What Is Your Total Cost Of Risk?

Since the future is unknown, the range of bad things that can happen to your business – from very small to very large – is also unknown.  What do you do about this?  Roll up in a ball on the floor and cry?  No.  You take action.  You manage your risk.

How do you do it?  Through Risk Management.   It can be formal or informal, but either way, the purpose is to minimize the uncertainty about the future.  Yes, through a solid risk management program you can take a very wide range of bad things that can happen to you and make it a very small range of bad things that can happen to you.  Reducing uncertainty is good for your business as well as your personal health (because you’ll have less stress).

As I explained in my previous post, there is a five step process to managing risk.  And as I wrote about in another post, there are six general classes of risk that your business faces.  If you apply that five step process to all the possibilities of bad things that could arise from those six classes of risk, you will be able to arrive at your Total Cost of Risk (TCOR).  There are many other insights you will arrive at and action steps you will want to take by doing this exercise, but your TCOR is what I want to focus on in this post.

So what is your TCOR?  It is the dollar amount that you pay in advance to minimize risk, and the amount that you will pay if and when an accident happens.

Here are all the components of TCOR:

Insurance Costs

• Premiums
• Letters of credit
• Security deposits

Retained Losses

• Active – deductibles, self insured retentions
• Passive – unidentified exposures (this is when you paid for an uninsured loss out of pocket)

Risk Management Departmental Costs

• Salaries and employee benefits
• Risk Management info system
• Administrative expenses (training, travel)
• Management overhead (corporate allocation)

Outside Service Fees

• Fee-for-service insurance brokers
• 3rd Party Administrators
• Consultants
• Loss Control
• Actuarial
• Legal

Indirect Costs

• Disruption
• Management time spent on loss-related activities
• Overtime costs
• Hiring and training replacement costs
• Lost opportunity costs
• Loss of organizational value
• Social costs (public image, reputation, etc.)

If you can put a number on these costs, you’ve come up with your Total Cost Of Risk.  Perhaps the hardest to quantify is the last category – Indirect Costs – as it will be the one with the most variance.  The best way to figure out costs that don’t have a fixed price is to look backward, see what you’ve paid in the past, and average the costs out over the last few years.

For smaller businesses like mine, the TCOR is simpler to quantify because many of the categories don’t apply to us.  For example, we don’t have a dedicated Risk Manager, so that category is eliminated.  What our TCOR amounts to is the insurance premiums we pay + the deductibles we could potentially pay if we do have a loss + the average amount of the historic costs of the remaining categories.  I’m still new at this exercise so I’m sure I’ll refine it and make it more accurate as time goes by.

It’s relieving to know your TCOR because it eliminates the fear of the unknown, or at least reduces it because, of course, the future is never known.