Managing Risk: A Guide For Your Business Client, Part 1 Of 4

Every governmental or corporate entity that owns property or conducts any business or government activity is exposed to:

1. Loss of property from fire or other peril, including financial dislocations caused by the need to carry on activities in substitute quarters
2. Claims from persons injured (either bodily or through property damage) by an act or omission of the entity
3. Payments mandated by law, such as medical and indemnity payments to injured workers (Workers Compensation)

All these expenses are subject to management control. In fact, they're probably more susceptible to reduction from skillful handling than most areas of finance. Too many risk-management programs have been permeated by insurance thinking-which is natural, since insurance agents and brokers have more complete knowledge. However, risk-management concepts and procedures help achieve control of the bottom line: total risk-management costs.

'Total risk-management costs' refers to the sum of costs for:

• Losses incurred, direct and indirect
• Loss prevention
• Claims adjusting
• Insurance premiums
• Administration

Losses incurred may be controlled through various loss-control measures. Also, the amount of liability claims may be affected-strongly-by prompt and fair payment of legitimate claims combined with vigorous resistance to questionable claims. If claims are not handled in-house (and few public entities handle them), you can monitor the claims adjuster's work.

Loss-prevention costs may be minimized by questioning expenditures for safety, fire protection, and security. Relate them to actual anticipated reduction in loss costs. If the cost of a protection device can't reduce losses enough to amortize the cost, it's not justified. Even safety devices, where injuries rather than property damage are concerned, should be subject to hard-nosed financial analysis.

Claims-adjusting costs are subject to little control in a fully-insured program, but when they're handled by contract adjusters, much can be done in selection, instructions, and monitoring.

Insurance premiums are controllable through risk retention, informed shopping, conscientious communications with agents/brokers and underwriters, and loss control.

Administrative costs may be controlled through critical analysis of:

1. Jobs that should be done
2. Their importance as expressed in dollars
3. Degree of improvement that could result from informed treatment

Balancing and minimizing these interacting elements of risk management is the risk manager's job-and it's a big one. A measure of its importance can be estimated by putting as accurate a figure as possible on each element. Insurance premiums and loss costs are easily measured, but more trouble will be encountered trying to quantify loss prevention, intangible aspects of losses, and administration. Nevertheless, an informed estimate is far better than no estimate at all.

With a total cost-of-risk figure in mind, the value of risk management will be much better appreciated.

One person should oversee all risk-management functions. Exceptions occur, and much depends on the particular entity and individuals. Since risk management calls for a wide range of different skills, a person with broad knowledge is more effective than a specialist.

For entities without a full-time risk manager, duties are often as follows:

• Chief Administrative Officer (CAO). The CAO, whether a city manager, county executive, district manager, mayor, governor, or whoever, is responsibile for seeing that the function is properly structured. In a small entity, he may do it himself. In a larger entity, he'll delegate the function to one of the following:
• Chief Financial Officer. The CFO, treasurer, director of finance, controller, or the like will most commonly have this function because risk management is largely financial. However, this person must rely heavily on the skills of other departments.
• Personnel Director. This position frequently oversees safety, possibly Workers Compensation, and in a few instances, other risk-management functions (although this is not common). Generally, the personnel director is too involved with individuals and labor problems to retain the necessary objectivity and financial skills.
• Purchasing Officer. In the past, the purchasing officer often had the responsibility of buying insurance. It's now more clearly understood that insurance is not a commodity to be purchased, but an element of a total risk-management program. Except in rare instances, the purchasing officer should have little or nothing to do with insurance or risk management.
• Chief Engineer. The chief of public works, chief engineer, or similar official may be responsible for maintaining building values and informing the risk manager of any changes-deletions or additions of properties and change in costs or values. This person will also frequently supervise the issuance of contracts to contractors. These contain insurance and indemnity provisions that should be carefully worded and supervised. The chief engineer may also design and maintain loss-prevention equipment, so close cooperation with the risk manager is essential.
• Counsel. The chief legal officer writes contracts that usually contain indemnity or insurance provisions. His work strongly affects risk assumption. He may also have a responsibility for supervising liability or Workers Compensation (except for large liability claims), although this is a specialized function better handled by specialist claims adjusters.

Whoever carries the mantle of risk manager will need to communicate closely with all the officer just mentioned.

As an organization grows, its risks become more complex, insurance premiums rise, and loss assumption capability grows. A point will be reached when a full-time risk manager should be placed on the staff. Though each situation is unique, some guidelines can help.

There are two points that, if quantified, will help you decide whether to take on a full-time risk manager:

• The cost of paying one
• The savings to be expected, considering not only insurance premiums, but the broader aspects of risks, such as losses reduced, claims better handled, and so forth

The first element can be determined with little difficulty. It consists of the salary and overhead plus whatever clerical support is needed. The second item is more difficult. Benefits might be summarized in the following fashion:

• The risk manager should bring order to an otherwise possibly confused situation, improving all departments' efficiency.
• Insurance premiums should be reduced when more careful attention is given to establishing coverage criteria; hard negotiating with agents, brokers, and direct writing companies; and familiarity with the insurance world.
• Actual losses should be reduced because attention is given to loss-control needs, careful scrutiny of loss reports, and knowledge of whom to contact for specialized help.
• Careful attention to loss reserves and adjusting practices can sometimes have a startling effect on costs. Public liability and Workers Compensation claims require special skills for adjusting. Insurance companies generally provide the adjusters, although sometimes a self-insured program will be used with contract adjusters.
• Rhe improvement in efficiency should more than offset the increase in administrative costs due to additional record-keeping, correspondence, and working hours involved.

Possibly the most desirable approach is to have a chief executive officer-or someone familiar with the organization and with risk management-make a subjective evaluation of all these points and then develop a recommendation. A more objective approach would be to put a figure on all the quantifiable items such as:

• insurance premiums
• dollar value of claims handled
• dollar value of loss prevention
• devices installed

These figures would then be added up to develop a number that represents the total dollars which the risk manager will be controlling. It may then be postulated that the risk manager, if competent, should be able to effect a 10% reduction in these figures. If so, a figure of 5% of this total may be justified as the total risk management budget.

As an example, consider a large city with the following costs:

Insurance premiums $800,000

Average claims 250,000

Loss-prevention expenses 50,000

Total $1,100,000

This figure represents nothing but the amount of dollars that the risk manager may control. To be effective, this person should be able to reduce the cost 10%, or $110,000. So a budget of up to $55,000 for this office might be justified.

Risk managers are much more than buyers of insurance. Their responsibility is to integrate all activities concerned with conservation of assets and continuation of activities following accidental loss. They should handle directly or oversee:

• Risk identification and measurement
• Loss control (fire protection, safety, and security)
• Risk retention and loss funding
• Insurance or other risk transfer
• Claims adjusting
• Record keeping and administration

The risk manager has two principal objectives: protection against catastrophic loss and cost reduction.

A catastrophic loss is one that causes serious financial dislocation or impairs an important service. The extent to which a dollar loss would cause serious financial dislocation varies almost in direct proportion to the size of the budget, but is influenced by the availability of funded reserves and the flexibility of the financial structure.

Risk managers' job relating to catastrophes is principally to see that adequate insurance exists and that coverage is not negated by unfavorable policy provisions. More fundamentally, they should evaluate risk exposures to see that protection features are commensurate with the hazard. This is not easy. Many potentially catastrophic risks are unwittingly assumed through ignorance in various ways, including:

• Failure to recognize an unusual property peril, such as snow loads on a roof
• Inability to identify a hazardous condition, such as loss of business income or costs associated with setting up a temporary location
• Ignorance of policy exclusions or mandatory conditions-for example, exclusions for damage to property in your custody or a requirement to report all occurrences that might lead to a claim

Reducing costs means reducing the total of all risk-management costs-not just insurance premiums. More details for approaching each element are found later in this article.

Elements of the risk manager's job are:

1. Risk Identification and Measurement. This is the most basic-and most important-function, but it's often slighted. The risk manager must understand everything happening or about to happen in the organization. In addition to understanding the entity and its people through years of experience, the risk manager should:

• Physically inspect major properties often enough to know what's going on
• Talk regularly with key staff and operating officials
• Study the annual budget to attain a feel for each activity's financial aspects
• Review all requests for funds for changes
• Read contracts, bond indentures, leases, and similar documents that may have insurance clauses or indemnity (hold harmless) provisions
• Study reports of all insured and self-insured losses
• Read minutes of meetings of the governing body, and review the agenda to see whether any item has risk-management implications
• Establish dollar values of all significant loss potentials

2. Risk Management Policy Development. The risk manager generally prepares a written policy for consideration and approval by the governing body.
3. Risk Finance Selection. Through knowledge of his entity's financial structure, the risk manager selects the method of funding risk and administering losses best suited to the situation.
4. Insurance Negotiation. 'Negotiate' is more appropriate than the term 'purchase' for insurance. Risk managers must know their firm's insurance needs, and then must go to the marketplace to find the best coverage at the lowest cost. In most cases, this involves working with one or more agents or brokers, but sometimes it means going directly to the insurance company. Part of the insurance function is selection of the broker by the risk manager.
5. Claims Adjusting. Because liability claims involve the public and Workers Compensation claims deal with employees, their proper handling is a management responsibility. Risk managers don't adjust claims but monitor those who do. They should:

• Investigate to see that legitimate claims are paid promptly and efficiently-and conversely, that questionable claims are resisted effectively.
• Follow reserves to see that they're not excessive and that they're removed from the record immediately after final payment.
• Check claims-adjusting personnel for adequate training, experience, and exercise of good judgment.
• Ensure that subrogation (recovery) procedures against outside parties are being efficiently pursued.

6. Record Keeping. The risk manager's basic tool is a complete, well organized set of records detailing insured and uninsured losses. Other important records include:

• Property valuations, broken down by location
• Insurance policies, current and expired
• File of management decisions
• On larger properties, building layouts showing fire separations
• Files of correspondence and telephone calls concerning coverage and other important subjects

7. Creation of Risk Management Manuals. Firms with many locations may want a book of instructions on how to handle claims, details on use of personal autos, how to report values, what to do about insurance inspectors, and so forth.
8. Communications. Risk managers must let their superior know what they're doing and why-usually by means of a regular formal report. They must also communicate to others in the organization and get their cooperation in carrying out their portions of the risk-management function.
9. Accounting. In larger entities, the risk manager will be involved in developing charges to various divisions or cost centers. Much of this takes informed judgment.
10. Loss Prevention. Though they can't be an expert in all phases of loss prevention, risk managers should have general knowledge backed by their own loss information. This should enable them to determine the best method of obtaining what loss-prevention counsel is needed.
11. Risk Function Administration. Miscellaneous duties include supervising contractors' Certificates of Insurance, attending public hearings on insurance matters, and helping legal counsel develop standards for such items as purchase orders and leases. Risk managers may also handle bid, performance, and permit bonds.
12. Professional Networking. As in any professional field, continual contact with peers is essential. Membership in the following groups is recommended:

• Public Risk and Insurance Management Association (PRIMA)
  1101 Connecticut Ave. N.W., Suite 1009
  Washington, DC 20036
  (202) 293-1892
• Risk and Insurance Management Association (RIMS)
  205 E. 42^nd St.
  New York, NY 10017
  (212) 557-3210

Roughly half of all risk managers also have responsibility for employee benefits. Some consider benefits to be part of risk management, but others disagree, saying that benefits are not risks but deliberately assumed costs. Most agree, however, that they're separate professional fields, overlapping only in that they both may call for the purchase of insurance-although usually through different markets.

There are two benefits you'll get by combining these functions: (1) You'll coordinate insurance-buying expertise, and (2) you'll upgrade the risk manager job to a higher level.