STEP 4—S ELECTION AND IMPLEMENTATION OF RISK TREATMENT
METHODS
The fourth step in the risk management process is selection of appropriate
risk management methods for the exposures that have been identified. Risk
management methods are divided into risk control methods and risk finan-
cing methods . Risk control methods are those activities that affect the fre-
quency or severity of loss. Risk control methods include avoidance, loss
reduction, and loss prevention. Risk financing methods are the strategies
that are employed to pay for the losses that do occur. The fundamental risk
financing methods are retention and insurance. These risk control and
risk financing methods will be covered in more detail in a later section of
the chapter.
STEP 5—ADMINISTRATION OF THE RISK MANAGEMENT PROGRAM
Administration of the risk management program involves review and
evaluation of the risk control and risk management methods that were
chosen. In reviewing and evaluating risk treat ment methods, there are two
key questions. First, we want to know if the chosen procedures worked. Did
they have the desired effect (i.e., did they reduce losses)? Second, we will
determine whether they were cost-effective. In this step, the risk management
objectives will also be reviewed periodically. Remediation, correction, and
general monitoring of the risk management activities will be the emphases of
this step in the risk management process.
SOME CORE RISK MANAGEME NT PRINCIPLES
In the formulation and admini stration of a risk management program for
any economic entity, there are several core principles. These can be guides to
effective risk management practice. One of those—‘‘Do not risk more than
you can afford to lose’’—has already been stated. Following are several
others that have proven to be useful over time.
RISK MANAGEMENT ISA PROCESS,NOT AN EVENT
The use of the word process indicates that risk management is an ongoing
activity. Some entities have used the classic ‘‘muddle through’’ method of
risk management. When a loss occurred, they added that exposure to their
Essentials of Risk Management 335
listing and began to treat that exposure. This works fine—unless a severe
loss occurs before sufficient resources are in place to offset that loss. To be
truly effective, risk management must be incorporated into the planning and
budgeting processes.
EXPOSURE IDENTIFICATION IS THE KEY TO SUCCESSFUL RISK
MANAGEMENT
One of the classic truisms of risk management practice is that you cannot
treat a loss exposure that has not been identified. This principle prompts us
to find various methods for exposure identification. Some of those were
mentioned earlier, and it is common to use a combination of identification
methods to accomplish this task. One method is clearly superior to the
others, the periodic inspection of the entity’s facilities and operati ons.
More and more it is common practice to involv e employees in the exposure
identification process. They often are closer to the sources of incidents and
accidents, and they often have wisdom about causation and preven tion. The
key is to allow them to report conditions in a ‘‘blame-free’’ environment to
encourage them to do so freely.
LOSS CONTROL EFFORTS WILL PAY FOR THEMSELVES
Loss control (prevention and reduction of losses) is often the most cost-
effective approach to improving the overall risk management strategy of the
firm. Losses that never occur have savings that go beyond the direct costs of
the loss, such as personal injuries and lost product. Controlling losses in the
first place reduces indirect costs, such as supervisor time and time lost by
‘‘onlookers’’ at workpl ace incidents. These sometimes ‘‘hidden’’ costs are
often greater than the direct costs of the loss.
The most important reason for loss control, however, is that it can reduce
insurance premiums markedly. Insurance companies reward ‘‘good behav-
ior’’ in their premium structures. A place where this effect can be dramatic is
in workers’ compensation insurance. Insurance is normally required, and an
employer is given an experience premium modifier (often called simply the
MOD factor) that reflects recent experience. The standard premium, based
on employee job classifications, is multiplied by the MOD factor. With
medical cost inflation driving workers’ compensation premiums, losses that
are pr evented save not only the actual outlays but the ‘‘upcharge’’ from the
MOD factor as well.
336 Essentials of Risk Management

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