Tuesday, February 10, 2015

Enterprise Risk Management (ERM) – Risk Profile Development – Identification of the Risks

A few months ago, we described the optimal Context of Risk Profile Development. This article in the series describes how to identify the risks organizations face, and how to create a framework for analyzing, measuring and managing them.

Even within an organizational culture of openness, flexibility and “ownership”, identifying risks and creating structures to measure and manage them are some of the most difficult tasks to undertake. Why? Because any threat to the current or future continuity and profitability of the organization requires the owners to address the risks immediately, and to determine the root causes and conditions of the situations. This takes time and specialized tools, many of which are not readily available.

It’s harder as organizations grow, when they tend to take on the personalities of the individuals and managers who are tasked with organizational stewardship. If the responsible persons have an “ownership” mindset, and are dedicated to preserve, protect and enhance the organizational value, the organization will embrace risks and flourish. To identify risks for profiling, the best place to start is to understand any significant threat to the mission, values and profitability of the organization.

To illustrate an Enterprise Risk Management example, let’s use Apple Inc.’s recent threat to its mobile business from Android devices. The mission statement of Apple recently reported on their website is “Apple designs and creates the iPhone, iPad, Mac notebooks and desktop computers, iOS 8, OS X, iPod and iTunes, and the new Apple Watch.” A risk to having this mission flourish has been the competitive pressures of Samsung’s Galaxy line of cell phones. As soon as the Galaxy line came out and gained rave reviews from analysts and consumers, Apple went to the drawing board to create the iPhone 6 and 6 Plus series. With enhancements and integration of the entire iPhone platform to meet what consumers wanted and needed for their everyday use, the company embraced the competitive risks and has consequently flourished around the world. As a measure of the results, Apple has just reported the largest quarterly profit success of any corporation, $18 Billion, largely based upon the reengineering and success of its new line of phones.

To demonstrate a traditional operational risk identification process, let’s use a Workers Compensation insurance (and self-insurance) example. Because these increasing labor-related costs are a significant threat to most organizations profitability, it requires the owners and managers to address the risks immediately with each occurrence. The past way of looking at identifying these risks has been to gather all of the information once per year (insurance policy, new operational details, claims history, loss control and safety procedures, etc.), ship the stack of paper or electronic files off to the broker, have the broker market the risks, and then hope for a few quotes that don’t break the bank for the renewal. Does this sound like your normal risk identification process? Is this what you are employing now?

Perhaps a better way to identify risk costs is to understand the components of your work force, how each segment contributes to your unique Workers Compensation Risk Profile, and how your unique composition compares to other companies in your industry. As you may know, there is an established industry premium rate history built around individual classes of workers, measured by the classification payroll. Once you calculate your unique composition, it is a relatively easy step to determine how your composition compares to your industry.

The big differences between companies within industries are the way in which they predict and execute strategies to reduce and eliminate claims.  The most severe actual or predicted chronic and legacy claims generally represent 5% of the frequency of occurrences. However, these claims represent 40-60% of the costs of the Workers Compensation Risk Profile. The remainder of the costs of the Risk Profile is administration (management, loss control, actuarial, etc.), allocated costs (adjustment, legal expenses, etc.) and single non-recurring expenses such as minor accidents where the persons return to work immediately.

By utilizing predictive analytical tools and professional services that identify excess costs for each existing or future chronic or legacy claim, the organization can ultimately reduce Risk Profile costs by 20-40%. Is this approach something you would like to consider employing in your organization? Call us to learn more about our products and services.

The next subject in our series will address the Risk Profile Analysis phase…so stay tuned for how to analyze Risk Profiles once you have identified the key components.

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