Allocating risk costs only makes sense

By Bob Carruth
Risk Control Manager

There is a proverb from the Bible that is often quoted – "whatsoever a man sows, that also shall he reap." In other words, there are clear consequences to actions we all take. This holds true not only in our personal lives, but also in the context of risk. You may be short-circuiting your risk management program by not allocating your overall cost of risk internally within your organization.

What does it mean to allocate your risk costs? A simple definition of allocation is the assignment of resources (or this case, cost) to designated functions or departments. When you think about it, we already do this – through our programming and budgeting process. For the NCACC Risk Management Pools, the fact that every member's annual contribution is proportional to the size of the organization is a function of allocation. If this did not occur, then those counties that adequately control their losses would be subsidizing those counties with poor loss records, and smaller counties would see a disproportionate share of their budgets being paid for insurance vs. larger members.

Put more simply, allocation of risk costs to the particular unit or program to which the risky activity has or will occur is just an extension of the budgeting process.

If it is a simple concept to grasp, then why is it not done more? In many instances, there has to be a fair process to determine where the costs will be allocated, and the development of a tool can become very complicated. Historically, we know that public safety and transit services provide the greatest proportion of loss exposure and costs to our members. Over the past five years, for instance, these functions have contributed more than 50 percent of the loss costs to the Association's Workers' Compensation and Liability and Property pools. Most counties mirror this distribution as well.

For the allocation process to work, there has to be a sense of fairness in how the cost is allocated, and the tool used to allocate must provide the flexibility for county leaders to determine how much individual functions will be held accountable for the cost of risk in the organization.

In order to create a fair and equitable system, three questions must be answered. First, how do I handle large, one-time losses; secondly, do I allocate based on my exposures or my losses; and finally, how long of a period do I assess? Let's look at each of these questions briefly.

First, to ensure a department's entire budget is not decimated by one or two large, one-time losses, you should set a limit on the loss amount for any one loss. Once this loss level is reached, all remaining losses for that function are equally divided among the other functions.

Second, you should have a balanced approach to allocation based on exposures and losses. One is "prospective" and looks at where losses will probably occur in the future, and the other is "retrospective," which is based on where losses actually occurred in the past. This may be set so that each count equally, or any percentage of distribution you may desire to achieve the desired effects.

Finally, in using past loss history, more than one year is certainly needed to determine long-term loss trends, but using too many years will provide a false picture – especially if a function is improving over time. For instance, in the computation of the annual experience modifier for workers' compensation, three years of data are reviewed. Most insurance carriers use five years of data to determine the historical performance of a specific account. Given this, using three to five years of data will be sufficient in determining a good loss profile for a function or department.

The next challenge is developing the tool itself, as it can soon become very complicated. This is where your Risk Management Pools staff has saved you a great deal of time by creating a simple tool for you to use. This tool is assembled using the three principles discussed above and incorporates your actual exposure data provided to our underwriters, as well as the actual losses for the last five years (or actual years you have been in the pool, whichever is less). Finally, it provides a way for you to designate what the maximum allocated loss per function will be and lets you determine the balance between exposure and loss-based allocation. This tool is available for any pool member and can be a great aid as you approach the next budgeting cycle.

If you are interested in seeing a demonstration of the tool and/or what your actual allocation profile looks like, contact the NCACC Risk Control team at (919) 719-1150 or bob.carruth@ncacc.org.

As Risk Control Manager for the NCACC, Bob Carruth manages the operation of the Risk Control Team for the Risk Management Pools. The team assists members with development of safety policies and programs and identification of liability exposures and controls. Carruth is a Certified Safety Professional and is certified as an Associate – Risk Management. A current Cabarrus County commissioner, he serves on the Board of Directors for Piedmont Behavioral Healthcare and the Water & Sewer Authority of Cabarrus County.