Chapter 4 - Total Cost of Risk Flashcards
Benefits of Allocating TCOR
- Identifying Factors Contributing to the TCOR
- Creating Accountability
a. Each department, cost center, division, store, etc 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 TCOR.
d. Identifies areas that need risk management attention. - Enhancing loss control
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. - Supporting the competitive advantage
a. Tracks and accounts for all types of costs.
b. Holds fluctuating costs to a minimum
c. Limits manipulation of data and results - Altering Behaviors
Possible Negative Implications Due to TCOR Allocation
- Middle management pushback
- Circumventing accident reporting procedures
- Late reporting/non-reporting
- Poor morale
- Distorted goals & objectives
- Disparate financial consequences
- Can damage team approach to risk management4.
Methods for creating active participation in others
- Inform all employees about the allocating methodology and rationale.
- Provide frequent TCOR updates (monthly or quarterly) to keep employees engaged in the risk management process.
- Provide opportunity input.
- Actively involve members from all levels of the organization to identify opportunities to lower TCOR.
Steps in the TCOR Allocation Process
1 - Define Desired Result
2 - Define the Costs
3 - Select the Allocation Variables
4 - Create the Allocation Model
Step 1 - Define Desired Results
- Goals and Objectives. 2. Impact 3. Compatibility a. Accounting system, Claims management system HR database, RMIS 4. Consistency and equality 5. Communication 6. Additional considerations.
Step 2 - Define the Costs
- Insurance costs 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 (before incurred?, as they are actually incurred? at the end of the year? etc.
Step 3 - Select the Allocation Variables
- Structure and ownership 2 Geographic 3. Economic Factors such as business cycles, strikes and natural disasters 4. Political climate 5. tax structure.
Step 4 - Create the Allocation Model
- Common approaches to allocating the cost of risk are:
a. Exposure method - costs are allocated based on exposure units
b. Experience method - costs are allocated on an experience basis
c. Combination method - a mix of allocating portions of costs to operating units based on exposures and experience that can take many forms. - Determine what level of costs will be allocated
a. Minimum costs
b. Maximum costs or caps
c. Aggregate limits - Determine if the allocation will be prospective or retrospective
a. Prospective allocations are “one and done” allocated at the beginning of the time period and generally not adjusted at the end; a solid loss pick is required
b. Retrospective allocations begin with a “deposit” allocation at the beginning of the time period and adjusted at the end of the time period, usually upon experience. - Test the allocation model
- Because of organizational diversity, there is no one “best Model”
Different Allocation Models
Exposure-Based, Experience-Based & Combination
Experience-Based Methodologies
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.
Combination Method
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.
Percentage of total method: TCOR is allocated according to the percentage that the amount of exposures or experience of each allocation division bears to the total of 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 based, ex. 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,
Exposure-Based Method
Definition: Each unit is assigned costs on an equitable basis, based on exposures 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
4. Units produced
5. square footage
6. Value of assets
7. Miles driven
Two variables involved in this method:
1. Change in exposure values ex. appreciation of an asset such as a building
2. Change in number of exposure units, ex. increase or decrease in 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.
