Risk exists in every business decision, and to be effective, risk management should be a part of daily business operations and leadership. Business owners understand the need to incorporate risk evaluations in project management, change events, strategic planning, and technology and process implementations.
These risks are all part of running a business and most business owners understand that these are all risks that are not generally transferred to others (insured). The cost of these risks and uncertainties should be well understood and managed daily and process and models exist that can help with that evaluation and business decision quality.
On the other hand, risks such as worker injury or automobile accidents are usually transferred to others (insured). The cost of this risk is, in theory known to the business owner in the form of annual premiums. The fixed premium cost covers those risks, regardless of the number of size of the claims. The economics feel like they are that simple. However, when you dig a bit deeper, the real cost of these risks is much greater than the insured amount. Only a portion of the risk is transferred. The real cost of these risks lies just beneath the surface.
An often-referenced Stanford University study included in Business Roundtable publication, Improving Construction Safety Performance, suggests that the indirect costs of a WC claim can range from 100% of the initial claim (claims over $10,000) to over 400% (for smaller claims). That means that a generic $25,000 WC claim, could result in an additional $27,500 of cost that is the responsibility of the business. Assuming a 5% profit margin, those indirect costs would require $550,000 of new sales just to break even (that would not include additional business risks because of those new sales).
You might immediately argue that the workers compensation policy should cover the claim. The policy, does pay for the medical costs for the injured worker and some lost wages for the worker. In other words, the policy payments, benefit the injured worker; but what about the employer? The employer is then responsible for the indirect costs which may include items referenced by NCCI such as:
- Wages paid to other employees during any work stoppage because of the injury
- Overtime required by others
- Administrative time by supervisors, leaders, and safety managers to manage the claim
- Training of a replacement worker
- Reduced productivity due to revised schedule
- Fines and penalties
- Negative publicity
- Impact on experience mod and future premium payments
Automobile accidents tell a similar story. The auto liability policy pays for resulting injuries and damages to the vehicles. However, the policy would not cover:
- Cost of an investigation
- Administrative costs including manager and leader time
- Negative publicity
- Increased cost for replacement vehicle
- Project delay; productivity and schedule delays
It follows that the costs of proactively managing these more traditional risks benefits the business just as much, if not more, than the insurance company. It is easy, for example, to say that technology to decrease distracted driving should be paid by the insurance company as the insurer will benefit from reduced risk. However, it should now be clear, that most of the risk is still retained by the business. We know that distracted driving is the leading cause of auto accidents. We also know that inexpensive technology exists to reduce that risk. The cost benefit analysis for these protections makes for an easy decision which improves safety, protects workers, and reduces the uncertainly of the financial cost of these risks.
Part of managing a successful business includes understanding the uncertainty in the business and quantifying the cost of that risk. That structure should improve the quality of daily business decisions. When evaluating that risk cost, a business owner should consider strategic and operational risks that are not transferred and the cost of risk that is transferred (insurance). Beyond that, it is just as important to make certain that those indirect costs that are hidden below the surface are also considered as part of daily business decisions, risk cost evaluations, and overall risk management practices