DMB Risk Solutions, LLC

Risk Allocation: Accountability Through Accounting

Introduction

In response to the increasingly sophisticated needs of today’s risk and insurance buyers, the market place has responded with a number of risk alternatives (deductibles, captives, self insurance options, etc) to provide the financial flexibility and accountability our clients are demanding.  Those customers who have accepted these alternatives have found it advantageous to manage their risk needs by accepting the financial accountability that traditional complete risk transfer products did not offer. 

These organizations now look to share that accountability internally across their operations.  One of the most effective means of instilling accountability is through financial allocation to the areas of the organization that contributes to the overall risk exposure.

DMB Risk Solutions, LLC has extensive experience in developing allocation tools and methodologies that address the financial, management and behavioral components of risk.  These allocation systems are built around our client’s needs, taking into consideration the organization’s objectives, culture, structure and operations.  These systems are designed to complement our client’s goals, not compete with them.

Cost of Risk Allocation – Consulting Process & Methodologies

The first factor in an allocation process is to identify what basis will be used; exposure or loss.  Exposure allocation addresses the cost of risk based solely on a nature and size basis (i.e. payroll, sales, number of employees, type of operation, etc.)  Although this is one of the simplest allocation methods, it does little to address accountability and areas that manage risk well see little, if any benefit. 

Loss allocation address the cost of risk based upon the cost center’s claims or loss experience. An organization can use two separate means of loss allocating; fixed and variable.  The fix component budgets the current financial period using past loss experience as a basis.  Although this process does provide some accountability, there is a lag period between loss performance and the financial benefits received from the allocation process. 

The variable component of loss allocation is the most effective and quickest means to promote accountability.   Loss expenses are sent back to the cost center as the losses are generated.  These costs can be calculated using a number of different factors including actual incurred, paid or some other financial projection.  Other options include allocation on a cost per incident basis that can be adjusted depending on the nature of the claim or management’s post incident response. 

For instance in worker’s compensation, an organization can allocate $1,000 for each medical only workers compensation case, but increase the allocation to $10,000 per indemnity case.  If the incident was reported late (or early), factors can be applied to penalize (or reward) a cost center for their post incident behavior including investigations, return to work efforts and corrective response. 

DMB Risk Solutions, LLC has found the most effective allocation methods blends a number of these options to create a process that is equitable and promotes the behaviors that reduce the organization’s cost of risk.

Our methodologies have also addressed some jurisdiction challenges (such as California) where loss based allocation systems may increase our client’s liability exposures.  By developing a process that focuses on activities and behaviors, allocation systems can be developed that can pass regulatory scrutiny. 

Our allocation processes can also address property cost of risk issues.  By providing rewards (and penalties) based the reduction (or increase) in Normal Loss Expectancies (NLE) or Probable Maximum Losses (PML), managing the organization’s property exposures can be financial rewarded.

Allocation Models

We work directly with our client’s risk and financial functions to develop allocation models that are administratively simple to use and manage, regardless of the methodology that is adopted.  Data that is used as the basis for these models can come from a number of sources including carrier/ TPA RMIS, internal claims logging/ tracking systems, payroll information or other management accountability processes.  These models are designed around the dynamic nature of claims and loss generation.  Therefore they can “track” the development of claims overtime and will credit/ debit cost centers without the need of “manual” intervention to make adjustments. 

These allocation models have been adopted by a diverse set of industry and client types including retail, service, real estate, manufacturing, healthcare, financial institutions and municipalities for all the major lines of coverage including general liability, auto, workers compensation and property.  We not only help and design these processes, but will work closely with our client in developing a communication and management strategy to ensure that those accountable for their cost centers will have the knowledge and tools to help manage their own cost of risk.

Conclusions

Risk allocations systems can be an effective tool in driving financial accountability of risk across our client’s operations.  However if not designed properly, they can require significant administrative resources and encourage the wrong behaviors from leadership throughout the organization. 

DMB Risk Solutions, LLC understands these challenges and has built a consulting practice around risk management, RMIS and financial disciplines.  These collective skills are used to design and develop tools like allocation systems to help our clients control their cost of risk.