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Have Risk-Management Cuts Gone Too Far?

During the recession, companies slashed their risk costs by 3.1%, a recent study found. As a result, a major catastrophe could test their ability to respond.
David M. Katz, CFO.com | US
July 16, 2010

Among the targets in the wave of cost cutting that hit Corporate America last year were insurance and risk-management expenses. To be sure, buyers of commercial property-casualty and workers' compensation coverage were aided by a hotly competitive market that drove prices down. Nevertheless, risk and insurance budgets were also deflated by companies' almost universal urge to trim their margins. The question now, however, is: were the cuts too deep? 

Indeed, a new study suggests they were substantial. The combined impact of lower insurance premiums and lower risk-management administrative costs led to a 3.1% drop in average total cost of risk (TCOR) per $1,000 of revenue in 2009, to $10.35 from $10.68 in 2008, according to an annual benchmarking survey sponsored by the Risk and Insurance Management Society and produced by Advisen, a research firm. (TCOR is the sum of insurance premiums and fees, property-casualty loss expense retained by a company, and the costs of running a corporate risk-management department.)

On paper, insurance costs plus the cost of uninsured losses constitute an overwhelming portion of a company's total risk costs. Last year, for instance, the average cost of insurance premiums plus retained losses per $1,000 revenue was $9.11. At the same time, risk-management administrative costs stood at a relatively meager $1.24, according to the study, which is based on data from more than 1,400 companies in the United States and Canada. (The cost of  premiums plus retained losses in 2008 was $9.38, and risk-management administrative costs were $1.31.)

Still, an especially severe slashing of administrative expense can have a disproportionate effect on cost of risk as a whole. Cutbacks in risk-management departments may have left companies more exposed to costs if disaster strikes, says Robert Cartwright, a RIMS board member and loss-prevention manager at Bridgestone Americas Holding. "When a catastrophe hits, you have less people who are able to handle the problems out there, and it becomes a major problem," he says. "If  you've cut too far down, you don't have the resources available to get things back on track in a very quick manner."

For overly lean companies in storm-prone areas, a particularly active hurricane season this year may represent a major peril. Property damage, loss of income, and business-interruption risks may burgeon for such corporations, especially if they operate in a number of affected states, warns Cartwright.

In fact, Cartwright says he's seen some companies' costs rise because of excess cutting. Lacking adequate staff to prevent workers' compensation claims, such companies have seen claims rise — and insurance premiums go up accordingly. In turn, they've cut their risk-management staffs to make up for the expense hike. "The recession had a domino effect on risk management and risk managers in general," adds Cartwright. "Risk managers are being asked to do more with less."




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