Understanding Your Total Costs of Risk

At the 2018 Chicagoland Risk Forum, a session discussed understanding a company’s total costs of risk management. The speakers were:

• Jessica Wacek – Marsh
• Jaci Mennenga – County Financial

Risk has a cost whether or not you buy insurance. Focusing on the premium alone is short-sighted as the premium can be a small piece of your overall total costs of risks. The components of your total costs of risks include retained losses, volatility, and costs of claims management. When you buy insurance you introduce two new categories into the total costs of risks. Premium and collateral. These elements are all related as increasing or decreasing costs in one area will likely impact costs in other areas.

Insurance premium involves trading a fixed expense for a variable expense. It reduces uncertainty and volatility in your total cost of risk, but may not necessarily reduce your costs. When deciding on the proper amount of insurance and retention levels, risk managers must evaluate the annual losses expected, their risk appetitive, and their risk bearing capacity. Risk bearing capacity means the ability to cover losses without having a material impact on the company. Companies should always purchase insurance for losses they cannot afford to pay.

Reducing the volatility with insurance has value to a company in that it frees up their capital that would have to be set aside for potential losses. Then that capital can be redeployed into the business.

Reducing risks requires understanding the nature of risks. Things that are low likelihood but high financial impact are the best to to protect with insurance. Risk mitigation is the best way to reduce your total costs of risk. If you can reduce the frequency of losses you reduce your retained loses, claims management costs and diminish the volatility of your claims.

In using analytics for risk transfer decisions you should look at the following:

• Coverage adequacy.
• Limit adequacy.
• Economic costs of risk.
• Efficiency of the risk transfer.
• Payoff probability.

Analytics can also help you find opportunities to impact your total cost of risk. For example, evaluating causes of accidents can help you take steps to prevent these losses. Analyzing lag times in reporting can help you see the impact that late reporting has on claim costs.

Loss volatility can also be addressed with both pre-loss and post-loss strategies. For example, pre-loss mitigation strategies include:

• Auto safety programs.
• Ergonomics programs.
• Limits of liability.
• Emergency response planning.
• Fire warning systems.
• Employee training.

Post-loss mitigation strategies include:

• Legacy management.
• Disability duration.
• Medical management.
• Audits evaluating best practices, reserving, managed care, leakage, and performance guarantees.