The Evolving Metric: Cost of Risk - Insurance Thought Leadership

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December 3, 2014

The Evolving Metric: Cost of Risk

Summary:

The C-suite rarely has a good view into all its workers' comp risk -- which can be as high as 45% of revenue.

Photo Courtesy of Mighty June

Measuring the effectiveness and impact of risk management remains a challenge, and it is difficult to convince many C-suite leaders that the discipline is more than just buying insurance. Central to this question is how effective workers’ compensation reporting is and whether anyone has a truly helpful view into workers’ comp’s cost of risk (COR) and its related trends.

Based on numerous meetings with key risk and HR leaders throughout the U.S., I can confirm that many need more insightful risk reporting in many areas of exposure, most particularly employee injury and disability. They want to go beyond what most consider the “standard” risk metrics to those that truly reveal the trends.

Arguably, depending on your industry and the size of your company, employee injury costs may be the largest component part of the total cost of risk (TCOR). Because most risk managers measure their hazard-based risk costs using TCOR (among other techniques), it seems logical to look more closely at how worker’s compensation costs are specifically measured and how effective those data points are.

We should start with that very question: What is success in this realm, and how do we get key stakeholders to care more about these costs and their impact?

Hint: Think strategic priorities.

In my experience, senior management in many companies pay scant attention to this area of expense, even in larger companies with lots of employees. While it may be that the entirety of risk management gets similarly limited attention in these companies, we’ll leave that debate for another time. Let’s proceed on the assumption that TCOR matters to stakeholders and that workers’ comp is often the largest component driver of this measure for many risk managers. Can companies afford to ignore the direct costs of workers’ comp — an expense that may represent anywhere from 1% to 5% of revenue? One would hope not, but we should not stop there.

What about the cost of lost productivity from employees not available to perform their jobs, in whole or in part? It’s been estimated that this “indirect” cost component represents anywhere from two to nine times the “direct” costs in question. Translating that to more meaningful dollars, and using just the midpoints of those two estimated direct and indirect ranges, we’re working with 3% of revenue, with a multiplier of five and a half, giving us an estimated “total” cost impact of 16.5 cents per revenue dollar.

Let’s stretch out that math and apply it to both ends of the range. On the low end, we can use an estimate of 1% of revenue in direct costs and an indirect cost multiplier of two, for a total of 2 cents per revenue dollar. But now let’s look at the other end: an estimated 5% of revenue in direct costs with a multiplier of nine — a total of 45% of revenue.

The tail of this range may seem absurd to many observers, but that is the point; we don’t often take into account the full impact (direct and indirect) of disabled employees and by extension the potential maximum impact their absence has on companies’ performance.

I would further suggest that key senior stakeholders, whether the C-suite, the board or operations management, often have limited understanding of the true cost of the worker’s compensation exposure risk, regardless of how often they see the typical workers’ comp metrics. Clearly, they need more information to make better decisions related to this risk.

While there are, of course, those who do a fine job of parsing and reporting on a lot of workers’ comp data and allowing for some comparison and benchmarking, some of these efforts reflect a more dated historical view and focus more on how states are performing against each other, rather than how companies are performing relative to their own short- and long-term strategies for maintaining a motivated, productive workforce.

Getting more to the specifics, let me suggest that the big opportunity may be to not only take full account of the indirect costs typically related to lost productivity but to find a more focused way to marry the myriad of workers’ comp cost data with the various exposure data so that, when paired and analyzed effectively, there is a more comprehensive and useful story.

For example, one large national retailer has achieved much success in telling its workers’ comp story to management through a selected group of metrics that include the standard traditional measures such as ultimate, incurred or paid losses as a percentage of gross revenue or payroll coupled with more progressive metrics such as claim frequency per 10,000 hours worked (excluding claims without payments). These and other metrics are developed on an enterprise-wide basis, a regional basis and a store-by-store basis with historical comparisons for each to show trend. This approach allows for focusing on controlling frequency and severity on a specific and targeted basis, as each focus would call for distinct reduction and control techniques. The approach also enables a drill-down into significantly underperforming units and specific causes of loss that may be aggravating trends.

There are many ways to measure workers’ compensation performance, and obviously the approach and design should be driven by the needs of the company, the type of industry it operates within, the culture of the company and, of course, the needs of management for information to make decisions that would support both their short- and long-term goals. This nexus between metrics and goals is often overlooked as risk managers can easily get distracted by micro-tactical issues that may not be significant to decision-makers.

A claim director client recently asked me how to respond to her risk manager boss about how managing the workers’ comp unit relates to managing risk strategically. The answer is as simple and as complicated as knowing what the strategic imperatives for her company are and then assessing and informing management on those elements that most affect those goals. Keeping this sight line will minimize the risk of risk-management irrelevancy.

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About the Author

Christopher E. Mandel is senior vice president of strategic solutions for Sedgwick and director of the Sedgwick Institute. He pioneered the development of integrated risk management at USAA.

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