One of the most important risk management concepts to understand is the idea of the Total Cost of Risk. The face value of your insurance premium and any claims you have only scratches the surface of what your risk can really cost you.
How we define total cost of risk
Total cost of risk is defined as the ultimate financial exposure to a company’s assets. It of course includes the value of easy-to-measure things such as deductibles, uninsured losses, and premium dollars.
The things that are often overlooked in estimating the total cost of risk lie in the indirect losses, such as down time, damaged equipment, overtime, customer satisfaction, and the damage to your reputation should an incident occur. An insurance policy may or may not help you cover these losses, but all of this should also be factored in to your risk management planning.
Often indirect costs can range from three to five times the actual losses – and sometimes much higher. If you view your cost of risk in its totality and take it into account in the planning process, you’ll be much better positioned in the event of a serious claim.
Accounting for Total Cost of Risk In Your Strategy
If your risk management strategy starts and stops with an insurance policy, you’re missing the boat. Insurance is just one piece of the puzzle. Depending on your company’s size, it could be a very large percentage or a small percentage of your total cost of risk.
I like to think of business insurance as financing your past and future losses. In other words, if you had a house mortgage, think of losses as your principal. As your principal goes up, so does your mortgage payment (principal and interest). The best way to reduce your principal is to reduce or eliminate losses; reduce your losses and your insurance premium will follow.
Sounds easy enough, right? Actually, it all boils down to one simple concept: planning ahead.
Planning for Hidden Expenses Related to Total Cost of Risk
Indirect losses associated with an accident or incident, such as down time, damaged equipment, overtime, customer satisfaction, and the damage to your reputation can be greatly mitigated by advance planning.
A strong safety program is a non-negotiable in managing your total cost of risk. Employee training and orientation should convey to all employees that this is a top priority for the company, and everything from job descriptions to performance reviews to management techniques should reflect this.
Damages to customer opinion and your standing in the marketplace is something that should definitely factor into your view of your risk as well. This is often the hardest loss to recover in the event of a high-profile accident or incident. Obviously the best technique to avoid this is to eliminate or reduce these losses in the first place -- which goes back to having a strong safety program. Additionally, having a reputational risk management plan in place that includes communication policies and strategies can help to an extent.
How Total Cost of Risk Should Affect Decision Making
An estimation of your total cost of risk can be useful to record year after year, as well as the actual total value of any losses you experienced (including the indirect costs.) This helps you measure how you’re progressing with your risk management goals, and helps educate others on the successes of failures of your program.
Total cost of risk can also be used as a quantifiable target for incentive programs, especially those connected to safety efforts. Looking at the total value of any losses can help you explain the impact of each individual’s behavior on the overall risk to the organization.