Total Cost of Risk – Definition

Total Cost of Risk (or TCOR) is the only accepted measurement of an organization’s entire cost structure as it relates to risk.

Components of Total Cost of Risk

Total Cost of Risk is the sum of four major components that are individually measured and quantified:

1. Risk Financing Costs
2. Loss Costs (Direct and Indirect)
3. Administrative Costs
4. Taxes & Fees

Risk Financing Costs

Risk Financing Costs include all insurance premiums and attendant costs. Attendant costs include broker commissions/fees, captive contributions, dividend adjustments, letters of credit, and any other costs impacting the funding of risk transfer or retention.

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Loss Costs

There are two types of Loss Costs: The direct cost and the indirect cost of losses. Both loss components impact the organization’s Total Cost of Risk.

• Direct Costs of Losses — Deductibles and claims that are anticipated and funded inside the organization’s risk financing program (e.g., captive, deductible, or self-insurance programs.)
  
  The cost of administering claims by third party administrators (TPA’s) are also considered a direct cost, as the TPA expense is usually a direct correlation of the claims experience. An uninsured loss is also a direct cost of loss.
  
  
• Indirect Loss Costs — Every loss creates a corresponding expense that is unfunded and, in some cases, unanticipated. While the risk financing (insurance) may pay the known claim, there is a high correlation of additional unfunded business expenses that arise from virtually any claim.
  
  These indirect loss costs are commonly known as the portion of the iceberg that lurks below the surface. Indirect costs must be quantified and measured to create an accurate Total Cost of Risk calculation.
  
  For more on the subject of Indirect Loss Costs, see the Wikipedia Indirect Loss Cost topic.

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Administrative Costs

Administrative Costs are the financial impacts associated with providing services to administer a Total Cost of Risk Program effectively. They include claims management, risk control, and all other project costs such as data analytics. If a firm pays additional fees or expenses for these services, they are an addition to the TCOR formula. However, when a third party (insurance brokerage or risk management services provider) provides the services as part of the relationship, they reduce the TCOR to the extent the measurable ROI exceeds the cost of the services.

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Taxes and Fees

Taxes and fees attached to the placement of the risk financing program must be added to the TCOR. These are the various state taxes attached to insurance placements and are paid to governmental and regulatory bodies (e.g., state surplus lines or admission fees.)

Calculate TCOR – The Formula

The Total Cost of Risk Formula is:

Risk Financing
+ Loss Costs (Direct and Indirect)
+ Administrative Costs*
+ Taxes and Fees
= Total Cost of Risk

^{*In cases where the administrative projects are provided as part of the risk financing costs, the Administrative Cost is a cost reduction based upon the valuation of the services provided.}

Uses of Total Cost of Risk

Executives use TCOR inside the financial and risk services industry in various ways:

• Risk Management Professionals – TCOR provides an accurate analysis of their complete cost structure. Professionals use the TCOR analysis to allocate expenses throughout an organization (by business unit or location) and to determine the ROI to the organization.
• C-Suite Executives – Through the analysis of TCOR using comparison years, the C-Suite can accurately budget costs and review the increase or decrease of their cost structure. 
• Brokerage and Risk Services Providers – Total Cost of Risk is the only method that a brokerage (or a risk services provider) can demonstrate the quantifiable impact of their services to buyers. The valuation of loss costs, indirect loss costs, and the value of risk control and claims management projects provide the complete TCOR picture.