able to make suggestions that go beyond the traditional realm of insurance to improve your overall financial picture.
Because of the broad-based approach taken, total cost-of-risk analysis will yield recommendations that will be more justified and have wider impact on your corporation's bottom line.
Implement. Some recommendations may require the participation of all employees affected, division managers and outside providers/suppliers, so effective project management becomes a key to success.
This phase might also involve experimenting with different implementation approaches, such as team-based problem-solving.
Your broker/consultant may be able to help you select the most appropriate implementation procedures and processes. You should feel comfortable with the broker/consultant's plan, its use of resources and its ability to meet established timetables.
Your company's facilitators should start with a kickoff meeting to bring together individuals from various disciplines to form an implementation team.
They should lead the team by consensus and allow all affected parties to develop personal ownership for the project and the results.
Measure impact of solutions. Measuring success in terms of reduced cycle time, improved efficiencies, reduced defect rates or other measures is natural in other parts of an organization-and logically should be in the risk management area as well.
Depending upon the project assignment, some of the metrics you may want to use in the risk management area include: customer satisfaction ratings, accuracy and timeliness of payment, accuracy of coding, speed of first call made by a third-party administrator to the claimant, minimization of loss due to natural hazards, satisfaction at conclusion of large property losses, minimization of political risk, ability to obtain business licenses in certain countries, reduction in auto claims, reduction in litigation rates, duration of disability, reduction in costs (premium, vendor, machinery, overall, etc.).
Your broker/consultant must be able to provide you with concrete measures of the success it has had on a project.
For example, if your organization is having a problem with product defects, the cost-of-risk work may revolve around the minimization of loss. You'd first have to determine the impact potential of trying to minimize this kind of loss and then be able to measure the success after some agreed-to period of time.
Communicate the results of your corporation's initiative to reduce total cost of risk, congratulate all involved in the process and celebrate the results!
Improve. Next, you need to answer the question, "Where do we go from here?"
The total cost-of-risk process requires continuous improvement. Begin the process again, starting with the "Discovery" phase to set new priorities and identify additional areas to reduce the financial impact of risk.
There's no better time than now to think differently about your exposures and your risk management programs. Managing total cost of risk is not only purchasing the proper insurance coverage to ensure adequate protection against losses. It's an incredible opportunity to properly manage your organization's risk to enhance your corporation's bottom line.