4. Total Cost of Risk

Question 1

Benefits of Allocating TCOR Include:

Answer 1

1. Identifying factors contributing to the TCOR – where do the costs originate?
2. Creating accountability
3. Enhancing loss control
4. Supporting the competitive advantage
5. Altering behaviors

Question 2

Benefits of Allocating TCOR Include: Creating accountability

Answer 2

a. Each department is responsible for its cost of risk
b. Bonuses, salary increases, and performance evaluations can be tied to the results of the allocation
c. Employees become aware of the costs associated with losses, exposures and other components of the TCOR
d. Identifies areas that need risk management attention

Question 3

Benefits of Allocating TCOR Include: Enhancing loss control

Answer 3

a. Motivates employees to focus on reducing frequency and severity of losses, thereby reducing the TCOR
b. Builds risk control into projects, products and business decisions
c. Provides managers with specific loss and exposure information
d. Demonstrates the cost‐effectiveness of investments in safety, loss prevention, and risk control equipment

Question 4

Benefits of Allocating TCOR Include: Supporting the competitive advantage

Answer 4

accounts for all types of costs

b. Holds fluctuating costs to a minimum
c. Limits manipulation of data and results

Question 5

Possible Negative Implications Due to TCOR Allocation

Answer 5

1. Middle management pushback
2. Circumventing accident reporting procedures
3. Late reporting/non‐reporting
4. Poor morale
5. Distorted goals & objectives
6. Disparate financial consequences
7. Can damage team approach to risk management

Question 6

Methods for Creating Active Participation in Others

Answer 6

1. Inform employees allocating methodology and rationale
2. frequent TCOR updates employees engaged in the risk management process
3. opportunity for input
4. Involve members organization to identify opportunities to lower TCOR

Question 7

TCOR allocation model. Name the 4 Steps

Answer 7

Step 1 – Define Desired Result

Step 2 – Define the Costs

Step 3 – Select the Allocation Variables

Step 4 – Create the Allocation Model

Question 8

TCOR Process Step 1 – Define Desired Result

Answer 8

1. Goals and objectives
2. Impact
3. Compatibility with other systems
4. Consistency and equality across organization
5. Communication channels

Question 9

TCOR Process Step 2 – Define the costs

Answer 9

1. Insurance costs – premiums, premium taxes, letters of credit, deposits, collateral, etc.
2. Retained losses
3. Risk management departmental costs
4. Outside service expenses
5. Quantified portion of indirect expenses
6. Sources of cost data and information
7. Decide when to allocate costs

Question 10

TCOR Process Step 3 – Select the Allocated Variables

Answer 10

1. Structure and ownership
2. Geographic
3. Economic factors such as business cycles, strikes and natural disasters
4. Political climate

Question 11

TCOR Process Step 4 - Create the Allocation Model

Answer 11

1. Common approaches to allocating the cost of risk are:
2. Determine what level of costs will be allocated
3. Determine if the allocation will be prospective or retrospective
4. Test the allocation model
5. Because of organizational diversity, there is no one “best model”

Question 12

Exposure Based Method

Answer 12

Definition: Each unit is assigned costs on an equitable basis, based on the exposure each unit presents

Examples of exposure units:

1. Number of employees or number of Full‐Time Equivalent (FTE) employees
2. Payroll
3. Sales, receipts, revenue

Two variables involved in this method:

1. Change in exposure values, e.g., appreciation of an asset, such as a building
2. Change in number of exposure units,e.g., increase or decrease in the number of vehicles or employees

Characteristics:

1. Easy to administer and adjust if exposures change
2. Simple to understand
3. Supports period‐to‐period consistency
4. Not linked to loss experience
5. No incentive to reduce losses because of allocation

Question 13

Experience Based Method

Answer 13

Experience‐Based Method
Definition: Each unit is assigned costs on an equitable basis, based on the loss experience each unit presents.
Each unit’s own loss experience is the only variable involved in this method.

Experience‐based allocations:

1. Number of losses
2. Cost of losses

Characteristics:

1. Encourages loss control
2. Supports accountability
3. Doesn’t allow for strategic or discretionary allocation
4. May be more difficult to administer due to the volume of data

Question 14

Combined Method

Answer 14

Definition: Each unit is assigned costs in a model that balances a mix of exposure‐based and experience‐based allocations based on relative percentages of exposures or experience

TCOR is allocated according to the percentage that the amount of exposures or experience of each allocation division bears to the total of the exposures or experience

Per unit method: TCOR is allocated based upon a per unit TCOR (the TCOR for each unit of exposure or each unit of experience) times the number of exposure or experience units for each allocation division

Examples:

1. Insurance costs (all or a portion) are allocated on an exposure base that varies with the type of insurance
2. Risk management department costs are fully allocated using an appropriate exposure base, e.g., number of employees
3. Outside service costs are allocated to those allocation divisions that use them
4. Portions of insurance premiums not allocated on an exposure base are allocated according to historic losses for that type of exposure
5. Retained losses are generally charged to the allocation division that had the loss, but may be limited to mitigate the impact of catastrophic losses; the portion not allocated may be assigned to the general overhead