Total cost of risk needs to be viewed as a dynamic, not static, figure

Organizations are not viewing their total cost of risk (TCOR) as a dynamic number and consequently they are not capturing the cost of capital associated with volatility, Ben Fidlow said during a Marsh Webinar.The Webinar, Strategic Risk Management: Expectations and Opportunities, explored the findings of the joint Marsh and Risk and Insurance Management Society (RIMS) study, Excellence in Risk Management.The eighth annual study surveyed more than 1,000 risk managers and C-suite, finance and other executives involved in risk-related functions in 2011 Q1. “Two-thirds of those surveyed said they measured total cost of risk, but the big problem is that there is such a wide range of methodology and use,” said Ben Fidlow, leader of Marsh Business Analytics, during the June 15 Webinar. There is no single standard form for measuring TCOR, but Fidlow suggested using common measurements such as retained losses, transfer costs and risk management costs, including broker remuneration.But often survey respondents are not using these common measurements, Fidlow said. “Only 12% said they measure the capital cost relative to volatility, which means there are very few viewing TCOR as a dynamic calculation,” he said. “Instead, it is seen as a static calculation that places little to no explicit value on the reduction of volatility that comes with sound risk management practices.” Nearly two-thirds of respondents said they paid more attention to TCOR’s expected amounts than its volatility. The finding suggests an emphasis on budgets, rather than on the greater value that might be provided by risk management. One of the main benefits of risk management is volatility reduction, Fidlow continued. “Viewing TCOR in such a limited way can lead to decisions like raising retentions and relinquishing hedging mechanisms simply to save a few thousand dollars,” he said. These decisions can serve to increase unintended risk-taking and costs. “In many cases, risk managers focus on the costs of their insurance premiums, but that is often not the cost that is material to the organization.”