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Managing your risk by Michael Kelly

NCACC Risk Management Director Michael Kelly writes a regular column on risk management for CountyLines. With more than 41 years of risk management/ insurance experience, he holds the CPCU - Chartered Property & Casualty Underwriter, ARM-P - Associate in Risk Management for Public Entities, CRM - Certified Risk Manager, ARe - Associate in Reinsurance and CIC - Certified Insurance Counselor Professional Designations. He can be reached at michael.kelly@ncacc.org or (919) 719-1124.  For archives of this column click here.

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Jun 28

Back to basics – risk identification

Posted on June 28, 2013 at 5:35 PM by Chris Baucom

It is generally accepted that the ability of a risk manager to identify the exposures that are most likely to cause a loss is not only the first, but the most important step in the risk management process.  In July 2010, I discussed the primary tools used most often to uncover and identify loss exposures confronting counties. (See: http://www.ncacc.org/index.aspx?NID=264.) In an effort to explain further, this month I want to segregate into logical classifications the four basic types of exposures that need to be considered and outline some of the highlights in each category.  

The four general loss exposure classifications are: Property, Human Resources, Liability and Net Income [1].   While these are in fact separate categories, they are not completely independent of each other and a single loss may impact two or more at a time. An example might be a fire loss damaging owned property (such as a computer server) which could also impact the bottom line net income from not being able to continue to function as a business.  
Now getting down to specifics:

Property exposures are comprised of real property, other tangible (touchable) and in-tangible property such as good will, copy writes, trademarks, research & development and other intellectually based property.  Obviously real property is likely the largest exposure area of this classification a county faces, with typically high values for buildings and their contents.

Within this category, there are three criteria of loss exposures for property risks:
1. There is property of value that is actually exposed to loss.  (i.e. building & contents)
2. A peril must have actually damaged the property causing a loss.  (such as a fire)
3. The damage generates a measurable, negative financial consequence as a result of the loss. (calculated reconstruction cost necessary to return to a pre-loss condition)

Items 1 and 3 are somewhat closely related, in that the value of the property exposed to loss would be the pre-loss value and the measurable negative financial consequences would be the amount of the property damaged from the cause of loss.  The value exposed and consequences of loss have been defined in the previous “Managing Your Risk” column, date March 2010, (http://www.ncacc.org/index.aspx?NID=268) but the main type of loss valuation typically desired to a county risk manager is replacement cost, or more simply, what it would cost to replace property, applying no discount due to its age or condition, with new materials of like kind and quality. 

Human resources exposures are composed of a loss arising out of the absence, or significant change in an organization’s owners, managers, key employees, board members, or even outside contracted consultants, depending on circumstances.  Such key employees suffering disabilities or death can greatly impact the management capability and financial results of an entity.  Other employee related perils might be retirement, resignation, termination or even a developed negative morale in the workforce.  While it is not always possible for a risk manager to fully mitigate such human resources exposures, it is possible to anticipate and take preliminary steps to keep the entity in the best position possible through such things as cross-training and/or sharing of duties.  Development of health enhancing benefit programs (exercise/wellness employee programs) as well as a senior management perpetuation plan  may also go a long way to positively impact this exposure to loss.

Liability exposures are related to property and human resources as well as the operational activities of an entity or business.  With the caveat, by stating I am not an attorney, always defer  to your own county attorney for any specific legal advice. Liability exposures may emerge on or off the entity’s property and can also originate out of products or services provided by the entity to the public.  The two liability class categories are criminal and civil.  Criminal liability is broadly defined as a breach of duty owed to society and is not typically a concern to the public risk manager.  However, civil liability is a major concern to the risk manager, more specifically classified as tort law, contract law and statutory law.  

Tort law is defined as a private or civil wrong, (other than through a breach of contract) where the courts are utilized to derive a proper remedy typically through the award of damages.  Most torts are in some way associated or stem from negligence and the failure to exercise proper care based on what a prudent, average person might do in similar circumstances.
  
Liability imposed through contract law generally results from an agreement or promise not being met by one of the parties that participated in the contract agreement.  In order for a contract to be enforceable, four characteristics must exist. 
1. Those participating must be competent parties (of legal age and mental capacity).
2. There needs to be a genuine agreement between the parties (all participants in assent).
3. There must be an exchange of legal consideration (typically money).
4. The reason for the contract must be for a legal purpose (not a contract to kill an opponent).

Remedies in contract law for failure to perform or breach of contract are damages, reformation, injunctions and/or specific performance.

Net income exposures are typically caused by or related to the destruction or damage to property, human resources or the imposition of legal liability. They may also arise from a more speculative source such as fluxuation in the financial markets impacting your return on investments or consequential in nature such as loss or damage to a vendor or client that provides contracted professional services to your operation.  Any such occurrence may decrease the amount of income, or increase the cost of your operations continuity – either of which impacts the bottom line net income negatively.  Of the four major classes of exposures for a county government, this area is probably less subject to net income loss arising out of an insurable event and more through changes in revenue streams from the State and local taxpayers.   As a risk manager, planning for the insurable event is a lot easier than the latter.

Remember, it is the loss exposures the risk manager fails to reveal before a loss occurs that will bite you – but when you take the time and effort on the front end to uncover them through classification, using the tools previously discussed, then your chance of missing a major exposure is greatly decreased.  In short, you can’t fix it, if you can’t find it.

[1] Risk Management Essentials 1st Edition – The National Alliance Research Academy