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Allocations and Your RMIS
By Craig Hoffman, Senior Account Manager, Mahwah, NJ
A risk manager's favorite—or least favorite—topic is the allocation process. Allocations can become a risk manager's worst nightmare, as they usually involve a complex mathematical algorithm and charging premium to business units. Unfortunately, there is no right or wrong way to allocate to your various business units, and no two allocation models are alike. For this reason, RSG learned a long time ago that adding a generic allocation model to Sigma EncoreSM really didn't make sense. Instead, we use all of the various tools in Sigma EncoreSM and work with each client individually to design a model specific to their business needs.
Why should RSG clients allocate out insurance costs? Some of the common outcomes or reasons to allocate include:
- Encourage loss prevention by charging losses back to the business units
- Facilitate claims management involvement by business units
- Recover risk management overhead
- Improve workforce productivity
Generally, an allocation is based on three types of inputs. The first input, premium, can include any component of the total cost of risk. Examples include risk management department payrolls, insurance premiums, actuarial loss projections, brokers' fees, engineering fees, and RMIS service. The second input is the exposure unit, which varies based on the type of allocation. For instance, in a workers' compensation allocation, the exposure could be payrolls, employee count, hours worked, or revenues, depending on the type of operation. The final input is a component of loss experience. This could include loss incurred, loss paid, claim frequency, or a combination of the three.
RSG has seen clients allocate using complex calculations involving variations of these three components. Shown below is a sample exposure module of property values showing different categories of values for each location. Using this module along with the claims, the client was able to quantify the exposures by location and allocate out the property premiums.
The most important aspect of an allocation is communication. We at RSG have found that if the methodology and reasons for allocating aren't communicated properly, there can be many problems. Only after the information has been communicated to the business units can the allocation effectively reduce the cost of risk. It is also critical that senior management understands the reasons for allocating.
Specific Examples of RSG's Experience
Example 1: A risk manager had thousands of locations and no way to allocate claims cost back to them. Since the locations were small, many of them never even had claims. After working with an RSG account manager, it was decided that all fixed costs associated with the program will be charged based on revenues, while the claims costs will be allocated to each operation. We designed a monthly spreadsheet that charged the first $25,000 of every claim back to the location. This is a very simple form of allocation that can be effectively and easily managed in Sigma EncoreSM using change reporting and a variety of distribution methods (Web reports or e-mail).
Example 2: A company wanted to allocate out the cost of products claims and the cost of their insurance program. They decided to use the 10-year average claims experience output from Sigma EncoreSM and match it to future product revenues. This involved exporting the data out of Sigma EncoreSM and adding it to a template in Excel®. The client was then able to update the premium inputs and finalize the allocation. This allocation was subsequently fed into the accounting system and billed to each location every month. In this case, the monthly billings did not depend on actual claims since their products exposure had a long tail.
Example 3: A company needed to allocate out only the forecasted loss estimate to their divisions. They were not convinced that the actuarial estimate was an accurate forecast of their future claims. RSG designed a similar forecasting model using multiple methods in order to verify that the loss estimate was, in fact, overstating future reserves. This resulted in a significant cost savings for the company. Once this was finalized, the client consulted with RSG for assistance in splitting the forecast down into smaller divisional allocations. Before they could do this, they required us to take out the amount forecasted for corporate claims exposure. RSG pulled historical exposure estimates and reduced the overall allocation for operations. The allocation was done using a variety of methods including frequency analysis, exposure analysis, and total incurred analysis. The end result provided the client with an allocation they were happy with and could explain to operations.
Allocations can be a complex process. In order to take full advantage of Sigma EncoreSM and RSG's experience, contact your account manager to customize an allocation solution for your company.
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