How to Effectively Evaluate Your Risk Management Program

Leap | Carpenter | Kemps Insurance Agency | Apr 1, 2021 | minute read

Developing a Cost of Risk Model

Charts and tabletMany business owners are looking for methods of evaluating their business insurance and risk management program. Often they use the quick and simple method of comparing business insurance premiums over a period of time. If premiums are going up, then the figure the program is in trouble, and if premiums are going down, they figure they are in the right direction. Let’s start by dispelling that thinking.

Why Business Insurance Fluctuates

There are many reasons why business insurance premiums change, some of which can be tied to your risk management program’s performance.

Considerations as to Why Premiums Increase

  • General market changes
  • Economic conditions
  • Financial returns of insurers
  • Losses suffered by the industry
  • Your business has expanded into new areas
  • New governmental regulations
  • Increase in your business property values
  • Overall company growth; sale, payroll, etc.
  • Increase in your claim frequency
  • You adjust your coverage or limits

Consideration as to Why Premiums Decrease

  • Positive financial returns of the insurer
  • Multiple years with no losses
  • Adjustment of coverage or limits
  • A decrease in sales or payroll
  • Competition among insurers

Think Outside the Box

It is wise not to evaluate your insurance and risk program solely on premiums, as there is much more to think about. We can help you by providing a simple framework for evaluating your program in a holistic way. There are two points to our simple evaluation methods. One; your risk management program is made up of many different components and two; the best way to evaluate is through comparison and contrast.

What Makes up Your Risk Management Program

  • Insurance premiums
  • Loss control costs
  • Administration
  • Broker fees (if any)
  • Deductible or self-insured costs
  • Legal fees

The Best Way to Evaluate is Through Comparison and Contrast

To fully complete an evaluation of your risk program you need to compare your total costs of the above items with another component of your business. The best indicator we have is revenue. Revenue tends to be a general indicator of your company’s strength. You can make an argument that profits are a better evaluation indicator, but we think revenue is good for our purposes.

If you add the annual expenditures of the above items, then divide it against revenue, you will get a percentage of your risk cost compared to revenue. That is, your cost of risk. If you were to do that year over year, you can see how your cost of risk compares over time.

If your cost of risk number goes down and revenue goes you can make a reasonable argument that your program is effective. If revenue is down but your cost of risk number is growing, you can make an argument that something in your program needs work. The benefits to this calculation are:

  • Reveals what is driving costs
  • Allows you to actually manage your risk

This is not a perfect model or method, but it is a good method to help you evaluate and compare how you are doing. As the example below shows, the cost of risk is outperforming the company. In this example, sales are increasing while the cost of risk has been declining. Here is a good way to start the evaluation process. Plug in your numbers and see where you are. Under this example, if you evaluated your risk management program solely on premiums, you might fire your broker. However, it might be the broker who is actually helping you keep your losses in check—and providing valuable safety services.

Cost of Risk Evaluation Model

                                                                        2015                     2016

Broker Fees                                             $5,000                   $5,000                  Fees paid to broker for services

Internal Risk Administration              $12,000                 $13,000                 An allocation of your time and expense

Legal and Claims Expenses               $17,000                 $18,000                 Legal fees and cost of deductibles

Uninsured Loss Costs                          $3,000                  $3,000                  Claims that are not insured

Safety Program Costs                          $2,000                   $5,000                 Cost of training, equipment, etc.

Insurance Premiums                          $143,000                $149,000           Total of all business insurance premiums

Total cost of risk                                    $182,000                $195,000             

Gross Revenues/budget                    $14,000,000           $18,000,000

Cost of Risk as % of Sales .013                          .011                         

This method forces you to look at more than just business insurance premiums. In the case above, the premiums actually went up but the cost of risk went down. This does not account for safety services offered through your insurer or broker. If that is the case then you might be able to lower your cost of risk even more.

This is designed to be a simple tool to help you communicate with your leadership team how your risk management program is performing.

Leap/Carpenter/ Kemps Insurance Agency can help you develop a business insurance program to meet your needs. This would include identifying your cost of risk. Our team of professionals is ready to go to work for you.

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About The Author

LCK Insurance Agency is one of California's most prominent independent insurance agencies. They offer commercial business insurance, employee benefits, life & health insurance, and personal insurance.

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