Ask management about their cost of risk and they will point to the premiums they pay for insurance. This misconception is in part to blame on the insurance industry for promoting the idea that insurance is risk management. In reality, insurance is a form of risk financing, and does nothing to control risk.
Measuring your cost by the amount of premiums paid subjects you to the ups and downs of the insurance industry pricing cycles that alternate between periods of soft and hard conditions. In a hard market, coverage is harder to place and premiums grow. A soft market indicates premiums are stable or falling and coverage may be more readily available. On their own, insurance premiums do not represent a good measure of performance.
In fact, insurance premiums are just one component of the cost of risk, and quite often it is the smallest part of the company’s cost. The Total Cost of Risk (TCOR) concept was first developed over 40 years ago as a yardstick by which to measure the effectiveness of an organization’s risk management program. Recognizing all of the costs and expenses associated with the risk management function of an organization allows you to do so with credibility.