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| Justifying The Cost of Risk Management Information Systems |
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| by Barbara F. Jacobs |
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| Developing a cost-benefit analysis of a prospective RMIS purchase can help secure management's support for the acquisition costs. |
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By providing timely information, the means to access and analyze it, and reducing an organization's cost of risk, an effective risk management information system (RMIS) ultimately pays for itself. But many risk managers must be able to cost-justify their investment in a new RMIS to obtain the budget authorization for the purchase.
How do you go about doing this? One way to gain management's approval for a new purchase is to express the request in investment terms it understands. For a prospective RMIS purchase, you can present your request in traditional cost/benefit terminology. A cost/benefit analysis can show how an RMIS investment can make a positive contribution to the organization's bottom line.
Here are four steps to achieve this.
Step One: Identify and Quantify Costs
The costs associated with an RMIS typically include some or all of the following:
- RMIS software licensing and service costs (initial and annual ongoing fees)
- Third-party software licensing and service costs (initial and annual ongoing fees)
- Workstation hardware costs (including maintenance fees)
- Server hardware costs (including maintenance fees)
- Training costs
- Data conversion fees
- Telecommunications costs
- In-house MIS costs
Step Two: Relate the Costs to the Organization's Total Cost of Risk
In this case, it may be useful to think of the total cost of risk as a financial investment or portfolio. Elements of this cost typically include:
- Uninsured or self-insured loss costs
- Insurance premiums
- Broker expenses
- Litigation expenses
- Loss control expenses
- Risk management department salaries and operating expenses
- Third-party-administrator (TPA) expenses
- Opportunity costs of the above funds (that is, would your organization invest the money otherwise spent on the above items, and get a good return on that investment?)
- Other costs (e.g. employment agency fees for hiring replacement workers, etc.)
Step Three: Define the Benefits
An effective RMIS can, for example:
- Identify key cost drivers, so that your organization can prioritize cost control efforts
- Measure cost trends, so your organization can focus on high-impact areas
- Provide timely feedback to local management, thereby facilitating proactive and properly targeted loss control practices throughout the organization
- Identify internal best practices, so they can be spread throughout the organization
- Reduce premium costs as a result of submitting credible information to underwriters for quotes
- Improve vendor effectiveness through ability to monitor vendor performance indicators and negotiate vendor performance guarantees. For example, TPA performance indicators might include timely closing of claims; accurate coding of key information items, such as Location or Cause code; accurate billing for medical-only vs. indemnity claims, etc.
- Minimize overall claim handling costs through closer monitoring of claim administration practices
- Improve productivity by reducing or eliminating paper-handling, manual production of reports or statistics, or other time-consuming activities
- Reduce litigation expenses through proactive post-loss communication, review and monitoring
- Manage aggregates in a complex coverage structure; improve the ability to notify excess carriers in a complex coverage structure -- thus avoiding loss of coverage through failure to notify
- List each potential benefit you identify
Step Four: Quantify the Benefits
Attempting to put a dollar figure on the benefits expected from an RMIS is far from easy. The methodology used in the accompanying case study can be adapted to fit your own organization and situation. It involves identifying key risk management cost items, making some estimates of the savings that good information could bring, and then using both in some simple mathematical formulas to arrive at a reasonable dollar estimate for each expected benefit listed in Step 3.
In addition, if you can cite actual success stories that demonstrate savings in the various categories identified, these stories would provide powerful support for your assumptions. Good sources for such successes include discussions with risk management colleagues, electronic discussions through risk-management-related Internet sites, attendance at RIMS and other professional conferences, and attendance at RMIS vendor user conferences.
For example:
- One manufacturer settled over 300 historical claims totaling $14.9 million, and now has a strategy for large settlements whereby it expects to gain additional savings in the future.
- A provider of financial services, recovered $1.5 million from one of its insurance service providers as a refund for errors in billing claims handling fees.
- A firm with diversified global operations and a growth strategy of rapid acquisition, discovered double-coverage for business interruption. By canceling the overlapping coverage, the client saved over $80,000 in redundant premiums.
- A large governmental agency, reduced insurance premiums by $350,000 in the first year of installing the new RMIS. The first-year costs of the RMIS were approximately $45,000 for a demonstrable Return on Investment of $305,000 in that timeframe.
Many risk management executives recognize that there are a number of reasons for having an effective RMIS that do not translate easily into dollars and cents. For example, how does one measure the economics of saving a life, preventing pain, or freeing up a professional's time so it can be devoted to higher-level activities?
Nonetheless, the discipline of identifying and quantifying benefits can produce some real eye-openers. If specific benefits are greater than the RMIS costs and other uses of the funds are unlikely to result in greater savings, then the purchase of a new RMIS will clearly be a sound business investment — even without weighing in softer, less quantifiable considerations.
There are a few caveats that deserve emphasis. First, benefits can be difficult to identify — especially since some are "potential benefits" that haven't been realized. Second, they can be difficult to quantify. Third, projected benefits and projected savings cannot be guaranteed. Like any projection or forecast, they are at best informed estimates. And finally, even if all projected benefits and savings projections were realized, overall costs could still go up due to something entirely unrelated and unpredictable — like damage to a facility caused by a tornado or other catastrophic event.
The uncertainty represented by these caveats, however, should not discourage you from using the technique of identifying and quantifying costs as well as projected benefits, or from using them to make your case to management. After all, managing uncertainty is what effective risk management is all about, and steering the organization through an uncertain future is also what good organizational managers are all about.
Analyzing the Costs and Benefits of an RMIS: A Case Study
Proposed Annual Cost of New RMIS: $150,000
Assumptions Used for Cost/Benefit Analysis
Risk Management Costs: By questioning heads of other departments, TPA's and other external providers, the Risk Manager of ABC Company was able to identify the following line item costs associated with ABC's Cost of Risk. For your own organization, you may be able to identify additional significant line item costs.
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Risk Management
Cost Item
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Estimated Annual Cost
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Assumption Number, used in formulas which follow
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Number of non-zero claims (i.e. those with money attached)
per year
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2,500
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(1)
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Number of incidents (i.e. zero-dollar 'claims') per year
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7,500
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(2)
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Claim costs per year
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$8,750,000
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(3)
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Average claim cost (i.e. #3 divided by #1)
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$3,500
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(4)
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TPA Claim Handling Fee per claim
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$35
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(5)
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Annual fees for existing RMIS
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$60,000
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(6)
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Average number of administrative hours to handle one
incident
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3 hours
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(7)
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Administrative salary per hour (including benefits)
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$30
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(8)
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Average staff hours per month spent in data collection,
processing, investigation, compilation, reporting
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12
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(9)
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Staff salary per hour (including benefits)
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$60
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(10)
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Average legal fees per litigated claim
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$1,200
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(11)
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Per cent reduction in accident frequency estimated from
good information (and ability to prevent accidents)
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1%
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(12)
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Per cent reduction in accident amounts estimated from good
information, and ability to mitigate the severity of accidents through
post-loss activities (prompt reporting, focus on return-to-work, fraud
detection, etc.)
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5%
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(13)
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Average expense (in addition to TPA charges) for handling
an incident or claim. (Expenses might include postage, telephone charges,
goodwill coupons, etc.).
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$25
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(14)
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Using the answers to items (12) and (13) above, which related to potential savings which might result from good information, and using the other answers in formulas as indicated below, ABC's risk manager was able to quantify the potential savings from a good RMIS.
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Potential Benefit
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Potential Savings
per Year
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A. Savings from
Fewer incidents and claims
(A1) Direct Claims Costs:
25 fewer claims x $3,500avg. cost
[ (Assumption 1)*(Assumption 12)] times (Assumption 4)
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$87,500
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(A2) Indirect
Claims Costs (Lost Time, hiring and training fees for replacement
workers, Public Relations, Etc.): (Use your own estimate for calculating
indirect claims costs. The Insurance Institute of America's ARM course
generally estimates that indirect costs can be more than equal to direct
costs)
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$60,000
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(A3) Internal
Administration Costs:
(Assumption 2) * (Assumption 12) 70 fewer incidents x 3 (Assumption
7) administrative hours per incident x $ 30 (Assumption 8) admin.
salary per hour
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$6,300
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(A4) TPA Costs:
[(Assumption 1)* (Assumption 12)] 25 fewer claims x $(Assumption 5)
35 per claim TPA fee
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$875
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(A5) Expense
Handling Fees:
[Assumptions (1) + (2)] * (Assumption 12) 95 fewer incidents and
claims x (Assumption 14)$ 25 average expense
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$2,375
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B. Reduced Severity: (Assumption 3) $8,750,000
* (Assumption 13) 5%
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$437,500
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C. Prevent Litigation:
12 (estimate a number) litigated cases prevented x (Assumption 11)
$ 1,200 avg. legal cost
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$14,400
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D. Staff
Productivity: (time saved in data collection, processing, investigating,
compiling, reporting):
(Assumption 9) 12 hrs/month x (Assumption 10)$ 60/hour x 12
months
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$8,640
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E. Savings from
Proper Reserving (Use your own estimate. You would have a potential
savings if
- your losses were currently being over-reserved, and
- this over-reserving led to either increased costs ( for example, on an
incurred loss retro program) or to decreased profits (for example, because
your organization could have invested the money set aside for reserves and
gotten a good return on that investment)
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$0
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F. Savings from
Appropriate Funding Mechanisms/Retention Levels/Deductibles (Use your own
estimate)
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$0
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G. Premium Savings
(Use your own estimate)
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$30,000
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H. Savings from
Cash Flow Considerations (Use your own estimate)
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$0
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I. Savings on use
of current RMIS computer services (note: the existing RMIS may be totally
replaced, in which case 100% of its cost could be saved. Or usage of it could
be cut back, reducing its ongoing costs). (estimated reduction in
(Assumption 6))
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$30,000
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J. Other
(please specify).
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$0
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Total Projected
Annual Savings
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$677,590
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Interpreting the Example Above
Given that the cost of the proposed new RMIS is $150,000 a year, vs. the $60,000 annual cost of the current RMIS, ABC's top management might be inclined to think of the new RMIS as an "additional $90,000 expense," and therefore reject funding for it.
The above analysis, however, would indicate that the new RMIS could pay for itself more than four times over in its first year of operation. Who could argue with a 400+ percent return on investment? Furthermore, in the above example, even if all the savings estimates were too optimistic, if, say, they were twice as high as the actual savings would be — ABC Company's $150,000 annual investment in a new RMIS would still appear to be a cost-effective business decision.
This article appeared in Risk and Insurance Magazine, April 17, 2000.
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