While every profitable endeavor entails risk, very few business owners have a clear sense of which factors pose the most danger to their company. Failing to acknowledge all these possible risks can certainly leave your company vulnerable. But is there a point where over-thinking and overcompensating for something unlikely to happen becomes too expensive to justify the purpose?
These questions illuminate the value of an extremely important risk management concept known as “total cost of risk.” Let's look at how this applies to your company.
The True Nature of Risk
Some risks are straightforward and easy to manage. For instance, you can always insure your business property against the risk of fire or wind.
Other risks are not as evident. For example, have you considered how your business would be affected if your partner or best employee was involved in an accident? Or, what if your company was forced to defend itself against a frivolous lawsuit?
In the latter case, the legal costs are obvious concerns, but it can go even deeper than that. How would the negative media attention, for example, affect the bottom line in the long- and short-term?
In the wake of the Deep Water Horizon oil spill, for example, BP shares are still down over 30% and this in spite of more than $50,000,000 spent on television re-branding efforts alone.
Key to Understanding Total Cost of Risk (TCOR)
Conducting a thorough risk analysis taking into account all of the potential exposures forces you to consider whether your current risk management measures make sense. It's a chance to step back and determine how much risk exists and how much it would cost to transfer the risk or minimize it to manageable levels.
Risks often involve fear, so performing a comprehensive analysis helps you to make objective decisions instead of emotional ones. You may find particular risk management resources are allocated inefficiently, so a thorough review offers a chance to rethink your approach and implement new measures that make better sense.
Calculating Your TCOR
Understanding your total cost of risk is not easy. And the truth is, it's impossible to get it 100% correct – you can’t predict every variable. Essentially, it includes the cost of your insurance premiums, the realized cost of mishaps should they occur (from shared claim costs to fees to the impact of reputation on profits, etc.), and risk management administrative costs.
There are a number of tools that exist for guiding you through this complex process. A full total cost of risk analysis looks at:
- specific costs
- what percentage costs constitute of annual revenues
- industry benchmarks
By compiling this data, you can determine whether there are discrepancies with the industry norms and see if there is room for improvement.
Interpreting Your Total Cost of Risk
When calculating and interpreting your total cost of risk, remember every situation is unique, so don't interpret every deviation from the norm as a problem. The goal is to determine if there is an explicit reason for your total cost of risk to be higher and create strategies to protect your business.
In some cases, streamlining your risk management plan can be as simple as deciding a risk is small and insignificant enough to handle in-house as problems arrive. In other cases, something as major as a company-wide change in safety policy and related training may be in order and completely logical given the true cost of the mishap in question.
Either way, a complete view of your total cost of risk prevents decisions based on assumptions or knee-jerk reactions to perceived dangers. Rather, the decisions will be based on your careful assessment of your exposures, including legitimate calculations and research. In this way, you can save unnecessary expenses and rest assured your company is adequately prepared for what lies ahead.
To learn more about TCOR, contact your HNI relationship manager or comment below with questions.