RISK MANAGEMENT: MAXIMIZE GOOD AND MINIMIZE BAD
by Mike Manes
Risk management provides a powerful tool for serving your clients — and growing your bottom line.
Every person (and business) has two assets: Their person (in business, people) and their things. The price of things can be defined in many ways — replacement cost, actual cash value, book value, etc. The price of people must be determined in terms of people as economic machines: Their life is the machine, their health is the maintenance of the machine, and their income involves the production of the machine.
The task of risk management is to protect a person, or business, against exposure to loss.
Five types of “bad” can happen to people:
Two types of “bad” can happen to things: Destruction of or damage to property and loss of its use, or Lawsuits.
The potential loss determines the best method to handle the “bad.” Losses are defined by frequency (how often) and severity (how bad). The options in loss control are:
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Avoid (high frequency/high severity losses)
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Assume (low frequency/low severity losses)
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Reduce (high frequency/low severity losses)
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Transfer/Insure (low frequency/high severity losses)
Many people believe that “risk manager” is a euphemism for an insurance buyer or seller, claims manager, or loss control specialist. Not so. Insurance should be the last step in the RM process, used only to transfer those risks that present catastrophic exposure to the organization.
Risk can be subdivided into categories of “pure” (a chance of loss only) or “speculative” (a chance of loss or chance of gain). The risk of doing business is speculative (fast horses, slow women, and Enron stock). Pure risk (fire, windstorm, lawsuits, etc.) has traditionally created the need for insurance.
Risk can also be subdivided into “dynamic risk” and “static risk.” A changing environment (lighting, hurricanes, earthquakes, floods, etc.) does not affect static risks. Change does affect dynamic risk. In the 19th century, cowboys and Indians created risk for each other. Wars with muskets and cannon were a problem; nuclear war wasn’t. Train and stagecoach robberies were an issue; carjackings weren’t. Pollution was about road apples; today it’s about superfund sites and oil spills. In yesterday’s world, hurt feelings often led to a duel — today, they lead to lawsuits.
The world of business is changing; there’s a need for strategic and marketing planning, an evolving entitlement mentality, a growing sense of victimhood, and expectations for large short-term return on investments. We’re also seeing more class action lawsuits, higher punitive damages, and less confidence in our institutions and professions (legal, medical, accounting), etc. These developments present significant challenges and threats to every organization.
The traditional role of insurance has been to transfer catastrophic risks by identifying (selecting) the risk, defining coverage, and establishing a price. As a practical matter, in recent years the courts have often reinterpreted coverage to provide protection not anticipated or priced for when the policy was issued. In my opinion, we’re rapidly moving toward a system of policies without exclusions that will mean more loss funding and less risk transfer.
Tomorrow the dominant exposures (threats or challenges) facing business will be:
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The cost of the legal system.
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The expense of financing health care.
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The power shift from the manufacturer, distributor, and provider to the consumer.
There are more than a million attorneys in the U.S. — one for every 280 people — making litigation a growth industry fed by the skyrocketing growth of punitive damages, frivolous claims, and class action lawsuits. Our legal system is addicted to huge amounts of cash and will continue to find new ways to feed this addiction.
Our health care system is out of control. We spend about $5,035 per person on Health Care (HC). The inflation of HC costs could double the average Health insurance premium within three to five years. HC costs drive much of our WC, Casualty, and Group Benefits premiums. These cost trends, combined with the aging Baby Boomers and our growing societal entitlement mentality, will continue to accelerate unless we can encourage HC users to become responsible buyers.
In yesterday’s world, a business could mass market effectively based on a cost driven pricing model. Today, as Peter Drucker pointed out, companies must mass customize for a “niche of one” and compete with a price-driven costing system. Power belongs to customers, rather than manufacturers, distributors, or providers.
These realities make risk managers, and the RM process, more important than ever. They also accentuate your opportunity of serving your clients — and growing your revenues — by offering them professional risk management services.
Michael G. Manes can be reached at Square One Consulting, 625 Weeks Street, New Iberia, LA 70560, 337-577-3885, e-mail [email protected], Web site www.squareoneconsulting.com.