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

This is the generally accepted sequence of risk management activities:

1. The risk of loss is identified and measured.
2. It's reduced as much as feasible by loss-prevention techniques.
3. The loss is accepted as a budgeted cost to the extent that it can be fitted in to the financial picture.
4. As a last resort, the losses that can't otherwise be treated are transferred. Insurance is the usual means.

Insurance is so important as a risk-management tool and its cost so visible that other aspects have received relatively little attention. Nevertheless, they all tie together into the overall risk-management picture.

It almost goes without saying that risks must be identified before they can be treated. This is one of the measures of a good risk manager. Here are just some risks that occasionally elude the public agency risk manager:

• Loss of revenue from shutdown of an income-producing activity: utility, toll road or bridge, auditorium, and so forth
• Loss of taxes because of destruction of a principal taxpayer's property
• Extra expenses from administrative dislocations following any catastrophe
• Extra expenses from hand processing data after loss of data-processing facilities
• Unusual types of liability, such as liquor liability, that are not perceived as important until an unforeseen situation

Safety programs affect insurance costs indirectly by reducing losses (which in turn indirectly affect premiums), but few safety measures are recognized in liability rating. To find out exactly what measures are important, ask your insurance agent for a breakdown of your rating factors. Larger Workers Compensation programs will also have factors tied to loss prevention, so get a copy of that schedule, too.

Fire rating is directly affected by a number of building and contents hazards. The premium often can be directly affected by improving conditions. A cost-benefit analysis can follow identification of the charges and credits in the rating schedule. This should be performed periodically.

When planning insurance, the most important points are complete coverage and adequate limits. Complete coverage gives the most trouble.

With Property insurance, the goal is to have all-risk protection rather than 'named perils' coverage. The latter covers such perils as fire, windstorm, and explosion, and can create a false sense of security because it covers most recognized perils. However, insurance is meant to protect against catastrophes however they may arise, and old-timers in the business can recall any number of strange events that caused large losses.

For instance, are you protected against damage from flowing molasses after a huge storage tank ruptures? This type of loss has occurred, causing tremendous damage. The point is simple: Even with a vivid imagination, you can't conceive of all the things that can go wrong.

All-Risks protection is therefore essential to proper insurance coverage. With respect to property, this is usually written in a Difference-in-Conditions (DIC) policy.

The liability equivalent of the DIC is the Umbrella-probably the most important single policy of all. It supplies the needed high limits and broad coverage for the blockbuster liability claim. Be sure it's the broadest possible. Pay a little more if necessary, but don't settle for an inferior Umbrella.

The insurance world is fragmented into many compartments, some of interest and some of no concern to the risk manager.

One division that should be of no concern (but which has received inordinate attention) is whether an insurer is a stock company, mutual company, or reciprocal. The form of corporate organization is irrelevant to the buyer. Whether a policy is assessable is important, but major insurers don't issue assessable policies, regardless of their form of management.

Briefly, the definitions are:

• A stock company is owned by public stockholders, just as is General Motors.
• A mutual company has no stockholders. It's owned by its policyholders. In theory, they vote policy, but in practice they have about as much control as a GM stockholder has over Buick design.
• A reciprocal insurer is similar to a mutual. It's a group of policyholders combined into a pool that operates through a management organization called an attorney-in-fact.

The important point to the insured is the stability of the insurer. Stable and unstable companies exist in each category. The problem-and it's a difficult one-is how to judge stability.

The most widely used standard for judging this is provided by the A.M. Best Co. Every year, Best rates all operating insurers on two bases:

• Policyholders' Rating. Ranges from A+ (excellent) to C (Fair). This is essentially a judgment of underwriting and management.
• Financial Size. Ranges from Class I (very small) to Class XV (very large).

Ratings are often expressed by a combination of the two figures; for example, 'B+, IX.'

The Best ratings have only limited usefulness (some insurers with high ratings have become insolvent), so if you're concerned about a particular company, make as many inquiries as possible. The state insurance commissioner is one source.

Insurance companies are licensed in the states in which they operate. They're then subject to regulation by the insurance commissioner. Sometimes the licensed companies are unable to underwrite certain unusual types of risks, which can be written by non-licensed companies.

Though unlicensed and unregulated, these companies do a significant amount of business. They are called 'Surplus Lines' or 'Excess Lines' carriers and sell through Surplus Lines brokers, who are regulated. In some cases, you can do business with them directly. Many are large, well-managed companies with an excellent product. (Lloyd's is a surplus lines insurer in all states but Illinois and Kentucky.) Others are a little shaky. Have your broker analyze their stability. Don't hesitate to do business with a good Surplus Lines carrier.

Probably the most important single point for the risk manager is to have a highly competent agent, broker, consultant, or other professional resource. Most public agency risk managers look to their agent or broker as the expert. In many cases, this is desirable, but only a few insurance professionals can also call themselves risk-management professionals.

Risk-management professionals' credentials should be examined even more closely than the stability of insurance companies. One objective criterion is the extent of their outside study. Look for the CPCU (professional insurance) and RM (professional risk management) designations. Of the two, the CPCU is the more demanding, but the RM more pertinent.